Taxing rich people really works

A short history of the 90 percent top marginal tax bracket

I do not think that any American citizen should have a net income in excess of $25,000 per year after payment of taxes.

—President Franklin Roosevelt, radio address, April 28, 1942

During World War II Congress imposed a top marginal income-tax rate of 94 percent for income in excess of $25,000, or about $1 million today. Roosevelt wanted it to be 100 percent, but he settled for 94 percent. The top rate mostly stayed above 90 percent until 1964, when it dropped to 77 percent. From there it dropped further to 70 percent, where it remained until President Ronald Reagan brought it down to 50 percent and eventually 28 percent. For the last 30 years it’s varied from 31 percent to not quite 40 percent.

(The top marginal rate is not to be confused with the effective tax rate. The effective tax rate is how much of our total income we pay to the IRS. The marginal tax rate applies only to that portion of income earned in excess of a certain threshold amount.)

You hear a lot of people say that back when the top marginal rate was 90 percent or more, almost nobody actually paid that rate. That misses the point of a confiscatory tax. Almost nobody was expected to pay that rate. What was the point of a business paying an employee (in nearly every instance, the CEO) in excess of the 90 percent threshold if 90 percent of that cash would go to the U.S. Treasury? Even in that more innocent time, nobody was that patriotic. The purpose of these very high top marginal rates was to put an effective ceiling on incomes.

Take 1958, the year of my birth. In that year, the federal government didn’t want anybody who was married and filing jointly to have an income in excess of $400,000 ($3.7 million in today’s dollars). So it taxed income above $400,000 at a rate of 91 percent. The feds didn’t want anybody who was single to have an income in excess of $200,000 ($1.8 million in today’s dollars). So it taxed income above $200,000 at the same 91 percent rate.

The president in 1958 was not, I should remind you, Karl Marx. He was Dwight D. Eisenhower, a Republican whom liberals regarded at the time as a pretty boring fellow.

Did the extraordinarily high top marginal rates of the 1940s and 1950s work? In their book The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay, the economists Emanuel Saez and Gabriel Zucman argue that they did. From 1913 to 1933, when the top marginal rate seldom rose above 50 percent, the top 0.01 percent in the income distribution “earned on average 2.6 percent of all fiscal income each year. From 1950 to 1980, that number fell to 0.6 on average.”

Did the richest Americans actually earn more than their officially reported incomes and shelter the difference? The data on pre-tax income suggests not. (Tax-sheltering, Saez and Zucman demonstrate, had not yet become the competitive sport that it is today.) The top 0.01 percent’s share fell from 4 percent on the eve of the Great Depression to 1.3 percent in 1975.

Corporations retained only a little more of their earnings—6 percent of national income in the 1960s, as opposed to 5 percent over the past two decades. They didn’t dare retain more than 6 percent because shareholders would have demanded dividends and unions, which still had substantial clout, would have demanded wage increases. Also, taxes on corporate profits were much higher in the postwar era (48-52 percent) than they are today (21 percent).

The net result was that during the postwar era, when corporations enjoyed much more power over Americans’ daily lives than they do today, corporate chairmen didn’t live anywhere near so well as they do now, when corporations have become slaves to their bankers. Saez and Zucman quote a 1955 Fortune magazine piece titled “How Top Executives Live.”

Twenty-five years have altered the executive way of life noticeably; in 1930 the average businessman had been buffeted by the economic storms but he had not yet been battered by the income tax. The executive still led a life ornamented by expensive adjuncts that other men could not begin to afford…. The executive’s home today is likely to be unpretentious and relatively small—perhaps seven rooms and two and a half baths.

To the extent that the executive class indulged in private opulence, it was mainly through their expense accounts. In making this point, the great social historian Frederick Lewis Allen quoted in his book The Big Change: America Transforms Itself 1900-1950 a magazine article published in 1950 by John O’Hara that described “the new expense-account society.” Tourists visiting New York City, O’Hara explained, couldn’t get tickets to Rodgers and Hammerstein’s South Pacific because “There are customers at $100 a pair, and the customers are the big corporations…. The big corporation has first claim on everything, from restaurant tables to Pullman reservations home.”

On Mad Men, when you see Don Draper and his pals at Sterling Cooper wining and dining and forming lewd conga lines with the typing pool, they aren’t paying the bill. The company is paying, and then taking it off the income it reports to the IRS. In 1972, a disgusted Sen. George McGovern, then running for president, labelled this abuse the “three-martini lunch.” Its deductibility was eventually reduced to 50 percent in the 1980s, but this past December Trump restored it to 100 percent in his final Covid stimulus. Even the Wall Street Journal editorial page was appalled.

My latest New Republic column is about a change in corporate taxation first proposed by Bill Clinton in 1991 and expanded in Biden’s just-passed Covid relief bill. The change is that corporations may no longer deduct any income they pay their CEO and four other top executives in excess of $1 million. The Covid bill expanded that group to the top 10 executives who are paid in excess of $1 million.

When Clinton first proposed this tax, the idea was that, like the 90 percent top marginal tax on high incomes, it would not be paid; corporations would instead avoid paying top employees in excess of $1 million. Sadly, it was nowhere near as effective as the old high marginal rates on top incomes. First the corporations started paying their top employees in stock options, which were foolishly exempted from the ceiling. That accelerated runaway executive pay much more. Then, after that loophole was gradually closed—first by Barack Obama and then, believe it or not, by Trump—corporations simply went on paying excessive salaries, even if it meant writing a fat check to Uncle Sam. Never mind that the tax change raised the cost of compensation in excess of $1 million by about 25 percent.

Now Joe Biden is expanding this punitive tax by applying it not to the top five corporate employees but the top 10. In practice, this will mean mostly executives at banks and tech companies. But these banks and tech companies turn out to be much more willing to take it on the chin than Bill Clinton ever imagined, so there’s every expectation that the tax will get paid. The revenue will be used to help bail out some union-negotiated multiemployer pensions, so in a way it’s redistributive. Corporations that pay their employees too much will help keep truck drivers from losing their retirement nest egg. But nobody expects any longer that this sort of tax will impose a ceiling on corporate salaries.