Improving Our Standard of Living (Wattpad Edition)

Chapter 24: Taxation

People pay different tax rates based on their income. The minimum rate is the percentage that all adults must pay no matter how small their income. Many countries set the minimum at 0%. Poor families pay zero income taxes and usually receive welfare benefits. The minimum rate doesn't apply to consumption taxes and other forms not related to income.

The maximum tax rate is the percentage of income that the richest demographic must pay. The definition of "rich" varies from country to country, but typically these people make more than $400,000 per year. This category includes millionaires and billionaires.

In Norway, Denmark, Finland, Sweden, and Iceland, the maximum tax rate is about 55% [1]. Millionaires and billionaires in those nations give more than half of their income in taxes. This figure includes local taxes.

The Nordic countries have the highest tax rates on the wealthy in the world.

At one time, the United States held that title. Recall that, according to the Tax Foundation, from 1936 to 1981, the maximum tax rate averaged 80% [2]. In other words, millionaires and billionaires paid 80% of their incomes to the government. This was just federal taxes. If you include state and local taxes, this figure was closer to 90%. For every dollar a millionaire earned, he or she paid 90 cents of it to Uncle Sam.

However, as I explained earlier, instead of paying higher taxes, the rich often opted instead to pay their workers higher wages. Or they would invest more in their businesses and pour more money into research and development.

In other words, in response to higher taxes, large shareholders often took less corporate profit for themselves. And they took less money away from their employees. There was no point in pocketing large amounts of company profit because it would have been taxed away.

Things have changed a lot since then.

According to the Federal Reserve, American wages as a percentage of GDP have been declining almost every year since 1970 [3].

Where did that money go? According to inequality.org, the richest 1% of Americans today receive almost three times more of the nation's total income than they did throughout the 1940s, 50s, 60s, and 70s. The share of income going to the bottom 99% of the population—and especially the poorest 80%—has fallen substantially.

What this means is that a larger share of the economy is now going to dividends and corporate profits. In other words, the people that own the corporations take and keep a larger cut of the profits of labor than they used to. That's because tax rates on them have fallen. And also because of declining unions and minimum wage rates (adjusted for inflation).

Wealthy individuals would have less incentive to pay themselves a larger portion of company profits if they were required to pay a higher maximum tax rate. That's what happened in the United States during the middle of the 20th century. Rich people took a smaller cut of the profits for themselves. They knew they would've been required to hand over 90% of every dollar they earned to Uncle Sam if they took too much income from the companies they owned.

This is why the number of tax dollars levied as a percentage of GDP wasn't much higher in the mid-20th century than it is today. (I'm referring to Hauser's law.) Higher tax rates don't necessarily guarantee more government revenue. But they do encourage good behavior. When wealthy people are faced with paying higher taxes, they will often choose instead to reinvest their money back into the economy. The government may not receive more money, but everyone else will, including working class families.

Raising the tax rate on the rich reduces inequality, even if the government doesn't get more revenue.

Tax evasion was rare in mid-20th century America because tax laws were simple and loopholes were virtually nonexistent. According to The Washington Examiner, the current tax code is 150 times larger than it was in 1940 [4]. The rich couldn't get out of paying like they can today. They either had to pay the higher rate or invest their money back into the economy. There were no offshore tax havens.