"The power to tax is the power to destroy"
John Marshall, Chief Justice of the United States (1801-1835)
A recent blog post regarding U.S. income tax caught my eye. The post included an aesthetically beautiful infographic from data artist
Stephen Von Worley and his
Data Pointed blog that, according to multiple blog posts, purports to show once again that those #@*&# rich people are just not being taxed enough.
Unfortunately, as an engineer and scientist, I have a number of problems with the infographic. One problem is that the original chart is mislabeled, based on the data that it presents as I will explain below. Another problem is that many people apparently misinterpreted what the chart actually tells you.
Infographics, though often useful, are essentially "visual statistics," which reminds me of a favorite quote.
"Statistics are like bikinis. What they reveal is suggestive, but what they conceal is vital." -- Aaron Levenstein
Why the Chart is Mislabeled
The original post proclaims "The tax man cometh, and to illustrate the inequities of his cleft-hoofed embrace, we’ve charted the shift in U.S. income taxes from rich to poor over the past century." Unfortunately, the data behind the chart does NOT show this.
The chart claims to show relative tax burden, which in the post is defined as "the amount of tax due relative to the long-term average at each income level."
So what does the infographic actually show? After some reverse engineering, it actually shows the relative change in marginal income tax rate compared to historical averages. Keywords here are "relative change, " "marginal income tax rate," and "historical averages" It’s a common mistake, but high marginal tax rates DO NOT equate to actual tax burden or increased revenues for the government. High marginal tax rates do affect behavior and dissuade earning and investment plus encourage tax avoidance strategies.
Choose Your Average
The non-obvious distortion is that the chart relies on historical averages. Averages themselves can be greatly deceiving.
"Then there is the man who drowned crossing a stream with an average depth of six inches." -- W.I.E. Gates
"The average human has one breast and one testicle." -- Des McHale
Fist, a little background information. Since the inception of the federal income tax, the top marginal tax rate ranged from 7% to 94%. The chart below is color coded according to a chart used later in this post. The source data is available
here.
Marginal Tax Rate for Top Income Category, by Year (1913-2011)
Meanwhile, for the bottom tax bracket, the tax rate varied from a low of 0% in the 1970's/1980's to a high of 23% during the New Deal, World War II.
Marginal Tax Rate for Bottom Income Category, by Year (1913-2011)
The
average marginal tax rate for top earners was over
59%, with a standard deviation of ±25% for the specified 99 year period (1913-2011) since the 16th Amendment was passed. If considering the entire 235-year history of the United States, the average drops to
25%. If using just the last 25 years, then the historical average is
35.8%. Choosing the specific time period dramatically affects the average.
Relative Difference in Top Marginal Tax Rate Compared to
Historical Average, by Year (1913-2011)
Marginal tax rates for all income taxpayers were at historic highs for twenty years, from 1944 to 1963. For upper income taxpayers, the top marginal rate was 90% or more. Even for the bottom of the income ladder, the rates were over 20%.
However, there was a ten year period (1977-1986) when the marginal rate for lower-income taxpayers was 0%--zip! Mathematically, these zeroes reduce the average. For example, the average marginal tax rate for low-income taxpayers over the thirty-year period (1944-1963, 1977-1986) drops to 13.7%.
The History Embedded in the Charts
With due apologies to Stephen Von Worley for mashing up two of his beautiful infographics, here is some of the history of the U.S. income tax embedded in the charts. The numbered annotations are described below.
Marginal Tax Rate
This is an excellent infographic showing how the marginal tax rate changed over time. The tax rate is presented as a heat map. The higher the tax rate, the closer the color is to white hot. The lower the tax rate, the closer the color is to cool black. The data is also adjusted for inflation, which shows the effect of "bracket creep" over time.
Original, unmodified image:
I re-oriented this graphic to match the "tax burden" chart.
Changes in Marginal Tax Rate Compared to Historical Average
This is an aesthetically beautiful infographic showing how the marginal rates changed compared to their historical average, over the lifetime of 99-year history since the
16th Amendment was ratified.
Original, unmodified image:
(click image to enlarge)
Note 1:Two lines are added to the United States Constitution upon ratification of the
16th Amendment, legalizing federal income tax.
"The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration."
Congress subsequently passed the
Revenue Act of 1913. The 18 pages of legislation imposed a federal income tax ranging from 1% to 7%, depending on income. The
1913 federal income tax form and instructions are simple and run just four pages.
Note 2:
Treasury Secretary Mellon understood the negative impact on the high level of taxation.
"The present system is a failure. It was an emergency measure, adopted under the pressure of war necessity and not to be counted upon as a permanent part of our revenue structure. The high rates put pressure on taxpayers to reduce their taxable income, tend to destroy individual initiative and enterprise, and seriously impede the development of productive business…. Ways will always be found to avoid taxes so destructive in their nature, and the only way to save the situation is to put the taxes on a reasonable basis that will permit business to go on and industry to develop."
