Sixteenth Amendment, Revenue Act of 1913, Progressive Tax, Marginal Tax Rate, Tax Shelter, Tax Cuts and Decade of Greed

Posted by PITHOCRATES - July 10th, 2012

History 101

Americans find Taxes Repugnant and have a Long History of Making this Repugnance Known

American independence began with a tax revolt.  The ratification of the U.S. Constitution happened only with safeguards against the new federal government from growing too powerful.  And great efforts went to limiting the amount of money it could spend.  For a long time all federal tax revenue came from import tariffs.  Then from sales of federal lands as the population moved west.  It took a civil war for us to impose an income tax.  Our first income tax was 3% on incomes over $800 (or about $20,000 today).  The first income tax was a flat tax.  They passed this income tax to pay for the war.  They repealed the income tax following the war.  Americans wouldn’t see another federal income tax until 1913 when we ratified the Sixteenth Amendment.  And President Woodrow Wilson signed into law the Revenue Act of 1913.

Woodrow Wilson was a progressive.  The precursor to today’s liberals.  Who thought beyond the limited government of our Founding Fathers.  They wanted to expand government.  To make it a part of our everyday life.  Where the brilliant progressive politicians would make better decisions for us than we ever could.  And their changing of society included the funding of the federal government.  For their income tax was a progressive tax.  Everyone paid a flat tax of 1% on income of $3,000 or more.  About $66,100 today.  Then the progressive taxes came into play.   Adding another percentage to the income tax rate for increasing amounts of income.  The thresholds for these increases were as follows: $20,000 (roughly $440,400 today), $50,000 ($1,101,000 today), $75,000 ($1,651,600), $100,000 ($2,202,100), $250,000 ($5,505,300) and $500,000 ($11,010,700).  The top marginal tax rate on the super rich (earning $11,010,700) was 7%.

Our second income tax was quite controversial.  A lot of people hated it.  For Americans find taxes repugnant.  And have a long history of making this repugnance well known.  But thanks to the American Civil War a generation of men was lost.  And a generation of boys grew up without fathers.  Tended on by doting mothers.  Smothering them with love and affection.  And these boys grew up without knowing the manly hardships of life.  And they entered politics.  Becoming those early progressives.  Who wanted to change the government into a great doting mother.  And now they could.  For they had their income tax.

Few paid the Confiscatory Tax Rates of the Seventies by Hiding their Income in Tax Shelters

The rich paid our first federal income taxes after the Revenue Act of 1913.  And these were very small percentages we had them pay.  Back then the top marginal tax rate was lower than our lowest income tax rate today.  Think about that.  The richest of the rich paid only 7% of their income ($11,010,700 or more today) in federal income taxes.  While today single people earning the lowest bracket of taxable income (from $0 to $8,700) pay 10% of their income in federal income taxes.  Clearly the growth of government exploded thanks to the Sixteenth Amendment.  Much as our Founding Fathers feared it would if they had too much money to spend.

Of course, this is ancient history.  Few know about this today.  For few could even tell you why we fought for our independence.  Or even who we fought for our independence from.  (We fought for our independence from Great Britain because of their policies to tax us despite our having no representation in Parliament.  That’s where the phrase taxation without representation came from).  Today high taxes are sadly just an accepted part of life.  In fact, we have referred to our paychecks as take-home pay.  Our net pay.  Because gross pay is a myth.  No one sees their gross pay.  About a third or more of that disappears in withholding taxes.  So gross pay is a meaningless expression for us today.  (It wasn’t before the Sixteenth Amendment or before the progressives came to power).  Something that we sadly accept.  And we now fund our lives on the take-home pay the government allows us to keep.  All the while accepting these high tax rates.

Government spending took off in the Sixties and the Seventies.  As did our taxes.  If we had once thought that a 7% tax on incomes of $11,010,700 or more was an outrage, we didn’t see anything yet.  In 1978 the top marginal tax rate was 70% on incomes of $351,712 or more.  And there were 25 marginal tax rates.  As shown here adjusted for inflation (sources: Tax Rates, Tax Receipts, and Celebrity Incomes).

