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Flat taxes make fat cats fatter — we need more and higher tax brackets

Under the glossy allure of simplicity, conservative challengers for the presidency are engaged in a mighty struggle to offer a tax plan that likely will be even more advantageous to the top 1 percent than their current sweetheart deal.

Rep. Michele Bachmann has said she’ll reduce the number of tax brackets to three, details later. Before he suspended his campaign, Herman Cain announced his 9-9-9 plan — one bracket, sort of, but three numbers. Rick Perry achieved the holy grail: one single flat tax at the congenial rate of 20 percent.

Here’s the simple truth about all these simplistic formulas: All are great or better than the status quo for the top 1 percent of income earners, not so good for the rest of us. 

The popular appeal of such plans is based in part on an illusion that the current federal income-tax code has a complicated bracket structure with too many rates. In fact, there are now only six brackets, a historic low.

Three elements are key
Historical analysis of the alternative flatter tax plans should be focused on three elements: the number of brackets, the rate for each, and their income cutoffs. We have fewer than ever, and both the rates and especially the income thresholds are too low to balance our federal budget or to restore tax fairness.

 Most people seem to realize that the top income-tax rate was once quite high. How high? In 1944 it touched 94 percent. Sanity returned in 1946, when the top rate plunged to a modest 91 percent. There it hovered, with the economy growing by leaps and bounds, until 1964. The trend in the top rate since that time has been almost uniformly downward.

The top rate fell to 50 percent in 1982 and, with the 1986 tax reform, to 38.5 percent in 1987. It dropped further, to 28 percent, in 1988. Increases in 1991 and 1993, to 31 percent and then to 39.6 percent, reversed the trend slightly. Throughout the 1990s, growth surged. In 2003, the top rate crept back down to 35 percent. We know how that turned out. And there it remains today.

But where along the income scale did these top tax rates kick in?  First, for reference, in 2010 our top rate of 35 percent applied to all taxable income above $379,150. (This is for a married couple filing jointly.) Above that level, America’s wealthiest families already are enjoying a flat tax.

It was not always this way.

In 1939, a bracket for one
The history of our top bracket can boggle the mind. For six years, from 1936 to 1941, the top rate did not kick in until income rose above $60 million (this and all dollar values are in 2010 inflation-adjusted dollars). In 1939 one had to bring home an eye-popping $78.5 million in order to reach the top bracket. At the time, that awe-inspiring bracket caught exactly one taxpayer:  John D. Rockefeller. Some called it the Rockefeller tax. John D.’s personal top rate that year was 79 percent.

The highest income in 2010, at $5 billion, was collected by John Paulson, manager of Paulson and Co., a leading hedge fund. We have no Paulson tax, though. Quite the opposite: Like all income earned by hedge-fund managers, Paulson’s income was taxed as capital gains. He paid 15 percent on everything.

Just like the top rate, the threshold for the top bracket has fallen almost uniformly over the past six decades. In today’s dollars, the threshold stood at $3.6 million in 1950. From there it fell to $1.4 million in 1965, to $982,000 in 1973, to $517,000 in 1981, and to $134,000 in 1992.

It wasn’t only the top rate that changed during the Clinton years. So, too, did the threshold for the top rate, to $377 thousand in 1993. Since then it’s been indexed to inflation, so it holds steady in adjusted dollars. Still, today’s top threshold of $379,150 would have been unimaginably low to our grandparents in 1950.

In 1921, 56 brackets
Just like the top rate and the top bracket, the number of brackets has dropped precipitously. To those of us accustomed to today’s tax law and its tidy collection of six brackets, the number of brackets in the old days can also boggle the mind. In 1921 we had 56 brackets. For 35 years, from 1942 to 1978, the number of brackets bounced between 24 and 26.

Reagan’s 1986 reform dropped the top rate and the top bracket threshold. It also dropped the number of brackets from 15 in 1986 to 5 in 1987.

From the 1940s to the mid-1970s the almost rich could look up the income distribution to the truly rich and take comfort in the fact that those top incomes required a higher rate. No so today. Our top bracket captures those making $400,000, $4 million, $40 million, or $400 million. And those at $400 million are more likely to pay the capital-gains rate of 15 percent.

Something is not right with this picture.

Its the deductions that complicate things
Some will say that more brackets makes the annual tax chore too complicated. This argument never held any water. It’s the deductions, and all the extra forms required to claim them, that complicate things. With the help of inexpensive tax software, after accounting for the complex set of deductions, computing the amount of tax owed is no harder with 25 brackets than with six.

A move to fewer brackets is a move in the wrong direction. We need more brackets, not fewer. And we need a higher top threshold.

Jay Coggins is a professor of applied economics at the University of Minnesota and a policy fellow for Growth & Justice, a policy research organization that focuses on economics and building a broader prosperity. His views do not necessarily reflect the position of the University of Minnesota.

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Comments (7)

  1. Submitted by rolf westgard on 12/09/2011 - 05:55 am.

    Right on, Professor Coggins. Your analysis explains a major reason why our government is running short in the revenue area of the income statement. I’m afraid the analysis is a bit complicated for our “government is the problem, so let’s cut its revenue” legislators at various capitols.

  2. Submitted by Richard Schulze on 12/09/2011 - 07:01 am.

    The only flat tax worth having is a consumption tax (and / or a carbon tax). If you want to simplify the tax system, which is the appeal of these so-called flat tax plans, we already have half of the solution in place. The AMT is a flattish tax on high incomes. Keep the AMT, lose the regular income tax (including corporate tax), and put in a big (and flat) VAT. Taxing consumption is better economically than taxing income, and the big bonus is to lose the regressive tax deductions for medical plans and mortgages.

  3. Submitted by Richard Schulze on 12/09/2011 - 07:40 am.

    Oh, and the final and relatively obvious lesson is that if you raise consumption taxes, as many are sensibly proposing, you have to compensate by making income-tax rates more progressive. Otherwise you end up with poor people actually paying a higher share of their income in taxes than rich people do.

  4. Submitted by rolf westgard on 12/09/2011 - 08:20 am.

    Richard, I’ll buy the carbon tax, especially on gasoline. It serves many useful purposes including raising revenue.

  5. Submitted by Dennis Tester on 12/09/2011 - 11:05 am.

    Assuming that the purpose of taxation is to fund the government and not to encourage, discourage, or otherwise affect anyone’s behavior, there are a number of things wrong with the current tax structure.

    1. Taxing a man’s labor is immoral, reducing him to one step above slavery where, as a slave, he wouldn’t be allowed to keep any of the fruits of his labor.
    2. If you see nothing wrong with using taxation to affect behavior, then taxing labor is counterproductive because it discourages it the way sin taxes allegedly discourage sin.
    3. Since all citizens benefit from government services, all citizens should pay something for those services.

    The fairest way to collect revenue to fund government is through a consumption tax. Everyone buys stuff (even illegal aliens) and those who buy the most would end up contributing the most to fund government.

  6. Submitted by Dennis Tester on 12/09/2011 - 11:08 am.

    “Most people seem to realize that the top income-tax rate was once quite high. How high? In 1944 it touched 94 percent. Sanity returned in 1946, when the top rate plunged to a modest 91 percent.”

    Yes, well some people also know that the top rate in 1913, when the income tax came law, was 7%. The bottom rate was 1%.

  7. Submitted by Karen Sandness on 12/09/2011 - 01:42 pm.

    And Dennis, our society was vastly different 99 years ago. I doubt that you’d want to return to those days unless you were very wealthy.

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