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What The Numbers Tell Us About Taxes – Three Years Later

In 2008 I wrote about the danger of large deficits, and in particular how they impact high-income people. My conclusion was that it was good for us to have slightly higher tax rates.

Well now Washington is in melt-down mode as our elected officials are unwilling or unable to remotely balance a budget. Even the threat of a default on U.S. debt cannot move the debate forward. The Republicans lead by Speaker John Boehner have taken a hard stance against any increases in taxes, even those that impact high-income people and close
loop-holes for large corporations. Being an accountant I decided to take a look at where we are now and crunched some numbers to flesh out the facts.

Prior to 1913 the government funded itself largely from tariffs on imports. From 1913 Congress gradually increased rates from 1% to 94% during World War II and then 91% for many years.  This top rate is paid on income above a stated level, which affects a small percentage of taxpayers, but because these few earn so much it contributes a fairly large percentage of tax paid.  It is also a source of debate when Congress changes it as it only impacts a few people.

These high rates prompted many tax shelters and schemes to avoid taxes, and were eventually lowered first by Kennedy to 77%, then by Reagan to 50% (28% in his final year).  George H.W. Bush increased it to 31% followed by Clinton’s increase to 39.6%, and then George W. Bush reduced it to 35%.  The entire debate on tax increases to help
balance the budget is all about the extra 4.6% tax on incomes over $300,000 and
about closing loop-holes that benefit just a few.

We now enjoy some of the lowest tax rates in the past 50 years. However, are we and the country better off?  Do investments perform better in high tax periods or in lower tax periods?  What is the effect on the deficit, national debt, and gross domestic product?  The deficit and corresponding debt impacts inflation and the value of the dollar, which impacts our world purchasing power.  After all, high income tax payers are the people with all the money so they should probably be more concerned over the value of their money than paying slightly higher taxes.

For all the Tea Party’s rhetoric, I wonder if any know the facts.

  • Fact one, the U.S. has run a budget deficit every year since 1957.
  • Fact two, since 1960 the government spends about 18% more per year than
    it takes in taxes and fees.  Sorry Bill Clinton, despite the popular belief that you ran a surplus, you had a paltry, by Washington standards, deficit of just $18 billion in your last year.

The total debt of the U.S. Government is approaching $14.3 trillion, and is approaching the GDP of $15 trillion.  At $14.3 trillion the debt it is over 5 times the size of what the government takes in.  The equivalent is a company doing $1 million in revenue with over $5 million in debt which is highly leveraged and very risky.  In addition, the fact that it would take every man, woman and child, all 300+ million of us, to pony up over $45,000
each to extinguish the debt is dreadful.

The interest cost alone is now approaching $400 billion, or 10% of the
budget. Clearly spending is out of control with 40% of every dollar spent by
the Government being borrowed this year. This is one of the main reasons the dollar
has depreciated over 40% since 2000 compared with the Euro, and why it is so hard to keep inflation in check. We just continue to print money.

The deficit and growth in the national debt is wreaking havoc on the value of the dollar.  The large depreciation in the value of the dollar compared to other world
currencies such as the Euro, Canadian Dollar and Japanese Yen is also a huge
underlying “tax” on our savings.  It is a significant contributing factor to the increase in our national debt and deficit, especially compared to our slowing growth in GDP.

If one wonders if this has any real impact I suggest you look at the price of oil or imported goods from Europe and you will find significant price increases. If a few percentage points in tax rates can close the deficit, perhaps the dollar would be stronger and prices lower.

Looking at the data it is interesting to see that some of our best investment returns in the S&P 500 were earned in periods of higher tax rates, often after a tax rate increase was enacted. The growth rate of the GDP has been on a rather steady decline but the budget deficit as a percentage of the GDP increased in the Reagan and both Bush administrations when tax rates were lower. Real growth as measured by GDP minus inflation suffered under Carter and both Bush administrations, yet the tax rates were vastly different.
On balance some of our best years were during the Clinton administration where
we had a relatively low top tax rate (but higher than the previous administration) yet had smaller relative budget deficits, above average real growth and far superior investment returns. The key then seems to be a combination of modest tax rates coupled with modest deficits,  and it’s hard to have a modest deficit with really low tax rates.

I am all about cutting Federal spending but it appears that we are at a point where Republicans must offer up some additional taxes. As one of those “fat cat” Republicans in the top rate I would gladly pay some added tax on my income above a certain level and have much higher returns on my invested assets and the benefit of a lower deficit that otherwise is eroding the purchasing power of my money. So sorry to burst your bubble Speaker Boehner, I’ll gladly pay more taxes to balance the budget.  It’s just good business.

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5 Responses to What The Numbers Tell Us About Taxes – Three Years Later

  1. Mike says:

    Well done, the lack of historic perspective by the Tea Party is astounding. Very good commentary.

  2. Scott says:

    I like Paul Ryan’s comment about the tax problem.
    “Many in Congress, however, continue to push for imposing tax increases on those making more than $200,000 a year and increasing taxes on companies’ profits. But if a 100% tax were imposed on all individual taxpayers making more than $200,000 and married couples making more than $250,000, it would only fund the federal government for 7.5 months. If a 100% tax were imposed on all profits of Fortune 500 companies, it would only fund the federal government for 40 days.”

    So while I don’t want to pay more taxes than I currently do, this is really a spending problem we have and not a revenue issue.

    1. Reform Medicare.
    2. Reform Social Security.
    3. Everyone pays income tax.
    4. Cut military spending.

  3. Milt says:

    Great post Ray. If I could I would vote out every member of congress, impose term limits, limit campaign duration to 6 weeks and give free limited air time. I have had it with this dysfunctional government and society in which compromise, the basis of politics, has become a dirty word.

  4. Nina Vallion says:

    How about this:
    1. Have a flat tax; no loopholes;
    2. From our Preident down to every member of our government who now has a government pension and health insurance should only be entitled to social security and medicare or the same med. insurance as the rest of us;
    3. The social security system should be administered as a real trust fund in which the trustees have a duty to preserve it – not use it for
    improper purposes.
    That way our representatives may have A GREATER MOTIVATION TO REDUCE SPENDING on the military fighting in plces we have no business being, sending foreigh aid that never reaches the intended beneficiaries (charity begins at home, and we all know it is needed here)

  5. Mike Wilcox says:

    I agree with Scott relative to reducing spending, I disagree that we do not also have a revenue problem. Our tax base has been eroded due to the loss of higher paying blue collar jobs and we allow corporations to play the tax avoidance game far too easily. I think that a flat tax on all gross income would serve to eliminate all lot of this.

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