 In this example we calculated the average of some top celebrities.  And the top celebrities on average earned about $30,000,000 in 2010.  Using the 1978 tax brackets they would have owed $20,936,506 in federal income taxes.  Or approximately 69.8% of their total income.  Which is pretty much equal to the top marginal tax rate.  Of course, few paid these confiscatory tax rates.  They hid their income as best as they could in the Seventies.  In tax shelters.  And you know they did because despite these confiscatory tax rates the federal government still ran budget deficits.  Having to print money to pay for their explosion in government spending. 

The Low Tax Rates of the Eighties created so much Economic Activity the Opposition called it the Decade of Greed

The heyday of Keynesian economics was in the Seventies.  After Richard Nixon decoupled the dollar from gold the Keynesians were free to print money to stimulate the economy.  Which was their answer to ending a recession.  Stimulus spending.  Have the government print money to create economic activity that wasn’t happening in the private sector.  Their policy tool to end a recession was inflation.  By pouring money into the economy people would borrow it and buy cars and houses and furniture.  And everything else under the sun.  Creating a surge of economic activity.  And creating jobs in the process as businesses must hire new workers to meet that government stimulated demand.  With the dollar decoupled from the ‘cross of gold’ the Keynesians were finally able to prove their mettle.  And solve all the country’s economic problems.  It was the dawn of a brave new world.

And that world sucked.  For the implementation of Keynesian economic policy proved those policies did not work.  Instead of replacing high unemployment with inflation they just added high inflation to the high unemployment.  Something that was impossible to happen in Keynesian textbooks.  But it happened.  Stagnant economic activity.  And inflation.  What we called stagflation.  We added the unemployment rate to the inflation rate to come up with a new economic indicator.  The misery index.  The economy was so miserable during Jimmy Carter’s 4 years in office that he lost in a landslide to Ronald Reagan.  Who was a proponent not of Keynesian economics but of the Austrian school.  Or supply side economics.   And the Austrians believed in low tax rates.  For low tax rates would stimulate economic activity.  And the greater amount of economic activity would generate a greater amount of tax revenue even at lower tax rates.  Let’s look at that same celebrity paying taxes a decade later under Ronald Reagan.

 Much simpler.  And more in keeping with the Founding Fathers.  Instead of paying 70% of their earnings in federal income taxes they will only pay 28% (again, equal to the top marginal tax rate.  Which is pretty much the only tax rate the rich pay).  That’s still a lot of money to give to the federal government.  But it’s so much smaller that in many cases it was cheaper and easier to pay Uncle Sam than trying to hide that income.  So economic activity took off in the Eighties.  It was so great that the opposition called it the Decade of Greed.  Out of sour grapes because their policies could never produce anything like it.  But what about tax revenue?  Those on the Left say this economic activity came at a price.  Exploding deficits.  Well, the deficits did grow.  But it wasn’t because of the cuts in the tax rates.

Higher Tax Rates do not Necessarily Increase Tax Revenue 

In 1978 total tax revenue was $1,113.6 billion.  In 1988 total tax revenue was $1,421.1 billion.  So Reagan’s cuts in the tax rates produced $307.5 billion more in tax revenue.  An increase of about 27.6%.  Dropping the top marginal tax rate from 70% to 28% actually increased tax revenue.  So the cut in tax rates did not cause the deficits.  It wasn’t a revenue problem.  Revenue went up.  Spending just increased more.  And it was this excessive government spending that caused the deficits.  Not the tax cuts. 

The lesson here is that higher tax rates do not necessarily increase tax revenue.  Because changes in tax rates changes behavior.  Higher tax rates discourage people from investing in businesses.  They discourage businesses from expanding.  Or hiring new workers.  Higher tax rates may decrease the opportunity costs for hiding income.  The cost and inconvenience of hiding income in tax shelters and offshore accounts may become less that the cost of paying higher taxes.  Like it was during the Seventies.  Where despite confiscatory tax rates the government could not generate enough tax revenue to meet their spending obligations.

Income tax rates grew from a very small percentage on only the largest of incomes to high tax rates on very modest incomes.  And yet our deficits have never been larger.  Proving that our tax rates are either too high and dampen economic activity (as well as encouraging people to avoid paying their taxes).  Or that government spending has just grown too large.  More than likely it’s a combination of the two.  A fact that would shock and dismay the Founding Fathers were they alive to see what we did with the republic they gave us.