Note 3:
Due to the unpopularity of the Wilson Administration and World War I, Warren G. Harding was elected President, along with solid Republican majorities in Congress. Congress reduced tax rates by passing the
Revenue Act of 1921.
Note 4:
Congress, under the leadership of President Coolidge, reduced all income tax levels by passing the
Revenue Act of 1926. The bottom marginal rate was reduced to 1.5%. The top marginal tax rate was reduced to 25%.
Note 5:
The Republican Congress had previously passed the disastrous
Smoot Hawley Tariff, heavily opposed by Democrats. Democrats made major gains in the Congressional election of 1930.
Congress, under President Hoover, increased income taxes for all income levels by passing the
Revenue Act of 1932. The bottom marginal rate was increased from 1.5% to 4%. The top marginal tax rate was increased from 25% to 63%. It was the largest peacetime tax increase in U.S. history, up to that point.
The combination of bad policy and increased taxation lead to disastrous unemployment, shifts in economic activity, and decreased investment activity. Welcome to the
Great Depression.
Note 6:
Congress, under the President Franklin Roosevelt (FDR), passes the "soak the rich" tax policies of the
Revenue Act of 1935 (The Wealth Tax Act) and the
Revenue Act of 1936. Top marginal tax rates increased to 79%.
Roosevelt’s leadership was challenged by previous Democratic Presidential candidate, Alfred E. Smith, in his famous 1936 radio address, "
Betrayal of the Democratic Party."
Note 7:The immense costs of the "New Deal" policies of FDR's Administration plus World War II lead to the highest marginal tax rates for all income levels. Top marginal rates reach an astonishing 94%. Even low-income taxpayers faced a 22.2% rate.
The United States emerged from World War II with its industrial and manufacturing capacity relatively untouched. Much of Europe and Asia were enslaved by oppressive Communist regimes. India was seduced by the unfulfilled promises of Socialism. The United States helped
rebuild Europe and Japan and was engaged in a
Cold War with the
Soviet Union and the Communist Chinese.
Because the United States was essentially the only game in town for those that enjoy Western-style democracy, the federal government could continue to oppressive tax rates.
Note 8:
The
Revenue Act of 1964 cut all income tax levels by about 20%. Top rates were reduced to 70% while bottom rates were reduced to 14%.
The
tax cut was made popular by Democratic President John F. Kennedy and was an attempt to spur the U.S. economy. Unfortunately, President Kennedy was assassinated before the legislation was finally enacted.
This 0% rate effectively reduces the historical average for lower income taxpayers and causes the "birds eye" pattern in chart of relative marginal tax rates.
Note 10:Congress passes
Economic Recovery Tax Act of 1981 (ERTA), better known as the Kemp-Roth tax cut. Top rates were reduced to 50% while bottom rates remained at 0%.
Tax brackets indexed to inflation, reducing "bracket creep." Note how the white line in the tax brackets chart flattens after this point.
Note 11:
Congress passes the
Tax Reform Act of 1986, eventually reducing top tax rates to 28%, their lowest levels in modern history. The act also increased bottom tax rates from 0% to 14%.
Although many consider it the second Reagan Tax cut, the act was officially sponsored by Democrats, Richard Gephardt of Missouri in the House of Representatives and Bill Bradley of New Jersey in the Senate.
Note 12:
Congress passes the
Omnibus Budget Reconciliation Act of 1993, raising top marginal tax rates from 28% to 39.6%.
The act received no Republican votes and was opposed by some Democrats. Vice-President Gore provided the tie-breaking vote in the United States Senate.
Note 13:
In response to recession from the Dot-Com bubble, Congress passes the
Economic Growth and Tax Relief Reconciliation Act of 2001. The act is also known as the first of the Bush tax cuts. Rates were reduced at all levels. The top marginal tax rate was reduced to 35% while the bottom marginal tax rate was reduced to 10%.
The Open Question
So the question remains, are marginal rates too low for top income earners?
By international comparison, no.
The marginal tax rate is less important than the effective tax rate. Despite the official tax rate, how much to people really pay. This is measured as the tax paid divided by the adjusted gross income.
The Tax Foundation tracks this information (see
Table 8), but only since 1980. Using their information, the following chart shows that top tax payers pay more as a share of the adjusted gross income (AGI). The calculations for AGI changed with the 1986 tax law, which results in the apparent spike on the chart.
Because top taxpayers have more income, they would also pay more taxes in absolute dollars, even if their tax rates were the same or lower. However, the chart shows that high-income taxpayers do indeed pay a larger share of their income in taxes than do almost all income classes.
Average Effective Tax Rate by Income Class and by Year
See also ...
"The Rich Don't Pay Taxes" Lie: Purposely Deceptive, Or Backed Up by Data?
The Oppressive Progressive Income Tax: California Edition
