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How will the tax rate increases included in this week's budget deal impact the economy? One view receiving lots of attention is that the historical experience of the 1950s suggests that high tax rates are not an impediment to economic growth. After all, the 1950s featured a top marginal federal income tax rate as high as 92%, and the economy grew at an impressive rate — indeed, five years in the 1950s featured a real annual GDP growth rate in excess of 4%. But the tax and growth experience of the 1950s, as stated above, is misleading. My colleague Amity Shlaes sets the record straight in her recent column for Bloomberg. Shlaes writes that four main "illusions" are often thrown about in discussions of the 1950s tax experience. First, while official tax rates were indeed sky high in the 1950s, the effective rates (i.e., the rate people actually pay after all deductions and exemptions are figured in) were much lower. When income from capital gains is considered, effective rates were as low as 31% by 1960. The second fallacy Shlaes clears up is the belief that in the 1950s the "government soaked the rich." While "fairness" was certainly an important justification for the high rates during the 1950s (see the Bush Institute's recent study on this topic by fellow Joseph Thorndike), Shlaes writes that in the 1950s, "those earning more than $100,000 paid less than 5 percent of the taxes collected in the U.S., a far smaller share than the wealthiest shoulder today." Thus the lesson from the 1950s is not that "soaking the rich" leads to growth, but rather that raising rates on the rich can have the opposite effect. Third, Shlaes notes, the overall tax climate of the 1950s differed compared to our tax climate today. In the 1950s tax rates were headed in a downward trajectory, and people knew it. Today there's much uncertainty about taxes, but the cues coming out of Washington suggest that rates will only climb higher in coming years. While the prospect of lower taxes in the 1950s encouraged growth, today's fear of future tax hikes will likely hold the economy back. Finally, America's position in the global economy of the 1950s was quite different from its position in 2013. In the 1950s the U.S. enjoyed economic "primacy." In that decade the economies of most other developed countries were still trying to recover from the destruction of WWII. This meant the U.S. faced less international competition and could charge high tax rates without sacrificing too much growth. Today the international scene is much different. Global competition makes tax rates highly relevant, and the U.S. already has higher rates than most other developed countries. While the U.S. could get away with high tax rates in the 1950s, it is no longer afforded that luxury. Continued tax denial will spell continued slow growth. You can read Shlaes's entire column here.
Matthew Denhart is an expert on immigration policy and is the author of the Bush Institute’s America's Advantage: A Handbook of Vital Immigration and Economic Growth Statistics, now in its third edition. He currently serves as executive director of the Calvin Coolidge Presidential Foundation and is a founder of the Coolidge Scholars Program which provides full-ride merit scholarships to America's most promising college students. A summa cum laude graduate of Ohio University, Denhart has written and spoken widely on a variety of policy topics including the economics of higher education, labor, and taxes. He has contributed articles to numerous national publications including The Wall Street Journal, Forbes.com, CNN Opinion, and Bloomberg View.Full Bio