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When politicians try to “punish the rich” it is the middle class that pays the price.  History agrees as I will show  you later.  But lets take a practical example.

What would happen if movie theaters all raised the price of tickets to $75 per seat. They would all get rich correct?  Of course not. People would find something else to do and empty theater seats would insure less money to deposit in the bank.  You could also lay off all but one lonely worker to run the concessions.

I’ve always believed based on actual numbers that lower tax rates increase revenues. The goal of movie theaters is to find the sweet spot where they charge the most they can while still filling as many seats as possible.

If you “punish the rich” enough, like the former movie watchers, they will check out and find something else to do with their money besides put it at risk in business ventures.  Then, like the concession workers, people would lose their jobs as businesses close down and the money goes into safe things like tax-free government bonds.  This is exactly what Ross Perot did with his wealth.

Rather than punish the rich, the goal should be to maximize the revenues to government. The way you do this is to lower taxes.  This has been proven to be the case on several occasions in our history; the 1920’s, 60’s, 80’s and the early 21st century.

Let’s take a look at the 1920’s. At the end of Woodrow Wilson’s presidency the top tax rate was 73%.  Warren Harding convinced the super-rich, but introverted, Andrew Mellon to be his Secretary of the Treasury. Mellon, along with his brother, had made a fortune with the steel company they founded.  Andrew was the quiet brother who worked the numbers over the years.  He theorized that like in private business, that tax rates, like steel prices, had an effect on total revenue.  In his steel business Mellon knew that there was a price for steel that would maximize revenue.  Price it too high and while you would get more per ton you would sell steel.  Price it to low and you would sell all your steel without filling all the orders you could have. This would be like the movie theater selling all their tickets for a dollar and filling up their seats while more people were waiting in line.

Mellon, in the Revenue Acts of 1921, 1924 and 1926 lowered the top tax rate from 73% to 25%. Here is what happened.

‘Spurred in part by lower tax rates, the economy expanded dramatically. In real terms, the economy grew 59 percent between 1921 and 1929, and annual economic growth averaged more than 6 percent.

Notwithstanding (or perhaps because of) the dramatic reduction in tax rates, personal income tax revenues increased substantially during the 1920s, rising from $719 million in 1921 to $1,160 million in 1928, an increase of more than 61 percent (this was a period of no inflation).4

The share of the tax burden borne by the rich rose dramatically. As seen in Chart 5, taxes paid by the rich (those making $50,000 and up in those days) climbed from 44.2 percent of the total tax burden in 1921 to 78.4 percent in 1928.

This surge in revenue was no surprise to Mellon:

The History of taxation shows that taxes which are inherently excessive are not paid. The high rates inevitably put pressure upon the taxpayer to withdraw his capital from productive business and invest it in tax-exempt securities or to find other lawful methods of avoiding the realization of taxable income. The result is that the sources of taxation are drying up; wealth is failing to carry its share of the tax burden; and capital is being diverted into channels which yield neither revenue to the Government nor profit to the people.5″

Source: The Historical Lessons of Lower Tax Rates, The Heritage Foundation

As you can see in the chart below (red line), actual revenue to the federal government sky rockets as top rates fell from 73% to 25%

Not only did revenues increase but the percent paid by the rich increased. As shown in the chart below, the rich paid almost 80% of the taxes collected compared to 45% when rates were tax rates were highest.  If the goal is to make the rich pay more, it turns out the way you do that is by lowering tax rates on the rich. They are then more inclined to invest their money in business rather than hide it in safe places that create no jobs.

This same trend is seen with the Kennedy tax cuts of the 60’s, The Regan tax cuts of the 80’s and the Bush tax cuts in 2003.

Ironically it also shown that raising tax rates on the rich decreased revenues to the government in the 1930’s, the late 1960’s and the early 1990’s.

Two things stand out to me.

  • Like Andrew Mellon, Mitt Romney built a hugely successful business for scratch.  Mellon seemed to believe that a  maximum tax rate of 25% was the sweet spot that created maximum revenues and and economic growth. Mitt Romney has proposed the same maximum rate.
  • If President Obama is reelected and increases taxes on the rich, as he promises to do, you will see history repeat itself and the deficit will soar while additional jobs are lost.

If  you are interested in the examples from later years you can read the full Heritage Foundation article here.