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Ronald Reagan’s Reaganomics Increased GDP and Tax Revenue, Decreased Unemployment and Tamed Inflation

Posted by PITHOCRATES - August 8th, 2011

Ronald Reagan’s Supply-Side Reaganomics caused an Economic Boom

Politics is a struggle.  Between those on the Left.  And those on the Right.  And nowhere is it more partisan than when it is about one subject.  ReaganomicsRonald Reagan‘s supply-side economics.  Of the Austrian School.  That the Left belittles as trickle-down economics. 

His tax cuts during the Eighties sparked an economic boom.  No one denies this.  In fact, life was very good during the Eighties.  So good that the Left denounce those years as the Decade of Greed.  “Yes, a lot of people got rich,” the Left says.  “But at what cost?”  And then they point to those ‘soaring’ Reagan deficits.  Peaking at about $221.2 billion in 1986.  Or about $358.3 billion adjusted for inflation.  (Pretty tame by today’s standards.  Barack Obama has one in the $1.6 trillion neighborhood.)  But did Reagan cause them with his tax cuts?

To answer this question we look at historical GDP (gross domestic product).  And tax receipts.  From the Seventies and the Eighties.  From the heyday of Keynesian economics.  After the Nixon Shock in 1971. That ended the ‘gold standard‘.  When Nixon said, “I am now a Keynesian in economics.”  And through Reaganomics.  All dollar amounts are constant 2005 dollars (shown in billions).  These are graphed along with the top marginal tax rate, inflation and the unemployment rate.

(Sources: GDP, tax revenue, top marginal tax rate, inflation, unemployment)

Inflation Eroded GDP and Raised Unemployment in the Seventies

There are two relatively flat plateaus on the GDP graph.  Flat or falling GDP growth indicates a recession.  One starting sometime after 1972.  The other one around 1979. 

Both of these correspond to a spike in the inflation rate.  This happens because inflation erodes GDP.  By raising prices.  Higher prices mean we buy less.  Which means less GDP.  And higher prices tend to inflate business profits.  Where profit gains are from inflation.  Not from selling more stuff.  Which means less GDP.

Inflation is one half of the business cycle.  Which is a boom-bust cycle.  A booming economy.  And a busting recession.  Inflation.  And deflation.  Growth.  And recession. 

During growth there’s inflation.  Prices go up as more people want to buy the same things.  Bidding up prices.  The unemployment rate falls.  Because businesses are hiring more people.  To expand.  To meet this demand. 

When they expand too much there’s too much stuff on the market.  People can’t buy it all.  So prices go down.  To encourage people to buy.  And businesses cut back.  Lay people off.  With fewer people working there’s fewer people to buy that excess supply.  So prices fall more.  And businesses lay more people off.  To reflect the falling demand.  Which increases the unemployment rate.

The business cycle, then, corrects prices.  And readjusts supply to demand.  Keynesian economics was going to change this, though.  By removing the recession part.   Through permanent inflation.  At least, that was the plan.  The two plateaus in the GDP graph shows that the business cycle is still here despite their best efforts.   

And the Keynesians only made things worse.  By causing double-digit inflation.  By creating more demand than existed in the market.  People used that easy money.  To buy things they wouldn’t have otherwise bought.  Creating ‘bubbles’ of inflated prices.  Which are corrected by recessions.  And the greater the bubble, the greater the recession.

Easy Monetary Policy (i.e., Printing Money) made Inflation Worse in the Seventies

Government spent a lot during the Seventies.  A lot of that was Keynesian spending paid for with easy monetary policy (i.e., printing money).  Something governments can only do.  They are the only ones that can say, “Use these paper bills as legal tender.  We guarantee it.”

Making fiat money is easy.  But there is a cost.  The more you make the more you devalue your currency.  That’s the cost of inflation.  Money loses some of its purchasing power.  The greater the inflation the greater loss of purchasing power. 

They printed a lot of money during the late Seventies.  So much that the dollar lost a lot of its purchasing power.  Hence the double-digit inflation.

