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Why the Economy Is in the Toilet: Required Reading and Source Material

My latest Good Fences column looks at the gloomy state of the economy and argues that it’s a mistake to blame either President Obama or the recent President Bush. What we’re experiencing actually is the collapse of a snake-oil economic cult theory that’s had us in its thrall for the past 30 years or so, the so-called Washington Consensus, also known as Reaganomics. In this blog post I run through some of the sources for my numbers, so you can check my math or even do your own exploring.

My column looks mainly at the paradoxical results of lowering taxes in order to encourage economic growth, which is a core tenet of our post-1980 economic faith. Between 1946 and 1980 the top income tax rate averaged around 80%. In the 30 years since then, the top rate has averaged around 35%. For some reason, the past 30 years have not seen increased economic growth. What they have seen is an explosion of the national debt, plus a colossal divergence between the incomes of the richest Americans and everyone else.

There are lots of other factors besides tax rates that play into the divergence, including deregulation of finance, killing off labor unions (thus increasing the bargaining power of the employer versus the wage-earner), technological changes and more. has run a magisterial series by Timothy Noah, “The Great Divergence,” that explores the various factors, one by one. It’s worth the time.

Two recent newspaper articles have done a particularly powerful job of illuminating less-noticed aspects of the current crisis and its human impact. From The New York Times, “For the Unemployed Over 50, Fears of Never Working Again.” And from The Washington Post, “Families struggle to build nest egg in wake of recession.”

Some people find it hard to believe that income tax rates used to be at 91% in the good old days. Well, it’s true. No, nobody paid 91% of all their income in taxes. It was a marginal rate — the amount you paid on any income above a certain ceiling. Today’s top marginal rate, for example, is 35%, but it only applies to your earnings after your initial $312,000.

This chart shows you the top marginal income tax rate, year by year, going back to 1913 (when income tax began), along with the cutoff point in earnings above which the top rate was applied.

The marginal rate throughout the Eisenhower and Kennedy administrations — from 1951 (under Truman, actually) through 1963 — was 91% on income above $400,000. (Calculating for inflation, $400,000 back in 1963 was worth about $2.8 million in today’s dollars.) The only president whose full tenure coincided with the confiscatory 91% marginal rate was Dwight D. Eisenhower, Republican.

Overall between 1946 and 1973 the marginal rate fluctuated from 70% to 91%, but the average rate over that period, as noted in my column, was about 80%. Annual growth during those years averaged about 3.8%. (I left out the years 1974-1980 because they were years when a massive outside intervention, the Arab oil shock, made comparison meaningless.) Since 1981 the marginal rate has averaged about 35% per year, and the average annual growth rate has been remarkably the same (3.8%). Lowering taxes on the highest earners did not boost economic growth.

In fact, what did happen during the post-1980 low-tax period was that the national debt exploded, after remaining stable from World War II until 1980. During the high-tax period between 1946 and 1973 the national debt actually fell by 10%, corrected for inflation (from $270 billion in 1946 to $460 billion in 1973), despite the initial burden of World War II and the intervening expenses of the Vietnam War and the space program. The debt inherited by President Reagan at the end of 1980 was $905 billion (no increase from 1973 in real terms, because of the runaway inflation in the intervening years). In 2007, just before the current collapse, the debt was $9 trillion, a growth of about 250% in real terms. And that doesn’t even look at the explosion of private debt during those years. Bottom line, much of the post-1980 growth was subsidized by borrowed money.

This chart shows you the cumulative national debt in any given year.

This dandy little inflation calculator from the U.S. Bureau of Labor Statistics lets you figure the impact of inflation on the value of the dollar over any given time period. Plug in a dollar amount in year A and it will tell you what that’s worth in year B. Keep this on your Favorites menu. You will be quizzed on it. Spelling counts.

This chart, from the non-partisan Tax Foundation, shows you a year-by-year breakdown of the share of national income that goes to various fractions of the population. Among other things, it shows the fantastic transfer of wealth from the bottom half of the population to the very top 1% since 1980.

This explosive growth in inequality isn’t due only to the lowering of tax rates, though it seems inevitable that if you transfer the burden of funding the government away from the wealthiest onto everyone else, you’re going the change the flow of dollars. You’re not ending redistribution of wealth, as conservatives claim — you’re simply reversing the direction.

I’m not saying that higher taxes create higher growth. But this does seem to disprove the idea that higher taxes retard growth, a core principle of the so-called Washington Consensus that passes as given truth in our generation.

It’s amazing how an idea can catch on and hold its power for decades despite empirical evidence that it’s false. Shows you what an investment of a few hundred billion in conservative think tanks and endowed chairs can do, particularly in an era when two-party politics is driven by unlimited money.

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