Debunking Paul Krugman's Beloved 91 Percent Tax Myth

In his column yesterday, New York Times columnist Paul Krugman made the case for how the pro-union and high-tax policies of the 1950s led to America’s unparalleled economic success from the end of World War II until the mid-1970s. The essay is a classic example of how to use a few correct facts to make a completely illogical argument.

First Krugman says “Above all, the success of the postwar American economy demonstrates that, contrary to today’s conservative orthodoxy, you can have prosperity without demeaning workers and coddling the rich.” The only evidence of “coddling” he cites is lower tax rates on the wealthy in today’s America as compared to higher rates in the 1950s.

Krugman’s basic assumption here is that a law-abiding American does not own his or her legally-earned money. Instead, the money belongs to the government, at the generosity of the government.

Krugman’s next point looks at this alleged “coddling” in some detail:

Consider the question of tax rates on the wealthy. The modern American right, and much of the alleged center, is obsessed with the notion that low tax rates at the top are essential to growth. Remember that Erskine Bowles and Alan Simpson, charged with producing a plan to curb deficits, nonetheless somehow ended up listing “lower tax rates” as a “guiding principle.”

Yet in the 1950s incomes in the top bracket faced a marginal tax rate of 91, that’s right, 91 percent, while taxes on corporate profits were twice as large, relative to national income, as in recent years. The best estimates suggest that circa 1960 the top 0.01 percent of Americans paid an effective federal tax rate of more than 70 percent, twice what they pay today.

Unfortunately, his argument holds no water when one considers a couple of major factors holding back the American economy today – the world economy and America’s entitlements, especially as compared to the 1950s. From Reason Foundation on Jan. 25, in disputing Krugman’s declaration that America’s debt level post-World War II is comparable to today’s challenges:

First, we didn’t have a growing entitlements crisis in 1945. As aptly pointed out here, federal spending as a percent of Gross Domestic Product (GDP) dropped significantly after World War II, as did the level of debt as a percent of GDP. Looking forward 40 years, on our current path, we will have very opposite numbers as debt and spending continue to rise precipitously. Back in 1945, for example, Social Security was paid for by 42 times as many workers as retirees who utilized it. Today? That ratio is about 2.9 to 1, and getting worse. Meanwhile Medicare, which did not exist in 1945, is expected to grow from 3.6% of GDP to 5.5% of GDP between 2011 and 2035.

Second, the economic state of nations such as Germany, Britain, France, Japan, China and others are very different today than they were 66 years ago. After World War II, these nations had little infrastructure or economy left. Additionally, many of their young people had died in the war. Meanwhile, America was left with infrastructure, a stable monetary system, a first-class educational system and an economy that exported to the vast majority of the nations of the world. Unfortunately, America no longer has those advantages. In fact, we are in the middle of the pack educationally, according to a December 2010 Program for International Student Assessment report, and our infrastructure is aging rapidly while our imports increase and our exports decrease.

In short, Krugman’s argument ignores how America’s unparalleled economic dominance across the world more than made up for absurdly high tax rates. He also ignores how massive government debt holds back economic growth.

Two final points to finish putting Krugman’s column in a coffin: first, Krugman says “economic justice and economic growth aren’t incompatible.” He’s right. He’s just wrong on the solutions. On the tax side, the best way to match economic justice with economic growth is to eliminate all federal tax loopholes, broadening the tax base as a result, and subsequently instituting a Flat Tax. Just as we should not have taxation without represenation, is it fair to have representation without taxation? All these things are supported by many conservatives. These changes provide the potential for massive economic growth across all income levels – more than overcoming the higher tax rate on the bottom 20% of earners, who currently pay 1% of their income to taxes(the top 1% pays nearly 29%, as seen at the link). It also eliminates the many immoral and economically inefficient tax loopholes that make the tax code horribly complex.

Related, economic justice would include elimination of federal subsidies for the wealthy, including bailouts and farm and energy subsidies. It also would include prevention of tax increases on the middle class, something that regularly happens when taxes go up on the wealthy as seen with the Alternative Minimum Tax and individual income tax.

At the end of the day, America is indeed in great need of policies that make opportunity more equal. This is best done by bringing the federal government back within the Constitution on spending, and instituting either a national sales tax (along with elimination of the income tax) or a flat income tax.

Finally, Krugman says the wealthy paid “their fair share” in decades past. Given that the top 1% earn 50 times as much as the bottom 20%, but pay 1,500 times as much in taxes, and provide much of the nation’s charitable donations, private investments, and employment opportunities, what level of taxation would Krugman consider the “fair share” of their income? Is anything less than 91% unfair? As Peter Schiff found in interviewing Occupy Wall Street participants, the answer seems to be more talking point than policy change. I guess this is pretty common on the left, regardless of whether one has a Nobel Prize in Economics or not.