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Executive Summary #1443es on Taxes

May 22, 2001

May 22, 2001 | Executive Summary on Taxes

Executive Summary: Lowering Marginal Tax Rates: The Key to Pro-Growth Tax Relief

The decision to scale back the level of tax relief over the next 10 fiscal years means that less than 25 percent of the projected $5.6 trillion budget surplus will be returned to taxpayers. For this reason, it is more important than ever for lawmakers to craft the best possible package of tax cuts if they want to improve the economy's lagging performance.

One of the best ways to accomplish this goal would be to lower marginal tax rates on income, particularly the top income tax rate. This reform would have both immediate and long-term beneficial effects on entrepreneurship, investment, and small businesses.

By every reasonable measure, the tax burden in the United States is excessive and tax rates are too high. As the following statistics indicate, the time has come for across-the-board reductions in the rate of taxation.

  • Federal tax revenues in 2001 are projected to consume 20.5 percent of domestic economic output--the highest level of taxation the United States has ever experienced. It is matched only by the level reached in 1944, at the height of World War II.

  • The federal government is expected to collect $2.24 trillion in tax revenue this year--more than $16,500 for every worker in the country. The $2.24 trillion pouring into Washington is nearly double the amount of revenue raised as recently as 1993.

  • According to the Washington-based Tax Foundation, taxes at all levels now consume 39 percent of the average dual-earner family's income. Even medieval serfs gave the lord of the manor less than that.

  • Indeed, the typical dual-earner family will pay more than $26,750 in taxes to all levels of government and will have to work until May 3 to meet its tax bill. This is more than the family will have to spend on food, clothing, and shelter combined.

There is a distinct pattern throughout U.S. history: Simply stated, when tax rates are reduced, the economy prospers, tax revenues grow, and lower-income citizens bear a lower share of the tax burden. This experience teaches three lessons.

Lesson #1: Lower tax rates mean faster growth.

  • The tax cuts of the 1920s: Spurred in part by lower tax rates, the economy expanded dramatically. In real terms, the economy grew 59 percent between 1921 and 1929, and annual economic growth averaged more than 6 percent.

  • The Kennedy tax cuts: The Kennedy tax cuts helped to trigger a record economic expansion. Between 1961 and 1968, the inflation-adjusted economy expanded by more than 42 percent. On a yearly basis, economic growth averaged more than 5 percent.

  • The Reagan tax cuts: The economic effects of the Reagan tax cuts were dramatic. The tax cuts helped to pull the economy out of a severe downturn and ushered in a period of record peacetime economic growth. During the seven-year Reagan boom, yearly economic growth averaged 4 percent.

Lesson #2: Lower tax rates do not mean less tax revenue.

  • The tax cuts of the 1920s: Personal income tax revenues increased substantially during the 1920s despite the reduction in rates. Revenues rose from $719 million in 1921 to $1.164 billion in 1928, an increase of more than 61 percent (during a period of virtually no inflation).

  • The Kennedy tax cuts: Tax revenues climbed from $94 billion in 1961 to $153 billion in 1968, an increase of 62 percent (33 percent after adjusting for inflation).

  • The Reagan tax cuts: Total tax revenues climbed by 99.4 percent during the 1980s. The results are even more impressive, however, when one looks at what happened to personal income tax revenues. Once the economy received an unambiguous tax cut in January 1983, personal income tax revenues climbed dramatically, increasing by more than 54 percent by 1989 (28 percent after adjusting for inflation).

Lesson #3: The rich pay more when incentives to hide income are reduced.

  • The tax cuts of the 1920s: The share of the tax burden paid by the rich rose dramatically as tax rates fell. The share of the tax burden borne by the rich (those making $50,000 and up in those days) climbed from 44.2 percent in 1921 to 78.4 percent in 1928.

  • The Kennedy tax cuts: Just as happened in the 1920s, the share of the income tax burden borne by the rich increased following the tax cuts. Tax collections from those earning more than $50,000 per year climbed by 57 percent between 1963 and 1966, while tax collections from those earning below $50,000 rose 11 percent. As a result, the rich saw their portion of the income tax burden climb from 11.6 percent to 15.1 percent.

  • The Reagan tax cuts: The share of income taxes paid by the top 10 percent of earners jumped significantly, from 48.0 percent in 1981 to 57.2 percent in 1988. The top 1 percent of taxpayers saw their share of the income tax bill climb even more dramatically, from 17.6 percent in 1981 to 27.5 percent in 1988.

High rates of taxation and a tax code that punishes working, saving, and investing do not add up to a recipe for long-term prosperity. History shows clearly that lower tax rates are an integral part of a reform package that maximizes freedom and prosperity. Reducing all income tax rates is a responsible way to promote long-term economic growth.

Daniel J. Mitchell, Ph.D., is McKenna Senior Fellow in Political Economy at The Heritage Foundation.

About the Author

Daniel J. Mitchell, Ph.D. McKenna Senior Fellow in Political Economy