Democratic front-runner Hilary Clinton and her rival for the presidential nomination Bernie Sanders have both called for higher taxes. Both Clinton and Sanders have promised that they will increase the top rate of tax and, therefore, make the wealthiest pay more money to the Government.
The proposals of Clinton and Sanders have been incredibly popular, demonstrating, once again, that the politics of envy is alive and well in the United States. However, in addition to being an attack on individual liberty and entrepreneurship, an examination of the economic history of the United States and the United Kingdom reveals that it is also incredibly misguided.
For example, Calvin Coolidge cut the top tax rate. As a result, revenues nearly doubled, and the share paid by the most wealthy rose exponentially. Unfortunately, top rates rose again, but in the 1960s, John F. Kennedy drastically slashed the highest rate. As a result, the share paid by mid-to-high earners rose, and there was a dramatic increase in total tax revenue. And then, in the 1980s, Ronald Reagan introduced the largest tax cut in American history, cutting all taxes, and slashing top rates. Again, there was a huge increase in both the amount of tax paid by the wealthiest citizens and in total tax revenues. Furthermore, when George H.W. Bush attempted to reduce the deficit by increasing the top rate of tax, his policies had the exact opposite effect. Compare this with his son’s presidency: George W. Bush cut the top rate of tax, which led to a sharp rise in tax revenue.
A similar situation has been witnessed in the United Kingdom. For example, under Margaret Thatcher’s government, the top rate of tax was also slashed from an eye watering rate of 83% in 1979 down to 40% in the late 1980s. As in the United States, this resulted in the wealthiest paying more and also to an increase in tax revenue. More recently, the current Chancellor of the Exchequer, George Osborne, has revealed that his cut to the top rate of tax in 2012 has brought in an extra £8 billion in revenue from the highest earners.
This is an example of the Laffer Curve, which is frequently used by economists. It was popularized in the United States in the 1970s but can trace its origins to the 14th Century Muslim philosopher Ibn Khaldūn. It illustrates the relationship between rates of taxation and the resulting levels of government revenue. The Laffer curve illustrates the concept of taxable income elasticity in that taxable income will change in response to changes in the rate of taxation. As a result, increasing tax rates beyond a certain point will be counter-productive for raising further tax revenue.
Both economic history and theory demonstrate that the proposed tax policy of Clinton and Sanders is misguided and will be counter-productive to their aims of increasing tax revenue. Governments should focus on cutting the top rate of tax, as this will enable them to decrease the deficit, increase spending on essential services, and stimulate economic growth.