Spend any amount of time online, and you’ll be served with ads promising shortcuts and gimmicks to improve your health or credit score. Try this one easy trick, the ads say. But most of us know it’s never that simple.
Except it is when it comes to improving our economy.
Inflation is high, supply chains are garbled, and incomes are stagnant. How can we pull out of this tailspin? The Federal Reserve touts its arsenal of fancy-sounding tools: Interest rate changes, quantitative easing, and repurchase agreements, to name a few.
But the right way to grow our economy is much, much simpler: Cut the federal income tax.
In his new book, “Taxes Have Consequences,” economist Art Laffer examines the history of the major changes to the federal tax code since the establishment of our federal income tax in 1913.
Since its enactment, the top federal income tax rate has fluctuated immensely. The highest marginal tax rate has been as high as 91 percent (in times of war) and as low as 25 percent.
And throughout the last century, there has been a remarkable, consistent and irrefutable trend. The economy improves whenever this top marginal rate has been cut — and vice versa.
Consider the Roaring ’20s — which actually started with a whimper. High taxes imposed to fund U.S. involvement in World War I stifled economic growth. But that changed when Congress reduced the top income tax rate from 73 percent to 25 percent, and the economy took off. Cue “Great Gatsby.”
A similar situation happened after World War II. Federal taxes stayed high as the United States got involved in the Korean War, and the gross domestic product throughout the 1950s grew at a tepid 2.5 percent.
After his election in 1960, John F. Kennedy pushed a massive federal income tax cut that passed after his assassination. The result? GDP growth doubled to 5 percent.
Why does cutting federal income taxes help the economy?
First, taxing anything means people have less of it. If you passed a 1,000 percent tax on strawberries, everyone will start eating other fruit. Most politicians know this and even opt for “sin taxes” on things like cigarettes to reduce smoking. If you raise taxes on cigarettes, you’ll have fewer Marlboro sales. If you raise taxes on income, you’ll get less total income. Always.
With income taxes, higher rates discourage working. Who wants to work harder if the government will take 90 percent of what you earn?
Lower rates mean people can keep more of the money they earn. That incentivizes people to work more. It also means people have more money to spend — which is also good for the economy.
The top marginal rate — the rate paid on high incomes — is particularly important in this regard.
The top 1 percent of income earners provide a lot of revenue and also spend a lot. But they respond to incentives like anyone else. When taxes are high, high earners will look to make compensation in non-taxable ways.
In the high-tax 1950s, the top marginal rate was about 90 percent. People didn’t stop earning — they just changed how their compensation flowed to avoid taxes. Instead of paying their CEOs top dollar, companies shifted to providing huge perks — which were tax-free. Their salaries were lower, but they had their fine dining covered … daily.
A high-income tax rate also reduces federal revenues. As the federal government raised the tax rate in the early 1930s, overall tax revenue from the top 1 percent fell from $9.8 billion in 1929 to $3 billion in 1932. As people moved money out of the economy to avoid taxes, it helped exacerbate the Great Depression.
Don’t like loopholes? Who does? But the value of a loophole is tied to the tax rate. The higher the tax rate, the more valuable the loophole is to get out of paying taxes.
The best way to eliminate loopholes is to set the tax rate at a level that isn’t high enough to justify the hassle of ever having them.
What can the history of the income tax teach us about our present moment?
There are many parallels between the economic malaise of the 1970s and today. High inflation and stagnant growth combined to create “stagflation.” Interest rates skyrocketed, and unemployment reached double digits early in Ronald Reagan’s presidency.
How did we get out of that one? Reagan worked with Congress and received broad bipartisan support for tax reform in the 1980s. (Even Joe Biden voted for it.) These reforms led to economic growth in the late ’80s and ’90s.
As political strategist James Carville famously said, “It’s the economy, stupid.” More wealth circulating in the private sector spurs economic growth. High-income taxes take money out of the private economy and discourage productivity.
Lower taxes, better economy. And, as Arthur Laffer’s enlightening new book teaches us — if Reagan and JFK can do it, so can we.