Paul Volcker was a Federal Reserve chairman.  He started in the last year of Jimmy Carter‘s presidency.  And remained chairman for about 8 years.  He raised interest rates severely.  To constrict the money supply.  To pull a lot of those excess dollars out of circulation.  This caused a bad recession for Reagan.  But it killed the double-digit inflation beast.  This sound money policy was a tenet of Reaganomics.  Which was an integral part of the Eighties boom.

Reagan’s Tax Cuts Increased both GDP and Tax Revenue

The hallmark of Reaganomics, of course, is low taxes.  Reagan cut the top marginal tax rate.  He dropped it from 70% to 28% in four cuts.  After the first cut GDP took off.   Because rich people reentered the economy. 

They weren’t parking their money in investments that helped them avoid paying the top marginal tax rate.  They were starting up businesses.  Or buying business.  Creating jobs.  Because the lower tax rates provided an incentive to earn business profits.  And not settle for lower interest income.  Or capital gains. 

For business profits can be far greater than interest earned on ‘income tax avoiding’ investments.  Such as government bonds.  And if we don’t penalize rich people for risk-taking they will take risks.  Create another Microsoft.  Or Apple.  But they are less likely to do that if they know we will penalize them for it.  And that’s what a high marginal tax rate is.  A penalty.  Remove this penalty and they will choose risky profits over safe interest every time.  And make a lot of jobs along the way.

And this is what they did during the Eighties.  Their ‘greed’ created a boom in employment.  A rising GDP.  Accompanied with a falling unemployment rate.  Rich people were pulling their money out of tax shelters.  And putting it into businesses.  Where they could make fat profits.  And making fat profits in business requires employees.  Jobs.  Unlike making money with safe tax-sheltered investments. 

Tax revenue increased.  There were more business profits.  And more business income taxes on those profits.  There were more jobs.  More employees in the workforce.  Paying more payroll taxes.  And more personal income taxes

Successful businesses made more rich people.  And more rich people pay more income taxes than fewer rich people.  A lot more.  The top marginal tax rate was lower.  But there were more businesses and people paying taxes.   Because the lower rates created more taxpayers.  And richer taxpayers to tax.  Which increased overall tax revenue.

Tax Revenue Increased under Reaganomics but Government Spending simply Increased More

So to summarize the data during Reaganomics, GDP grew, tax revenue grew, unemployment fell and inflation was tame.  All the things you want in a healthy economy.  And this all happened when the top marginal tax rate was cut from 70% to 28%. 

So, no, the Reagan deficits were NOT caused by the Reagan tax cuts.  That’s a myth created by the Left to revise history.  To recast the successful policies of Ronald Reagan as failures.  So they can continue in their tax and spend ways.

Those deficits were a spending problem.  Not a revenue problem.  For tax revenue increased after the tax cuts.  So why the deficits?  Because government spending simply increased more.

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LESSONS LEARNED #38: “Repeating a lie doesn’t make it true.” -Old Pithy

Posted by PITHOCRATES - November 4th, 2010

Liars Lie

Lying works.  Political spin.  Poetic license.  Fibbing.  Slander.  Libel.  Call it what you’d like.  Politicians lie.  Because it works.  Especially when you can’t win in the arena of ideas.  If they can’t win the philosophical debate what do our politicians do?  Attack the messenger, not the message.  If the history doesn’t validate their policies what do they do?  Revise history.  It never changes.  The only thing that does is the people hearing the lies.

Presidents may dream, but the House of Representatives controls the purse.  That’s why there are numerous battles between Capitol Hill and the White House.  Between Speakers of the House and presidents.  Some of the big partisan battles in recent times?  Tip O’Neil and Ronald Reagan.  Tom Foley and George H.W. Bush.  Newt Gingrich and Bill Clinton.  Nancy Pelosi and George W. Bush.  When different political parties hold the White House and the Hill, the partisanship escalates.  And the lies get more brazen.  Especially on the political fringe.

