The Relationship Between Tax Rates & Job Growth

Note from your editrix: This post is from Bryan Ganz, a family friend who has researched the correlation between U.S. marginal tax rates and GDP. With his gracious permission, I am sharing his insightful analysis. For more information, please listen to his interview on NPR.

With all the noise coming out of Washington recently over whether or not we should raise marginal tax rates on the wealthiest Americans, I became curious to know whether the claims being made by Paul Ryan and the Republicans were accurate.  After all, I am the small business owner, that engine of job growth that is theoretically going to stop hiring and investing if marginal tax rates go up by 4.6%.  To be honest with you, when I heard this I felt pretty stupid.  I had never even thought about the top marginal tax rate when deciding whether to hire more empoyees.  Naively, the only thing I looked at was whether we needed the additional people to operate the business.

So I decided to do some research… on the Internet.  I am of part of that lost generation that still thinks the Internet is cool.  I never cease to be amazed by what I can look up online.  My kids on the other had think of the Internet as just another appliance, like the TV or the refrigerator.  In any event, I entered “top marginal tax rates” into Google and up came a plethora of sites.  The best one was “TruthAndPolitics.org.”  They provided a table of both the top marginal tax rate year-by-year and income level where the top rate kicked in.  I have to admit, I was fascinated by what I discovered.  First, as many of you probably know, there was no income tax in this country before 1913.  What you probably don’t know was that when the Federal Government first established an income tax, the top rate was only 7% and applied only to income over $500,000 – in 1913 dollars.  In today’s dollars that would be $11.4 million.  Clearly income tax was not something the man in the street needed to concern himself with in 1913.

As it turned out, however, income tax was like heroin – once you start you keep needing more.  By 1918 the top rate had jumped to 77% but applied only to people making more than $1.0 million a year ($16 million in 2011 dollars).  Then in 1922 the rates started to fall getting as low as 25% by 1925 where they essentially stayed until 1932 when they were raised to 63%.  It is interesting to note that the lowest rates in our history preceded the greatest economic depression of all time.  Rates were raised again in 1936 to 79% and again in 1942 to 88%. Then from 1942 to 1963, 21 years, the top rate stayed between 88% and 94%.  The top tax bracket, however, from 1948 to 1964 was $400,000.  While this was quite a bit lower than the $1.0 million of 1918, it was still between $2.9 million and $3.75 million in today’s dollars.  In 1964 the top rate was lowered to 77% and by 1971 had fallen to 70% where it stayed until Ronald Reagan reduced the top rate to 50% in 1982.  Then in 1987, things really started to get fun as Ronald Reagan and the George Bush (the first) lowered the top rate to 28%.  This turned out to be too much fun, however, and George (“Read my lips”) Bush was forced to raise rate back up to 31%, which as we all know, cost him the election.  This set the stage for Bill Clinton, who raised the top rate to 39.6% where it stayed for all eight years of his presidency.  Then in 2003 that self proclaimed “decider” George Bush (number two) lowered the top rate to 35% to spur the economy.  Go get ‘em Tex.  And that is where we are today.

So what effect did these vastly different top marginal rates have on job creation and economic growth?  Once again, back to the Internet (it is so cool!).  I looked up “GDP by year” and was able to find not only the actual GDP numbers but also the federal deficit was as a percentage of GDP from 1900 through today.  Job growth numbers were a little harder to find but I came across a site that had taken the raw data from the Bureau of Labor Statistics and provided job growth numbers by presidential term starting with Harding / Coolidge in 1921.  This actually worked quite well for my purposes as it smoothed out the more volatile annual numbers.

Here is what I discovered.  First, since the inception of an individual income tax, the average top marginal rate has been 58.7%.  It makes you wonder why some of our esteemed Senators and Representatives start to foam at the mouth at the thought of a 39.6% top rate.  That is still 19.1% below the historical average.  Second, over the last 110 years, GDP growth has averaged 6.4%.  Third, since 1921 when the Federal government started tracking “total nonfarm payroll employment” numbers, annual job growth has averaged 1.8%.  Finally, while over the last decade we have come to accept federal budget deficits as an inevitable fact of life, it has not always been so.  In fact, the federal government has run surpluses in 24 of the last 97 years (since the income tax was instituted).  Moreover, while we ran large deficits during WWII averaging 19.1% of GDP (a simply staggering number), once the war was over the country embraced fiscal responsibility, running surpluses in 7 of the next 11 years.  In fact, from the end of WWII through 1979, our federal deficit as a percentage of GDP averaged only 0.6% and we actually ran surpluses in 9 of the 33 years.  Since then our average deficit as a percentage of GDP has been running at 3.0%.  There was a bright spot during the Clinton years where we ran sizable surpluses for 4 years in a row. Since then, however, things have gone from bad to worse.

Armed with all of this data, I then wanted to see what happened to job growth and GDP growth in both high top marginal tax rate periods and low top marginal tax rate periods.  To do this I looked at those years when the top rate was 70% or above (48 out of the last 97 years) and those years when the top marginal tax rate was 40% or below (37 out of the last 97 years).  Together, these two periods accounted for 88% of the time since the imposition of a federal income tax in 1913. It seems that the pendulum swings back and forth, rarely stopping in the middle.  The results were surprising to say the least.  In those years where the top tax rate was 70% or above, GDP growth averaged 9.0% and job growth averaged 2.6%.  Conversely, in those years where the tax rate was 40% or below, GDP growth was an anemic 4.4% and job growth was… well actually there was no job growth.  The average for the 37 years where top tax rates were the lowest, job growth averaged zero!

