The top marginal tax rate

by Gaius Publius on 5/24/2010 08:40:00 PM

In a recent article, I presented some of the basics about Social Security and some of the history around it. The article attempted to make four major points plus a bonus idea. In brief:

1. You don't contribute to your own retirement. Your money goes to your parents. Your kid's money goes to you.

2. You already "fixed" Social Security in 1983, and paid for it in higher payroll taxes.

3. Reagan used that earlier "fix" to hide much of his massive deficit.

4. The Trust Fund has a lot of money. The real goal of the current "fix" is protect the budget, not Social Security.

BONUS. Reagan created the Gordon Gekko era by removing the disincentive that kept CEOs from looting their own companies.

In this post, I want to expand the final point above, the Bonus point. Paul Krugman conveniently posted this image twice this weekend, and added some comments. His initial point:

Basically, US postwar economic history falls into two parts: an era of high taxes on the rich and extensive regulation, during which living standards experienced extraordinary growth; and an era of low taxes on the rich and deregulation, during which living standards for most Americans rose fitfully at best. [emphasis mine]

Here's my annotated version of his graph:

The red line is Krugman's graph of the top marginal tax rate. (Note that this is not the tax rate on all dollars; it's the rate on the last dollars only, when the last dollar is in the stratosphere. No one ever paid 90% on all dollars earned.)

The blue line is Krugman's log-scaled median family income. As Krugman notes and I pointed out in my own article, that's a bit misleading, since by the 1980s two incomes were often used to get this result. The great rise in median income from 1948 to 1970 was a rise in one-income families.

The green lines and text are mine. My comments:

1. Reagan took the top rate (again, the rate only the very rich, like CEOs paid on their last dollars earned) into the cellar. Corporate productivity climbed, but salaries for you and me stayed flat — actually fell, since in the 80s, two incomes were needed to produce this uninspiring result.

2. Krugman won't make the causal point, but I will. Starting in roughly 1980, corporations made a ton of money that they weren't paying out in wages. Where to put those extra dollars? Well, there were only other two choices — plow them back into the company (what used to happen), or pay them out in exec compensation. With the top marginal rate now cut almost in half, exec compensation was the obvious choice. The incentives almost insisted on it.

Look again at the post-war boom. The top marginal rate was the great disincentive that kept CEOs from pocketing the profit. This allowed profits to go to higher salaries for everyone and real growth for the companies. Why swipe the second $20 million in salary if that $20m goes back to the gov't? (Again, only the second $20 million, or whatever, was taxed at the top marginal rate.)

3. After Reagan massacred the top rate, everything that followed is tweakage. Clinton made things marginally better — note the slight increase in top tax rate AND the slight increase in family income. Bush II brought the top rate back down and killed off Clinton's small gain in income.

Krugman sums up:

The basic point [ . . . ] is that the US economy did very well with tax rates and levels of regulation (and strong unions) that, according to modern mythology, should have been crippling. That’s why conservatives have invented an alternative history in which it never happened.

Larry Beinhart makes the same point, by the way, in this HuffPost article (h/t Thom Hartmann).

Gaius