Cross-posted at Reports from the Economic Front.

There are those that argue that lowering the top marginal tax rates on “ordinary” income (from wages or salary) and capital gains will stimulate economic growth.  Thomas L. Hungerford, in a Congressional Research Report, tests and rejects this claim.

He finds no statistical relationship between changes in either of these top tax rates and private savings, investment, productivity, or real per capita GDP growth.  However, he does find a strong statistical relationship between changes in these tax rates and income inequality.  More specifically, raising top tax rates can be expected to promote greater income equality without causing harm to the economy.

Tax Trends

There are two main tax concepts: the marginal tax rate, which is the tax paid on the last dollar of income received, and the average tax rate, which is the proportion of all income that is paid in taxes.  How much a person pays on the last dollar received depends on whether it is classified as ordinary income or capital gains.

Most importantly, as the chart below shows, the very top tax payers have enjoyed a steady decline in their average tax rate.

The next chart shows trends in top marginal tax rates on ordinary income and capital gains.  The top marginal tax rate on ordinary income has clearly been on the decline: from 91% in the 1950s, 70% in the 1960s and 1970s, to a low of 28% in 1986.  It now stands at 35%.  The top marginal capital gains tax rate has not changed as much.  It was 25% in the 1950s and 1960s, 35% in the 1970s, and is now 15%.

The Tests

Hungerford used econometric methods to test whether changes in top marginal tax rates affect private savings, investment, productivity, and/or per capita GDP growth.  Simply plotting the movement of top tax rates and each of these variables suggests that a decline in top tax rates is associated with a positive movement in each of these economic variables.

However, as Hungerford correctly states, correlation is not the same as causation.  Using regression analysis, he found that the relationships were only coincidental or spurious; there was no statistically significant connection between changes in the top tax rates and movements in any of the variables.

Hungerford also tested to see if changes in top marginal tax rates had any effect on the distribution of income.  The first chart below shows the scatter plot of top tax rates and the share of income going to the top 0.1% for the years 1945-2010.  The second shows the same with the top 0.01% of income earners.

As we can see the fitted lines suggest a very strong relationship between the variables.  As before, Hungerford used regression analysis to determine whether the relationships were statistically significant.  This time his answer was yes in both cases; changes in top marginal tax rates do affect income concentration.  In other words, lowering the top rates increases income inequality, raising them reduces it.

It is time for us to start agitating for raising the top tax rates.

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