I am not statistician, but I think that based on the historical data, if there is any correlation at all between lower top marginal tax rates and economic growth, the correlation is negative.  As a result, politicians need to stop fear mongering and tell the truth.  Raising the top marginal tax rates will not kill job growth.  Higher oil prices, the fallout from the tsunami in Japan and a moribund housing market may kill job growth – but not a higher marginal tax rate.

So based on this research what do I think we should do? Raise the top marginal tax rate of course.  In the immortal words of that famed Animal House sage and philosopher John “Blutto” Blutarsky – “We need the dues”.  Moreover, we should raise the top marginal tax rate above the 39.6% currently being discussed in Washington.  At the same time, however, we should add more brackets, substantially raising the income level where the top tax bracket kicks in.  I am no class warrior, however, as Willie Sutton famously said when asked why he robbed banks – “That’s where the money is.”  Raising taxes on individuals earning more than $5.0, million, $10 million or even $25 million a year may not in and of itself solve the problem, but it would surely help.  Moreover, it would start to chip away at a growing income inequality problem which is a going to become an increasingly important issue for America in the years to come.   For those who would say that raising the top rate would destroy the innovation and creativity that has come to define America, my only response is that America was a pretty great country for the 50 years from 1936 through 1986 when the top marginal tax rate was between 50% and 94%.   We would do well to regain a little of that greatness.

_________________________________________

Bryan Ganz is the CEO and Managing Partner of Scudder Bay Capital. Mr. Ganz has decades of experience in business and management, including ten years as a founding principal of Paramount Capital Group, an investment advisory firm that managed money for a broad array of blue chip clients; and fifteen years leading and growing Galaxy Tire, a specialty tire manufacturer. Mr. Ganz has served on the Board of Governors of Citizens Against Government Waste, a watchdog organization dedicated to promoting fiscal responsibility within Congress.

 Mr. Ganz graduated with honors from Georgetown University’s Business School with a BSBA in accounting in 1980. He received his JD from Columbia Law School in 1983, where he was a Harlan Fiske Stone Scholar.

Supporting research:
Taxes, Jobs & GDP Growth
Data for Tax rates, Job creation and GDP growth – April 2011 

Image Credit: vistavision on Flickr

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4 responses to “The Relationship Between Tax Rates & Job Growth

  1. here is the point that you do not address and , in fact, is rarely addresssed in all these discussions regarding tax rates. simply arguing about tax rates is ridiculous. the amount of tax one pays is a function of the tax base multipied the tax rate. for example, when the tax rate was 70% the Code allowed a Section 1202 deduction equaled to half of the capital gain one recognized, thus the taxpayer only had an effective rate of 35%. no matter how the politicians favor certain segements of the population over other segements of the population. in short, the ones who really bear the tax burden are not the rich, but the people that have to obtain their income by actually working for it. that is, compensation taxed as ordinary income. the rich and trust babies just park their assets in municipal bonds for tax free income and investment assets which they cash out at captial gain rates.
    the purpose of the income tax system is to raise revenue for the goverment at a rate that enhances growth. the percentage of GDP that constitutes tax revenue over time is 18-20% no matter what the rates. thus, our effective rate only needs to be 18-20%. the only question is who is going to pay the 18-20%? of course, if you pay zero, then i would have to pay 40% or if you and your neighbor paid zero, i would have to pay 60%, etc. if the idea is to really soak the rich, then a consumption tax is the way to go. but even then, we do not to soak them all that much if everyone contributes. this actually a good thing because we then all have skin in the game. people would demand more accountability of the goverment with respect to expenditures. we would eliminate the class warfare. i came from nothing and i do not and never did besmirched those who have money. however, it annoys me to be forced by the goverment to support those who only have their hands-out. those who can’t work ok, but those who won’t – i have zero tolerance.

  2. Needs graphs and visual aids to really bring the points home.

  3. Hi, I really like the fact that you took the time to do this analysis because it’s something I’ve been really interested in. Would you mind posting some of the sources you used so that I could look at some of the stats for my own analysis? I too believe that increasing taxes won’t decrease the number of jobs, mainly due to my belief that during times of uncertainty investors and businesses tend to save instead of investing in new equipment and capital, so by increasing taxes on the rich, we won’t be cutting investment so much as cutting there bank accounts. At any rate, I don’t currently have any raw data to support my belief, so i was wondering if you could post links to your sources so i could either substantiate or refute that claim.

    Also, the one thing that does worry me about your argument is that you draw a correlation between low tax rates and low economic growth, however correlation does not necessarily imply causality. If you look at crime stats, you would see cities with high crime have lots of police officers. You could argue by simply looking at the correlation that more police officers result in more crime, however this argument is obviously not right. Freakonomics describes this type of flawed logic very well. Likewise, I’m worried that while your argument relates the two, it’s possible that the economy was bad to begin with, so governments lowered the taxes, resulting in a correlation but not necessarily causality. Likewise, when the economy was good and thriving, the government wanted a share of the cake and decided to increase taxes without fear of hurting the economy. I think it would be interesting to look the relationship between the economic times preceding tax rate changes and then look at the change in growth immediately (next 2-3 years) following the change, kind of like comparing not the average growth vs. tax rates, but rather change in average growth vs. change in tax rates.

    Thanks!

  4. Pingback: Warren Buffett calls for Congress to Raise Taxes on the Rich

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