We Have Reached a Consensus on Tax Rates

Over time, ideas can imperceptibly evolve from unthinkably naïve, to politically plausible, to conventional wisdom. The value of low marginal tax rates is one such idea that has taken root, at least in the United States. During World War II, the highest marginal tax rates were 94 percent. Given the economic demands of that war such confiscatory rates might be acceptable as a short-term expedient. However, marginal federal income rates remained over 90 per cent into the early 1960’s. Then President John Kennedy’s Administration worked to lower the top marginal rate to 77 percent with a resulting decade of high economic growth. The rates lingered in the 70-percent range through the 1960s and 1970s. As inflation cut in, more and more people were pushed into higher brackets and higher tax rates. By the 1970s, the US was suffering under double-digit inflation rates and unemployment rates of over 8 percent.

The Ronald Reagan became president in 1980. During the Reagan years the highest marginal tax rates gradually dropped from 50 per cent to 31 per cent, the result was higher growth rates, lower inflation, and lower unemployment. During the Clinton years in the 1990’s the highest marginal rates increased to 39 per cent, higher than 31 per cent, but still very low by historical or international standards. The Bush tax cuts decreased the top marginal rate to 35 per cent, pretty much the average over the last 20 years. Democrats enjoy railing about the about how drastic the Bush tax cuts are and how they might raise taxes, but no one is talking about returning the rates of the 1970s, much less the confiscatory rates before 1980. The Reagan tax revolution has become about as permanent as anything gets in politics.

Unfortunately, this consensus has not reached a Europe that still languishes with marginal tax rates over 50 per cent. Since 1991, the United States with low rates has grown at the average annual rate of 3.3 percent, while Germany and France with high tax rates have managed only 1.4 percent and 2.0 percent, respectively. While these growth rates may not seem very different, compounded over many years they result in dramatic differences. From 1991 to 2004, Germany grew by 19.8 per cent, France by 29.4 per cent and the Unites States, by a whopping 52.5 per cent. If the US had grown as slowly as Germany, it would have to raise the mean current tax rate by over 25 percent to obtain the same of revenue it now achieves at lower rates. The Europeans remain too smart to see the value of low marginal tax rates.

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