In an excellent column featuring just a few of the many silly predictions made by mainstream economic thinkers of days past, Forbes’s Rich Karlgaard noted the back-cover description of MIT economist Lester Thurow’s 1980 book, The Zero-Sum Society: “the American economy will not solve its most trenchant problems — inflation, slow economic growth, the environment — until the political economy can support, in theory and in practice, the idea that certain members of society will have to bear the brunt of taxation and other government-sponsored economic actions.”
Just as the U.S. was about to begin an almost uninterrupted economic expansion that continues to this day, by way of marginal tax cuts that stimulated the growth that licked inflation, Thurow proposed an economic plan that would have set growth back, reduced money demand, and made environmental projects less pressing (as they would have been difficult to introduce amidst sub-par growth). However, while his assumptions were proven wildly incorrect, economic history in a strange way has proven him right for the wrong reasons.
What Thurow misunderstood was a basic truth showing that the best way to raise taxes on the rich, or to get the rich to foot more of the federal government’s spending, is to reduce the marginal tax burden on their success. In short, you raise taxes by cutting the marginal rate of taxation, not by increasing it.
Ahead of the Mellon tax cuts of the 1920s, a New York Times editorial put it this way: Treasury Secretary Mellon “wants in reality to get more money out of [the rich] than they are now paying. But he proposes to do it by making their rate of taxation lower.”
The next few years greatly vindicated the assumptions made by the editorialists at the New York Times. While the percentage of federal taxes paid by earners in the $100,000-plus category was 28 percent in 1921, by 1928, when the top rate was 25 percent, the $100,000-and-over earners accounted for 61 percent of all federal tax receipts. Conversely, those who earned $10,000 and less saw their share of the federal tax burden decline from 22.5 percent to 4.5 percent. As the late Warren Brookes pointed out, the Mellon tax cuts that set the stage for the Roaring ’20s were “the most ‘progressive’ in history.”
Moving to the 1960s, President Lyndon Johnson pushed through tax cuts proposed by President Kennedy that lowered the top tax burden from 90 to 70 percent. Walter Heller (chairman of the Council of Economic Advisors under Kennedy) later admitted that the lower rate on top-earners similarly proved progressive when it came to the “rich” increasing their contribution to federal revenues.
When Thurow’s book debuted, the top tax rate was 70 percent and the top 1 percent of earners delivered 15 percent of federal revenues. Fast forward twenty-seven years: With the top rate at 35 percent, the top 1 percent provide 34 percent of federal income-tax receipts.
The simple reality behind wealth creation is that it occurs when society’s most productive members are left to innovate as freely as possible from governmental roadblocks to growth. With tax rates well down from their 20th century highs, there are far greater incentives today to attempt new ideas that lead to new products and higher paying jobs. On the inflation front, products and jobs, at the core, are money demand — which means growth-stimulating tax cuts are the single best antidote to inflationary pressures.
Thurow, alas, was wrong all over. However, he should be given his due for noting that improvements to society will only occur in an economic environment where the “rich” are paying far more than their fair share. It simply comes down to how they pay it. For one, high incomes rarely reveal themselves when the penalty for doing so is excessive expropriation. And the idea of increasing the tax revenues supplied by America’s rich is incomplete absent the basic understanding that marginal tax cuts are the best way of achieving this goal.