Here We Go Again – Income Tax, Politics, and History

“Income tax returns are the most imaginative fiction being written today.” ― Herman Wouk

The election season is in full swing, and once again, we are hearing politicians campaigning on the idea of raising taxes on the wealthiest Americans and businesses to pay for various programs. 

Intuitively, it makes sense that if you raise tax rates, tax revenue will go up. Moreover, it seems logical that if you raise tax rates on the wealthiest Americans, they will pay a larger share of the income tax.

But it doesn’t work that way. We have written about this for the last decade, and yet history continues to repeat itself with each election.

Tax policy proposed to help lower- and middle-income American’s often hurts them. This is not an economic debate; the facts stand for themselves. This is simply, and unfortunately, politics. Never before have we seen such extremes proposed as we are now, and thus the risk is higher than ever before, for those who are most vulnerable.

Taxing the rich more isn’t the answer

Bernie Sanders is proposing a 97 percent tax on the wealthiest Americans via his “Corporate Accountability and Democracy Plan.” Elizabeth Warren has proposed a 70 percent marginal tax rate, while Alexandria Ocasio-Cortez has also proposed a 70 percent income tax on the country’s highest-earning citizens, to pay for a new green energy plan.

The reality is that today, the wealthiest Americans are already paying the bulk of all income tax.

According to the Tax Foundation, in 2016, the top 50 percent of taxpayers paid 97 percent of all individual income taxes. The top 1 percent of taxpayers paid more income tax (37.3 percent) than the bottom 90 percent combined (30.5 percent).

Some politicians are ignoring history

Yet the debate continues on raising tax rates in the face of mounting government deficits. It makes sense that the government taxes people more and uses the money to reduce deficits. Yet history objectively shows us the impact of lowering tax rates versus raising them, so any debate about this is purely political. Some of today’s issues, such as health-care reform, Social Security and immigration, are often difficult to quantify objectively because we have not had experience with proposed changes. On the other hand, we do have objective experience with income tax cuts and their impact.

Tax cuts have historically shifted the tax burden from middle-income people to the wealthiest Americans while creating jobs and increasing government revenue. This seems counterintuitive, but the fact is true and undebatable. Critics, often with the best of intentions, have said that extending tax cuts and further reducing income taxes will benefit the rich over the poor and will lead to more deficit spending. This simply is not the case. The only reason any informed person would propose raising income tax rates is to gain votes — or to intentionally hurt lower- and middle-income Americans.

The public is told we cannot afford tax cuts due to government spending on entitlements, defense and all the other important things the government does. While cutting taxes in the face of mounting deficits may seem counterintuitive, critics are ignoring history.

Past income tax rate cuts have increased government revenues, boosted our economy, created jobs and shifted the tax burden away from low-income families to middle- and upper-income folks. There is no doubt that we will have to deal with excessive government spending to balance the federal budget. Independent of that, extending and expanding tax cuts, while closing loopholes, is a proven way to increase government revenue. This approach benefits all Americans by shifting the burden to those who can most afford it.

TEFRA from 1982 gives us a great history lesson

The Tax Equity and Fiscal Responsibility Act of 1982 (Pub. L. 97-248), also known as TEFRA, was enacted on Sept. 3, 1982. According to US Treasury statistics, TEFRA increased revenues by $130 billion in its first four years — after tax rates were cut dramatically. The top rate was slashed from 70 percent to 50 percent.

TEFRA was created in response to the recession at the time and faced fierce opposition from those who felt that taxes should be increased, not decreased, to offset government shortfalls. Sounds like a familiar debate, doesn’t it? TEFRA reduced the budget gap by generating revenue from closed tax loopholes and enforcement of tougher tax rules, as opposed to changing marginal income tax rates.

This legislation modified some aspects of the Economic Recovery Tax Act of 1981 (ERTA). Both of these pieces of tax legislation took place during the Reagan presidency.

