The controversy over AIG executives' huge bonuses that appear to be coming out of federal bailout money is helping fuel a populist revolt against the wealthy that has been gathering steam for years. It will undoubtedly aid Barack Obama's plans to raise taxes on the upper class. Indeed, yesterday, 87 Republicans joined 243 Democrats to impose a 90% tax on AIG bonuses.
According to Gallup, support for soaking the rich is rising. In 1998, 45% of respondents agreed the government should redistribute income by imposing heavy taxes on the wealthy. This percentage rose to 49% in 2007 and 51% last year.
Harris has found even stronger support for raising taxes on the wealthy. According to a 2008 poll, 62% of Americans believe the government should tax them more heavily. Interestingly, this percentage was higher than that in many European countries, generally thought to be more egalitarian than the U.S. For example, only 51% of respondents in France favored raising taxes on the wealthy.
Even Rasmussen, which produces results that are often favorable to the conservative point of view, found in a February poll that 51% of Americans say Obama's plan to raise taxes on those making more than $250,000 will be good for the economy; 31% disagreed. This month, Newsweek found 49% favoring the Obama plan and 42% opposing it.
Such results are confirmed at the state level. According to a Quinnipiac poll in February, 79% of New Yorkers favor a higher tax rate on those making more than $1 million, with just 18% opposed. When the threshold is dropped to $250,000 per year, 56% of voters continue to support the proposal, with 40% against.
I am fighting Communism, Huey Longism, Coughlinism, Townsendism. ... To combat this and similar crackpot ideas, it may be necessary to throw to the wolves the 46 men who are reported to have incomes in excess of $1 million a year. This can be accomplished through taxation.
In truth, there was less to Roosevelt's efforts than it appeared. As historian Joseph Thorndike points out, the heavy lifting in terms of raising taxes on the rich was actually done by Republican Herbert Hoover. In 1932, he raised the top rate to 63% from 25%. The threshold for paying the top rate went up to $1 million from $100,000, but the threshold for paying the 25% rate fell to $38,000 from $100,000.
Roosevelt's 1935 tax increase raised the top rate to 79%, but also sharply raised the threshold to which the top rate applied to $5 million ($76 million in today's dollars). According to historian Mark Leff, there was only one person in the United States who paid even a penny of taxes at the new top rate for the next three years: John D. Rockefeller.
It's important to remember that very few people paid any federal income taxes in those days. In 1935, just 2.1 million taxable returns were filed, 1.6% of Americans. It wasn't until World War II that the federal income tax affected a large percentage of the population. By 1943, 29.4% of Americans were filing tax returns, about the same as today.
Another thing to remember is that the 1935 tax increase was significantly mitigated in 1938, when Congress lowered the maximum capital gains tax rate to 15% on assets held longer than 18 months. Since most of the income of the very wealthy was in the form of capital gains, the actual effect of the higher income tax rate on them was largely symbolic.
Finally, it is important to note that inflation has greatly affected our perceptions. High tax rates in the past that appear to apply to low incomes actually applied to incomes that were much higher in real terms. The following table illustrates this fact by looking at the taxable income to which the 40% or closest bracket applied and converts it to 2009 (inflation-adjusted) dollars. I picked 40% because Obama is planning on allowing the Bush tax cuts to expire next year, which will raise the top income tax rate from 35% to 39.6%.
Sources: Tax Foundation, Bureau of Labor Statistics, Office of Management and Budget.
As one can see, taxpayers in the past were required to pay 40% in taxes on each additional dollar earned at income thresholds that have varied widely. Despite Roosevelt's 1935 tax increase, a taxpayer still needed to make $850,650 in today's dollars before reaching the 40% bracket.
In the postwar era, inflation raised marginal tax rates relentlessly with little relief from Congress. By 1980, even those making just under $77,000 in today's dollars found themselves in the 40% bracket--a rate that had been reserved for someone making more than $1 million, even after Hoover's 1932 tax increase (someone making $77,000 today is in the 25% bracket).
This is why so many taxpayers of modest means were attracted to Ronald Reagan's effort to cut income tax rates across the board. Although liberals continue to decry that his 1981 tax cut as a give-away to the rich, Reagan understood that a large portion of the middle class was being taxed as if it was rich. Interestingly, even after the Reagan tax cut was fully phased in in 1985, the 40% bracket began at an income substantially below what will be the case in 2011 when the Bush tax cuts expire.
Keep in mind that expiration of the Bush tax cuts won't reduce income thresholds to their 2000 levels, because indexing of brackets is a permanent feature of the Tax Code. The IRS has already determined that the threshold for the top rate will be $372,950 for 2009. Since the anticipated higher rates will apply to income earned in 2011, I have multiplied this figure by the estimated inflation rate between now and 2011, as published in Obama's budget, to calculate the threshold for the top rate that year.
Too much commentary on taxation from the conservative side treats changes in the top rate as the be-all and end-all of tax policy. But it's important to know what income the tax rate applies to. This is especially important when comparing tax rates today to those in the past. It is essential to adjust tax thresholds for inflation before drawing any conclusions.
Raising the top rate to 39.6% is a bad idea, but it is not the end of the world and may be a small price to pay to avoid even more punitive taxes on the wealthy that appear to have widespread support. It should be remembered that, as recently as 1986, the top rate was 50% and the 40% bracket applied to those with a real income one-fourth of what Obama proposes.
Bruce Bartlett is a former Treasury Department economist and the author of Reaganomics: Supply-Side Economics in Action and Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy. He writes a weekly column for Forbes.