EDITOR’S NOTE: This piece appeared in the August 31, 1992, issue of National Review as part of “The Real Reagan Record” cover package.
Myth: The rich paid a larger share of taxes only because they had a larger share of income.
“Economic research shows that if a wealthy family paid more taxes than its middle-class counterpart during the Reagan-Bush years it was only because the rich had bigger paychecks…. It was all part of the ‘Reagan Revolution,’ during which federal income taxes of the wealthiest were reduced from a top rate of 70 per cent to a top rate of 28 per cent.”–Boston Globe, October 14, 1990
Federal Reserve Board Governor Lawrence Lindsey, who served on the staff of Reagan’s Council of Economic Advisors, lays waste to this notion in his 1990 book The Growth Experiment.
Lindsey, whose appointment to the Federal Reserve has been President Bush’s greatest economic-policy achievement, notes the effect lower rates have not only in high-income taxpayers’ willingness to work longer hours, but on “decisions about how to arrange their given financial conditions, such as choosing taxable or tax-exempt bonds, or one stock over another, or more cash over fringes in salary negotiation, or how much to contribute to charity.” In other words, how much income to shelter and how much to declare as taxable income, which is the data source for average-income comparisons.
“Consider the decision to buy a bond,” Mr. Lindsey explains. “Suppose a taxable bond yields 10 per cent and a tax-exempt bond, issued by a state or municipal government, yields only 4 per cent…. For a taxpayer in the 70 per cent bracket, the taxable bond yields only 3 per cent after taxes. The tax-exempt bond is the better investment. On the other hand, if this taxpayer’s tax rate is cut to 50 per cent, the after-tax yield on the taxable bond rises to 5 per cent, more than the tax-exempt bond. Thus one pecuniary effect of tax cuts is to cause investors to hold more taxable securities and fewer tax-exempt securities, producing more tax revenue.”
James Gwartney, an economics professor at Florida State University, notes that “the lower rates drew funds out of the tax shelters and reduced the attractiveness of pleasurable, tax-deductible, business-related expenses (e.g., plush offices, travel to nice places, and luxury automobiles). As a result the reported income–after deductions–from partnerships and Sub-S Corporations (two major vehicles used for tax-shelter investments) of the top 5 per cent of taxpayers rose from $12 billion in 1980 to $56 billion in 1988, a whopping 360 per cent increase. Similarly, the reported income from business and professional practice of the top earners skyrocketed during the 1980s.”
More important, the lower tax rates are conducive to entrepreneurial start-ups and greater work effort. Lindsey, again: “Indeed, the evidence suggests that high tax rates help ossify the class structure rather than break it down. In 1960, when the top rate was 91 per cent, the income of the rich was drawn disproportionately from interest and dividends. The top 2 per cent of taxpayers received 48 per cent of interest and dividends but only 8.7 per cent of wage, salary, and entrepreneurial income. By 1985, with a 50 per cent top rate, the share of interest and dividends received by this group was cut in half while the share of wage and entrepreneurial income had risen 28 per cent. The real losers from soak-the-rich taxation are not the presently rich, but the would-be rich. High income-tax rates bar access to the upper class.”