History shows that high taxes on rich don't work

August 27, 2011

Warren Buffett has been extremely successful in his common sense approach to investments. However I must agree with Brian Murphy's conclusion that Mr. Buffett is wrong in his approach to taxes ("Warren Buffett is wrong," Aug. 25) but for an additional compelling reason, history.

In 1920 Andrew Mellon (treasury secretary the previous four years) pointed out that people with high incomes were simply not paying the high tax rates that existed on paper because they were putting their money into tax shelters. After the 73 percent highest incomes tax rates were cut to 24 percent in 1925, as Mellon recommended, tax revenue increased, investment returned to the private economy producing high output, rising incomes, and more jobs. The annual unemployment rate in the following four years, never exceeded 4.2 percent. Moreover the recovery from this 1920-21 recession was quick and without any other government intervention.

Capital won't work for inferior returns. Mellon added: "Just as labor cannot be forced to work against its will, so it can be taken for granted that capital will not work unless the return is worthwhile. It will continue to retire into the shelter of tax-exempt bonds, which offer both security and immunity from the tax collector."

In other words, high tax rates that many people avoid paying do not necessarily bring in as much revenue to the government as lower tax rates that more people are in fact paying, when these lower rates make it safe to invest their money where they can get a higher rate of return in the economy than where they can get a higher rate of return in the economy than they get from tax-exempt securities.

The facts are plain: There were 206 people who reported annual taxable incomes of one million dollars or more in 1916. But as tax rates rose, that number fell to 21 by 1921. After a series of tax-rate cuts in the 1920s, the number of individuals reporting taxable incomes of a million dollars or more rose again, to 207 by1925.

As output surged, joblessness plunged. It should not be surprising that the government collected more tax revenue under these conditions. Nor is it surprising that, with increased economic activity resulting from more investment in the private economy, the annual unemployment rate from 1925 through 1928 ranged from a high of 4.2 percent to a low of 1.8 percent.

The actual results of the cuts in tax rates in the 1920s were very similar to the results of later tax-rate cuts during the Kennedy, Reagan and George W. Bush administrations — namely, rising output, rising employment to produce that output, rising incomes as a result and rising tax revenues for the government because of the rising incomes, though the tax rates had been lowered. Another consequence was that people in higher-income brackets paid not only a larger total amount of taxes, but a higher percentage of all taxes, after what were called "tax cuts for the rich." It was not simply that their incomes rose, but that this was not taxable income, since the lower tax rates made it profitable to get higher returns outside of tax shelters.

The conclusion: high tax rates that people don't actually pay do not bring in as much hard income as lower tax rates that they do pay. We have tried deficit spending our way to prosperity, isn't it time we seek the method with a proven record of success?

Benedict Frederick Jr., Pasadena

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