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Is It Patriotic Or Just Smart To Pay Higher Taxes? An Analysis of Historical Tax Rates.

Guest blogger Ray Link joins us again today with a very concise and interesting analysis of the relationship between maximum tax rates and the GDP – and whether it makes financial sense to pay more taxes. Ray is a big-brained finance guy, and a good example of what the Republican Party once stood for long, long, long ago; small government and fiscal restraint.

Should High Income People Want to Pay More Income Tax?

Senator Joe Biden recently made some comments that I thought were out in left field when he stated that “wealthy Americans must pay more taxes to show patriotism”. I have no real issue with high income people paying more in tax and to some degree even paying disproportionately more, but I never felt it was my patriotic duty to want to pay more. But am I better off with a higher tax rate or a lower one? So, being an accountant, I crunched some numbers to flesh out the facts.

A brief history is in order. The United States adopted an income tax in 1913 with the passage of the 16th amendment to the constitution. Prior to that time the government funded itself largely from tariffs on imports. Once it became law Congress gradually increased the rates from 1% in 1913 to a top rate, also known as the maximum marginal rate of 94% during World War II and then set the top rate at 91% for many years. The maximum marginal rate is the rate paid on income above a stated level, which usually impacts a small percentage of taxpayers. But because these few people earn so much it contributes a fairly large percentage of all income tax paid. It is also a source of debate when Congress raises or lowers the top rate as it only impacts high income taxpayers. These high rates prompted many tax shelters and schemes to avoid taxes and Congress eventually lowered the rate and the threshold and eliminated many tax shelters. A table of this rate since 1960 follows:

Year

Top rate

Starting at income above

 

1960-63

91.0%

$400k

 

1965-67

77.0%

$200k

 

1971-80

70.0%

$200k

 

1980-86

50.0%

$85K-$175K

 

1988-90

28.0%

$30K

 

1991-92

31.0%

$82K

 

1993-00

39.6%

$250K

 

2003-08

35.0%

$330K

 

Table is summarized and omits transition periods and minor changes.

Now that I am enjoying some of the lowest top tax rates in the past 50 years, I ask the question, am I better off and is the country better off?

I want to know if my investments do better in high tax periods or in lower tax periods. I also want to know the impact of tax policy on the deficit and the growth in our national debt as well as the overall growth in our gross domestic product or GDP. The GDP is the sum of all goods and services produced by Americans and it is an important gauge of the health of the country. The deficit and total growth in our debt impacts inflation and the value of the dollar which impacts our world purchasing power. After all, aren’t high income tax payers those people with all the money so they shouldn’t they be more concerned over the growth in their net worth and the value of their money than the tax on their income?

Let’s investigate the facts. Fact one, the U.S. has run a budget deficit every year since 1957. Fact two, since 1960 the government spends about 18% more per year than it takes in taxes and fees. Sorry Bill, despite the popular belief that you ran a surplus; you too in fact were 0 for 8 in your ability to generate a surplus. You did have the single lowest deficit since 1960 in the year 2000 with a paltry, by Washington standards, deficit of just $18 billion. Here are some alarming data on deficits and the size of our national debt:

 

 

 

2007 data

Total debt of the US government

 

$9 trillion

Total debt of the US government – per capita

$ 30,026

Deficit in 2007

 

 

$500 billion

Deficit (for year) as a % of gross receipts

21.3%

Total debt as a factor of gross receipts

383.2%

Total debt as a % of GDP

 

68.2%

Deficit as a % of GDP

 

3.5%

The above data are alarming but one that is really scary is that our total debt is 3.8 times the size of the government’s gross receipts. That would be like saying a company doing $1 billion in revenue would have debt of almost $4 billion which is highly leveraged and very risky. In addition, the fact that it would take every man, woman and child, all 300 million of us, to pony up some $30k each to extinguish the debt is dreadful. The interest cost alone on the debt is now approaching $300 billion or about 10% of the total budget. This is one of the main causes that the dollar has depreciated over 60% since 2000 compared with the euro and why it is so hard to keep inflation in check. We just continue to print money. Let’s look at what the deficit and growth in the national debt are doing to the value of the dollar since 2000:

Value of the US $ vs. Euro, Canadian $ and UK pound:

