America's rampant inflation in the late 1970s caused an increase in federal tax revenues unprecedented in peacetime. Individual income tax revenue surged from 8.25 percent of gross domestic product in 1978 to 9.7 percent of GDP in 1981. The reason: bracket creep, which results when inflation increases nominal incomes, pushing people into higher tax brackets even though their real incomes have not risen.

This inflationary surge set the stage for the lowering of individual income tax rates by Ronald Reagan, initially to a top marginal rate of 50 percent and by 1986 to 28 percent.

Those who maintain that the Reagan tax cuts caused the federal deficit to increase dramatically ignore the fact that federal spending has increased from 19.2 percent of GDP in 1974 to 22 percent in 1994, while federal tax receipts have stayed roughly constant during the same period; they were 18.8 percent of GDP in 1974 and 19 percent in 1994.

In addition, there is abundant evidence that lower marginal tax rates increased both the amount and percentage of taxes paid by the rich.

• The share of income taxes paid by the top 10 percent of taxpayers rose from just under 50 percent of 1980 to more than 57 percent by 1988.

• Thus the amount of taxes paid by the wealthiest taxpayers increased by 19 percent, while their marginal tax rate fell by 60 percent.

The wealthy paid more taxes even with a lower tax rate because they increased their taxable income by so much. The wealthy generally have great flexibility in how much taxable income they earn in a year. The lower tax rates were an incentive to earn more taxable income instead of buying tax-free bonds, investing in exotic tax shelters, taking their income in the form of tax-free benefits or simply working less. The incentive worked. After remaining stable for many years, the number of taxpayers reporting an income of more than $200,000 (in constant 1977 dollars) increased dramatically following the Reagan tax cuts.

As evidence that it was the tax rate cuts that made the difference, after the 1990 tax increase raised the top marginal tax rate, the number of taxpayers reporting an income of more than $200,000 dropped significantly.

Source: Bruce Bartlett, "Tax Cuts and the Rich," Brief Analysis No. 158, April 12, 1995, National Center for Policy Analysis, 12770 Coit Rd., Suite 800, Dallas, TX 75251, (972) 386-6272.

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