High Taxes vs. Incentive and Revenue

April 7, 1947

In a recent Gallup poll the question was asked: “About how much do you think a married man with two children who earns $50,000 a year now pays in Federal income taxes?” The typical answer was $9,000. The actual tax on such a net income, however, is around $24,000. It would be instructive to learn how many people know that a $300,000 net income shrinks to $66,000 after taxes and a $1,000,000 income to $161,000.

In its March letter the National City Bank publishes some illuminating income-tax tables. One of these shows how much is actually left at various income levels for the taxpayer himself out of every extra dollar he earns. The figures are for a married man with two children and legal deductions of 10 percent of his gross income.

When the Gallup poll asked people how much they thought a man who earns $50,000 a year ought to pay in income taxes the median average answer was $7,500. This is only about a third of what such a man actually does pay. The taxpayer is allowed to keep less than half of everything he earns above $22,000. The question of “fairness,” however, is one on which it seems impossible to get agreement. No matter how much is taken from the big incomes, some people cannot see why those who earn more than they do should be allowed to retain any amount higher than they themselves can earn.

It seems more profitable from a pragmatic standpoint, therefore, to consider not so much the “fairness” of the tax structure as its practical effects on the economy. One obvious effect (considering the present corporate as well as personal income-tax structure) is to soak up the principal sources of capital funds. The funds that the present tax structure takes are precisely those that would have gone principally into investment—that is, into improved machines and new factories to provide the increased labor productivity which is the only permanent and continuous means of increasing wages.

An even more important effect of taking so much of the taxpayer’s earnings is to diminish or remove the incentives to bringing such earnings into existence in the first place. This means not merely a loss to the taxpayer who does not trouble to earn the money. It means a loss to the wealth of the whole nation. It means a loss even to the Treasury itself. Another table compiled by the National City Bank, based on reports of the Bureau of Internal Revenue, strikingly illustrates this result. (The dollar figures stand for millions of dollars.)

Let’s see what this means. During the same period that the total national income increased 58 percent, total incomes over $300,000 fell 77 percent. If each individual’s income had risen by the same percentage, total incomes over $300,000 would have risen by a much greater percentage, for all incomes previously above $190,000 would now be counted among the incomes over $300,000. Yet even if the aggregate of such incomes had risen no more than proportionately to the whole national income, the total would have reached $2,637,000,000—seven times greater than it actually was. And if this income had been taxed at the same schedule as in 1926–28, with a top tax rate of only 25 percent, the yield to the Treasury would have been about $444,000,000.

It would have been, in other words, about 50 percent greater than the actual yield from the greatly reduced incomes taxed at a top rate of 88 percent. For there can be little doubt that overwhelmingly the most important reason for the contraction of incomes over $300,000 in 1942 compared with 1926–28 was precisely the increase in the top personal income-tax rate from 25 percent to 88 percent. In other words, there can be little doubt that a sharp reduction in the top tax rates prevailing today would eventually greatly increase rather than reduce revenues.