TEFRA was considered the largest peacetime tax increase in American history as part of a budget deal to get the federal deficit under control. Reluctantly signing the bill into law, President Ronald Reagan stated that he was supporting “a limited loophole-closing tax increase to raise more than $98.3 billion over three years in return for…agreement to cut spending by $280 billion during the same period.” In the period between 1981 and 1986, it was believed that TEFRA would reclaim approximately $215 billion of the $750 billion given up by ERTA. According to the Bureau of Economic Analysis (BEA), the economy’s growth rates after TEFRA took effect were among the fastest in history.

Two years later, the 1984 Deficit Reduction Act increased tax collections by $72 billion in the four years after taxes were cut again. The bulk of these revenue increases came from the wealthiest Americans. This should not have been a surprise.

The broad-based income tax cuts that President Reagan implemented in the 1980s set off an entrepreneurial boom that propelled the growth of the economy for the next 20 years. Certainly, the Clinton presidency benefited from the tax cuts, and to Clinton’s credit, he even added his own cut by reducing the capital gains tax.

Reagan’s detractors point to his lack of sensitivity for social issues and the legacy of his deficit spending — yet his legacy is a positive one. In the seven years following the Reagan tax cuts, almost 20 million good-paying jobs were created, according to the U.S. Department of Labor.

Top earners already pay the lion’s share of taxes

A Joint Economic Committee for the US Congress report in 1996 revealed that the share of the income tax burden borne by the top 10 percent of taxpayers increased from 48 percent in 1981 to 57.2 percent in 1988. Meanwhile, the share of income taxes paid by the bottom 50 percent of taxpayers dropped from 7.5 percent in 1981 to 5.7 percent in 1988.

The middle class also benefited — those between the 50th percentile and the 95th percentile for income. Between 1981 and 1988, the income tax burden of the middle class declined from 57.5 percent in 1981 to 48.7 percent in 1988. The increase borne by the top 1 percent of income earners is entirely responsible for this 8.8 percentage point decline in the middle-class tax burden.

According to the IRS, in 1981, the top 1 percent of income earners paid 17.6 percent of all personal income taxes. By 1988, their share had jumped to 27.5 percent — after the top tax rate had been cut from 69.13 percent in 1981 to 28 percent in 1988.

According to the Bureau of Labor Statistics, inflation, measured by the consumer price index, increased by 49.5 percent between 1977 and 1981. Between 1982 and 1986, inflation was 19.1 percent — much lower than it was prior to the tax cuts.

Across-the-board tax cuts were implemented way back in the 1920s as the Mellon tax cuts and in the 1960s as the Kennedy tax cuts. In both cases, the reduction of high marginal tax rates actually increased tax payments by “the rich” and also increased their share of total individual income taxes paid.

We are here for you, as always

Those who would benefit the most from lower taxes could be hurt, with the best of intentions, by the current path we are going down. Clearly, there is an optimal point below which taxes should not be cut but increasing taxes today does not make sense from an economic or even social standpoint. Lower-income taxes stimulate growth, create good jobs, increase government revenues and shift the tax burden from low-income families to upper-income payers.

If all the intellectual energy that is being used to debate historically established facts were channeled into solving problems that Americans face, instead of promoting partisan rhetoric, all Americans would benefit. Then again, it’s much easier to offer something for free if you’re just hunting for votes. We believe most Americans are too smart to fall for the false narrative about dramatically raising income tax rates.

Regardless of what happens in Washington, our team will continue to take a very proactive approach to legally minimizing taxes for our clients. At the end of the day, it’s not what you make that’s important, but what you keep, net of fees, expense and taxes.

Our Personal Vision Planning Process® focuses on developing a plan to help you achieve your personal goals, regardless of changes to tax rules, the economy or markets. We are here for you. You can contact me personally at randy.carver@raymondjames.com or (440) 974-0808.

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The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Randy Carver and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.