Some lies bordered on the ridiculous.  Like Ronald Reagan created AIDS to kill homosexuals.  That George H. W. Bush flew to Iran on an SR-71 to meet secretly with the Iranians during the 1980 presidential campaign.  Why?  To negotiate with the Iranians to keep the American hostages until after the election.  That George W. Bush blew up the Twin Towers to start a war that would let him invade Iraq.  No doubt there was some political damage from these lies.  But the lasting damage from these ridiculous lies pale in comparison to the Big Lies that the Left perpetuates to this day.

Trickle-Down Economics

Ronald Reagan was president from 1981 until 1989.  When he entered office, the economy was in the toilet.  Double digit inflation.  Double digit interest rates.  Unemployment at 7.1%.  Reagan wanted to cut taxes and spending.  The Democrat controlled Congress wanted to increase federal spending to ‘stimulate’ the economy (ala Keynesian economics).  The Congress fought him.  But Reagan used the bully pulpit and appealed directly to the American people.  They liked his message which brought pressure down on Congress.  They gave a little.  Reagan got his tax cuts.  The top marginal rate went from 70% down to 28% by the time he left office.  The result?  The economy boomed.  They call it the Decade of Greed.  Because we were very materialistic and greedy.  And people lived well.

Yes, but at what cost?  That’s what the Left always says to refute Reaganomics.  What they deride as trickle-down economics.  They point to military spending.  They point to Reagan’s deficit spending.  And the growing federal debt.  The Left says this is what Reagan’s tax cuts have given us.  Growth and prosperity at the expense of future generations.  Which is perhaps the greatest lie of the 20th century.  But because the Left has repeated it so often, a lot of people accept it as fact.  Even though the numbers refute this grand lie.

When Reagan entered office, federal tax receipts were $517 billion.  When he left office in 1989, federal tax receipts were $991 billion.  This is an increase of 91.7%.  Or, to look at in another way, tax receipts in 1989 were 1.9 times the amount they were in 1980.  That’s almost double.  So, despite the great lie of the 20th century, Ronald Reagan’s tax cuts did NOT cause deficits or increase the debt.  Cuts in the tax rates brought MORE money into the federal treasury.  Excessive federal spending caused the deficits.  Federal spending increased from $590.9 billion in 1980 to $1,143.7 billion in 1989.  That’s a 93.6% increase.  Spending, too, almost doubled.  In other words, spending increased 1.9% more than tax receipts by the end of Reagan’s second term.  Washington was awash in money.  They just spent it faster than it came in.

Blame the excessive spending on Cold War defense spending or domestic spending.  The point is moot.  Because it doesn’t change the fundamental truth that Reagan’s tax cuts INCREASED federal tax receipts.  Or the lesson learned that tax cuts stimulate the economy.  Anyone saying otherwise is lying and trying to revise history.

Wither on the Vine

The Reagan decade ended prosperously.  Reaganomics were a success.  Which was a threat to those with a vested interest in Big Government.  But people liked Reagan.  And only agreed to vote for George H.W. Bush when he made the infamous ‘read my lips – no new taxes’ campaign pledge.  But Bush was no Reagan.  He wasn’t as conservative.  Or as charismatic.  He couldn’t sell conservative America (center-right) his less than conservative policies (center-left).  The Left, seeing he was no Reagan, maneuvered him into a position favorable to them on the deficit.  The Republicans wanted to cut spending.  The Democrats, of course, wanted to raise taxes.  And with the Democrats in control of the House, he caved.  He raised taxes.  And when he did, he became a one-term president.  The American people were so angry when he reneged on his ‘read my lips – no new taxes’ pledge, the third party candidate in the 1992 presidential campaign, Ross Perot, got 18.9% of the popular vote.  No third party candidate did better.  Exit polling shows he drew equally from both Bush and Clinton, though only 20% of his voters were liberal.  The rest were conservatives and moderates.  Perot brought a carnival atmosphere to the campaign.  Charts and props made for good TV.  This spectacle, though, drew critical attention away from Clinton’s past.  Parts of which moderates would have found objectionable.