 

 

Year

Deficit in $ billion

US Gov’t debt in $ billion

Euro to $1

C$ to US$

UK to $

2000

17.9

5,674

$ 0.94

$ 0.68

$ 1.55

2001

133.3

5,807

$ 0.90

$ 0.65

$ 1.44

2002

420.8

6,228

$ 0.94

$ 0.64

$ 1.50

2003

555.0

6,783

$ 1.13

$ 0.71

$ 1.64

2004

595.8

7,379

$ 1.29

$ 0.80

$ 1.91

2005

553.7

7,933

$ 1.24

$ 0.82

$ 1.82

2006

574.3

8,507

$ 1.25

$ 0.88

$ 1.84

2007

500.7

9,008

$ 1.37

$ 0.93

$ 2.00

2008*

500.0

9,500

$ 1.52

$ 0.96

$ 1.93

Decline in value of dollar since 2000:

61.7%

41.2%

24.5%

* Projected deficit and total debt – excludes “bailout” package.

 

 

Values are averages for each year except ’08 which is value at end of August.

 

The large depreciation in the value of the dollar compared to other world currencies such as the euro, Canadian dollar and pound sterling is also a huge underlying “tax” on our savings. It is a significant contributing factor to the increase in our national debt and deficit, especially compared to our slowing growth in GDP. If one wonders if this has any real impact I suggest you look at the price of oil or imported goods from Europe and you will find significant price increases since last year. If a few percentage points in tax rates can close that deficit, perhaps the dollar would be stronger and prices lower.

So what happens to the deficit, GDP and investment returns in periods after a major tax increase or tax cut?

 

Administration

Years

Average max marginal tax rate

Budget deficit on average as a % of GDP*

Growth in GDP**

Total return S&P 500

CAGR S&P 500 return **

Inflation rate over period

Growth in GDP over inflation

Kennedy / Johnson

61-68

79.4%

1.1%

6.6%

73.5%

7.1%

2.2%

4.4%

Nixon / Ford

69-76

71.1%

2.5%

9.1%

3.0%

0.4%

6.4%

2.7%

Carter

77-80

70.0%

3.1%

11.9%

27.4%

6.2%

10.4%

1.5%

Reagan

81-88

48.2%

5.3%

7.9%

101.9%

9.2%

4.2%

3.7%

Bush I

89-92

29.5%

6.2%

5.6%

58.1%

12.1%

4.2%

1.5%

Clinton

93-’00

39.6%

2.7%

5.7%

194.7%

14.5%

2.6%

3.1%

Bush II

01-’08

36.0%

4.0%

4.6%

-9.1%

-1.2%

2.7%

1.9%

Average

 

53.4%

3.4%

7.1%

1846.3%

6.4%

4.3%

2.9%

* The average budget deficit by year divided by total GDP by year.

 

 

 

 

 

** Compound annual growth rates over time.

 

 

 

 

 

 

 

Lots of data but what comes out is that some of our best returns in the S&P 500 were earned in periods of higher tax rates, often after a tax rate increase was enacted. The growth rate of the GDP has been on a rather steady decline but the budget deficit as a percentage of the GDP increased in the Reagan and both Bush administrations when tax rates were lower. Real growth as measured by GDP minus inflation suffered under Carter and both Bush administrations yet the tax rates were vastly different. On balance some of our best years were during the Clinton administration where we had a relatively low top tax rate (but higher than the previous administration) yet had smaller relative budget deficits, above average real growth and far superior investment returns. The key then seems to be a combination of modest tax rates coupled with modest deficits and it’s hard to have a modest deficit with really low tax rates.

As one of those “fat cat” Republicans in the maximum marginal tax rate I would gladly pay another 4-5% in income tax on my income above $300,000 and have much higher returns on my invested assets and the benefit of a lower deficit that otherwise is eroding the purchasing power of my money. So sorry Joe, I’ll pay more taxes if it is good for my country and also good for me financially, but it is not my patriotic duty to do so. It’s just good business.

Ray Link is a CPA and has an MBA from the Wharton School and is CFO of FEI Company, the world’s leader in electron microscopes. He is a former city councilman from Florida and a 30 year member of the Republican Party.

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