The progressive income tax checks the greed that hoards income and chocks prosperity. How do we know this? For starters our strongest forty year period of US GDP growth roughly coincides with the highest forty year average top tax rate. Since Republicans started cutting the top tax rate in 1981 we have had the weakest forty years of growth in over eighty years. The tax cuts left the bottom half of society with their smallest share of the economic pie ever or at least in over a century.

Contrary to what billionaire owners of news media want you to believe a high top marginal tax rate leads to stronger growth by encouraging productive tax avoidance where business owners avoid taxes by plowing a larger share of business revenue into deductible expenditures like wages, equipment, marketing, training and research that build businesses and grow the economy. Given the choice of paying a high tax rate on taking an additional dollar of business revenue as personal income or plowing that dollar into building wealth tax free within a business the higher the marginal tax rate the more attractive building wealth within a business becomes.

Of course, to enable this productive tax avoidance and minimize unproductive tax avoidance the first five to ten brackets in an income tax schedule have to allow business owners to pull out enough revenue as income at a low enough average tax rate that those with great talent and/or capital have plenty of incentive to run and build businesses.

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The chart above shows how strong growth and a high top tax rate go together. There are some wild fluctuations on the forty year growth rate shown in the blue line above. For a bit of perspective in 1973 the Great Depression had just dropped out of the 40 year growth rate. From 1973 to 1984 the strong growth of 1934–1944 was dropping out of the forty year window and the blue line plummeted. From 1984 to 1989 the weak growth following WWII dropped out of the forty year period and the blue line rebounded. So the forty year period ending in 1989 (1950–1989) is the first one in six decades to not be affected by the Depression or WWII. It grew at 2.48 percent per person with a top tax rate averaging 72 percent. From there as the average top tax rate fell to 39 percent the growth rate fell to 1.59 percent.

The growth rate fell because capitalists running businesses, who have the power to take a larger share of the wealth and income, took a larger share. The long term growth rate is highly sensitive to the ratio of business revenue used to run and grow businesses and that ratio is sensitive to the top marginal tax rate. With the low top tax rate capitalists have been pulling trillions more dollars out of business as income than they would if the top tax rate were still 70 percent. Workers of course can’t get paid with dollars that were pulled out of businesses.

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The share of income going to the bottom half of society shown in the gray dots above fell to its lowest level in 2014. The data I have began in 1913. In the last 10 years (2010–2019) their share averaged 13.1 percent of the income, lowest ten-year average ever. The red line is an estimate or model of the influence of the top marginal tax rate and the capital gains tax rate on the share of income going to the bottom half of society.

The weak 10-year average corresponds with the capital gains rate of 15 percent which was in place from 2003 to 2012. The blue line for the capital gains rate is pushed forward seven years to show the time it takes capitalists to fully adjust how much income they take. So there is about a 7 year lag time between a change in the capital gains rate and its influence on the income of the bottom half of society. Notice I say influence not cause. Tax rates may be the primary influence on the share of income going to the bottom half, but there are enough other influences and preconditions that I don’t believe it constitutes a cause.  

The top marginal tax shown in the green line leads the share of income by nine years. So nine years after the top tax rate goes up there is a tendency for the share of income for the bottom half to rise. Movements in the tax rates are mirrored in the red line. If the green line goes up a quarter of an inch and the blue line stays flat, the red line goes up a quarter of an inch. If the blue line falls a half inch and the green line goes up a quarter the red line will fall by the difference, a quarter of an inch. This is not random; I scaled the axes of the two tax rates according to their correlation with the share of income.  

The bottom half of society was getting around 20 percent of the income in the late 1960s and early 1970s. This was their largest share ever and roughly corresponds with the strongest growth and the highest average top tax rate shown in the first chart.

The last gray dot shows the bottom half of society got 13.3 percent of the income in 2019. This is the last year influenced by the George Bush tax cuts. Most of those cuts expired at the end of 2012. The correlation in the red line suggests their share will rise to 14.7 percent in 2022.

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The income share for the 40 percent of society between the bottom half and the top 10 percent is comparable in size to the top 10 percent, but the relationship with tax rates is similar to the bottom half. High marginal tax rates mean the middle 40 percent get a larger share of the pie. The correlation maximizing lead time for the capital gains rate is the same at seven years, but the optimal lead time for the top marginal rate is thirteen years rather than nine years. I think this is because it takes longer for the top 10 percent to squeeze the income of the middle 40% than it does the bottom half.

The share of income going to the top 10 percent has an inverse relationship with marginal tax rates. The higher the rate the smaller the share of income the top 10 percent take. Notice the scales for the tax rate axes are inverted.

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 Business owners choose what share of business revenue to take as personal income and what share to plow into running and growing businesses. The lower their marginal tax rate the more income they take and the more they squeeze everyone else to take it. The higher the marginal rates the top 10 percent face, the more attractive growing wealth within businesses becomes and the larger the share of income goes to the bottom 90 percent.

There are lots of different beliefs about what distribution of income is fair. Dwelling on fairness appears to be a distraction. To me the more important question is what distribution of incentive leads to baking a big enough pie to satisfy everyone. We don’t want everyone to have the same income which would likely sap incentive of our most talented to fully use their gifts. If the top 0.1 percent ended up with all the wealth regardless of the effort put in by the 99.9 percent we would again have a dismal economy.

As I read the history the best growth comes when the bottom half gets about 20 percent of the pie, the middle 40 percent get about 45 percent of the income and the top 10 percent get about 35 percent. This may not be the optimal distribution of incentive, but history makes it pretty clear income/incentive is too concentrated to allow the best growth. 

I interpret this data to mean the top 10 percent has the political and/or economic power to take more income than they produce which leads to a mal-distribution of incentive and weaker growth. If the stronger growth of yore had continued the last forty years and the top 10 percent got the smaller share of the pie that they did in 1980 their income would be larger than it is now. 

It appears the top 10 percent pursuing their short term interest slashed the growth rate and harmed their long term well being along with harming the short term and long term well being of the other 90 percent. The greed of the top 10 percent unleashed by cutting the top marginal tax rate didn’t kill the goose that lays the golden eggs, but it shrunk the eggs. Restoring a more progressive income tax can realign the short term interest of the top with the long term well being of everyone and bring back those plump eggs.

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