Clinton ran as a centrist.  He lied.  As liberals are wont to do during a campaign in a center-right country.  Once in office, he swung to the left.  The American people were angry.  As people are wont to be when lied to.  At the 1994 midterm elections, the people spoke.  And gave both houses of Congress to the Republicans.  Newt Gingrich became the Speaker of the House.  He co-authored the Contract with America which was a Republican pledge to return America to a conservative path.  It appealed to the American people.  It’s what swept the Republicans into power.  And it scared the Left.  So they attacked it.  Called it the Contract on America.  And they attacked Newt Gingrich.  With a vengeance.

In 1995, Gingrich discussed an alternative to Medicare.  Number crunchers projected Medicare (and Social Security) to go into the red a decade or two out.  Medicare (and Social Security) is a big federal expenditure and a political third rail.  The Left uses the elderly as political pawns whenever they can.  Because that’s what Big Government does.  Get people dependent on Big Government and then scare the hell out of them by saying the Right wants to take their benefits away.  Gingrich was discussing high-deductible health insurance plans and tax free Medical Savings Accounts (MSAs).  The MSAs included an annual federal subsidy for seniors.  The plan would be appealing to seniors, Gingrich thought, because they could get better health care coverage with a private plan.  The MSAs and the federal subsidies would make it affordable.  Better care without paying more.  Who wouldn’t want that?  Once people made this choice voluntarily, they would move out of Medicare into a private plan.  Those comments in 1995 included this:

What do you think the Health Care Financing Administration is? It’s a centralized command bureaucracy. . . . Now, we don’t get rid of it in round one because we don’t think that that’s politically smart and we don’t think that that’s the right way to go through a transition. But we believe it’s going to wither on the vine because we think people are voluntarily going to leave it — voluntarily.

Wither on a vine?  Talk about a hanging softball.  There was no way the Democrats weren’t going to whack that one out of the park.  It quickly became ‘Medicare benefits’ and NOT the inefficient ‘centralized command bureaucracy’ that was going to wither on the vine.  The Left ran with it.  Another grand lie.  Repeated it at nauseam.  And scared the seniors.  Gingrich’s days were numbered.  And Clinton had a new enemy to demonize.  Which came in handy when no one wanted his policies.

The Lies that Keep on Giving

Big Government depends on getting as many people dependent on government as possible.  Medicare (and Social Security) is one program that does this very well.  And when Gingrich dared to threaten it, they destroyed him.  With a grand lie.  Like the grand lie that tax cuts stimulate deficits, not the economy.  Perpetuating these lies enables unsustainable government spending.  Threatens the future of all Americans.  And the longer it takes for the truth to come out, the deeper the hole we dig ourselves into.

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Let the Lying Begin

Posted by PITHOCRATES - September 8th, 2010

Labor Day has passed.  And you know what that means?  That’s right.  The kids are back in school.  But it’s not all good.  It also marks the beginning of the election season.  And the lying has already begun.  Well, it’s been going on since, well, the late 18th century.

The economy sucks.  There are no jobs.  But that’s no surprise, is it?  A Keynesian in the White House.  Keynesians in charge of both houses of Congress.   And if there is anything a Keynesian knows how to do is to kill an economy.

Andrew Mellon advised Warren Harding to cut taxes.  He did.  And we got the Roaring Twenties.  FDR gave us a decade long depression with his economic policies.  LBJ’s Great Society gave us, ultimately, the stagflation of the 1970s.  Ronald Reagan’s tax cuts gave us the ‘Decade(s) of Greed’.  The Left condemned the first decade.  But they praised the second decade.  Lucky Clinton.  Well, until that blue dress.

Keynes got it right.  Sort of.  You stimulate the economy with fiscal policy.  But not by tax and spending.  You stimulate by making the business environment more favorable for business.  This creates jobs.  Lowers unemployment.  And brings in great big piles of money to the government.

But what you will hear this election season is that we’re not going back to the failed economic policies of the past.  We’re not returning to ‘trickle-down’ economics.  And they’ll say that with righteous indignation.  Even though the economy was a helluva lot better with those ‘failed’ policies.  You know why?  Those policies work.  Their policies don’t.  But their policies give them more power.  Policies that work don’t.  And they know that.  So they lie.  To better themselves at our expense.

You’d think they’d be happy just to get the great big piles of money with a bustling economy.  But they’re not.  They want the power.  To satiate their great big egos.  And to establish themselves as a permanent upper class.

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