How the top tax rate works
Under the federal system, people pay a larger percentage in taxes as their income goes up. The more you make, the higher your tax rate.
But the highest rate you pay applies only to the last portion of your income — not your total income. The highest federal tax rate today is 37%, but on average, wealthy taxpayers pay only 25.6% on their total income, according to the IRS.
The tax code groups taxpayers according to their incomes into categories called tax brackets. The lowest bracket for single filers in 2022, applying to income up to $10,275, is 10%. The highest bracket taxes income above $539,900.
The system is considered progressive, especially when compared to states that tax their residents at the same rate, regardless of income. Even so, the federal system is far less progressive than it once was. Today there are only seven federal tax brackets, ranging from 10% to 37%. In 1970, there were 25 — from 14% to 70%.
Today, an upper-income person pays the same tax rate on any income earned above $539,900 as a wealthy investor would pay on millions of dollars in income above that amount. Decades ago, that wasn’t the case.
In 1985, all taxpayers reporting income of $1 million and up had an average income tax of $910,931, according to IRS data. In 1988, the first year showing the full impact of the law, that same group paid $226,000 less on average.
For Reagan, the low rates were the heart and soul of the bill.
“Our Founding Fathers … never imagined what we’ve come to know as the progressive income tax,” Reagan said while signing the bill on Oct. 22, 1986. He said it “struck at the heart of the economic life of the individual, punishing that special effort and extra hard work that has always been the driving force of our economy. … I feel like we just played the World Series of tax reform — and the American people won.”
Some won much more than others.
IRS data shows that taxpayers with upwards of $40,000 in income received on average a modest tax cut of $603 a year. Upper-income Americans earning $500,000 to $1 million took home an average of $73,617. And those at the top received far more.
To those who knew how the benefits of tax reform had been oversold to average Americans, this came as no surprise. Daniel Halperin, a former assistant treasury secretary, told a congressional committee as the bill was being considered: “Over 40% of American families will either have a tax increase or no change.” People with the highest incomes, he said, would be “the biggest winners.”
Republicans claimed that the 1980s tax cuts would stimulate so much economic activity that tax receipts and budgets wouldn’t suffer. But by the end of the eight-year Reagan presidency, revenues were an unprecedented $1.3 trillion short of federal spending. That was more than three times the deficits for the eight years before Reagan — combined.
In 1980, while running for the Republican presidential nomination against Reagan, George H.W. Bush called his competitor’s claim that the country could cut taxes but not add to the national debt “voodoo economics.”
In 1991, Bush, by then president, went along with a Democratic plan to raise the top tax rate for the richest Americans from 28% to 31% to stem the red ink. Though top rates remained far below what they were when Reagan took office, any tax increase was anathema to large swaths of the Republican party. Bush paid the price when he lost the 1992 election to Bill Clinton.
A tax tug-of-war
After that, every Democratic president tried to increase taxes on the wealthy and every Republican president did the reverse.
In 1993, with his party controlling the House and Senate, Clinton proposed raising taxes to deal with deficits and offset Reagan-era tax cuts, settling on a package that raised the top rate from 31% to 39.6%.
“After 12 years of trickle-down economics where taxes were lowered on the wealthiest Americans … we now have real fairness in the Tax Code,” Clinton said as he signed the bill in August 1993.
Republican lawmakers and conservative pundits condemned the increase and warned that it would hurt the economy. “It will kill jobs, kill businesses and yes, kill even the higher tax revenues that these suicidal tax increasers hope to gain,” said Rep. Christopher Cox, a California Republican.
Rather than tanking, the economy took off. The seven years that followed represented what was then the longest sustained period of economic growth in the nation’s history. Tax revenues soared, prompting three straight years of budget surpluses under Clinton — the only time that’s happened in the past half century.
The Clinton-era top rate and surpluses didn’t last long. The federal government began running deficits again after President George W. Bush put through two tax cuts in 2001 and 2003.
While those tax bills contained modest cuts for most Americans, the benefits once again flowed largely to the rich: The top 1% of households received an average tax break of $570,000 for the eight-year period that followed the second bill, according to the Center on Budget and Policy Priorities.
It wasn’t just a result of lowering the top rate to 35%.
For decades, dividends paid to shareholders — predominantly wealthier people — were taxed like salaries and wages. But the 2003 law created a new category called “qualified dividends.” What constituted such a dividend was complicated, largely how long the stock was held, but its main benefit was that it would be taxed at 15% rather than 35% for upper-income people.
An auto worker in Detroit who received $5,000 in qualified dividends might have saved $500 under the new law. An auto executive who received $100,000 in such dividends would have saved $20,000.
This tax break, narrowed since then but only modestly, has cost the U.S. Treasury an estimated $350 billion since 2004. Upper-income taxpayers have benefited the most. In 2019 alone, it was worth $16.2 billion to taxpayers earning $1 million or more.
To put that $16.2 billion in perspective: It’s the equivalent of the federal income taxes paid by everyone earning $50,000 or less in California, Idaho, Iowa, Kansas, Minnesota, Nebraska, New Hampshire, Oklahoma, Pennsylvania, South Dakota, West Virginia and Wisconsin — combined.
President Barack Obama later signed legislation that made the tax break permanent, but he also steered tax increases through Congress, pushing the top rate back to where it had been under Clinton as well as imposing a surtax on investment income and hiking Medicare taxes for high earners to help pay for the Affordable Care Act.
All this led to what would be the signature legislative triumph of the Trump presidency, the Tax Cuts and Jobs Act of 2017. The sheer magnitude of the tax cuts it gave to the wealthy and corporations made the law the most significant since the Reagan era.
The arguments for it sounded very familiar.
“I not only don’t think it will increase the deficit, I think it will be beyond revenue neutral,” Senate Majority Leader Mitch McConnell declared after the bill’s passage. “In other words, I think it will produce more than enough to fill that gap.”
Instead, with its generous tax cuts for individuals and companies, it gushed red ink. The Congressional Budget Office estimated in 2018 that it would add $1.9 trillion to the deficit over the next 10 years.
In 2019 alone, the tax cuts cost the U.S. Treasury $259 billion. Virtually half that money flowed to those earning $200,000 or more, according to data from the Joint Committee on Taxation.
Workers earning between $50,000 and $75,000 that year got a tax cut of $840 on average. Those earning $1 million or more? Over $64,000.
Corporate clout
As Congress cut the taxes of wealthy Americans after 1980, it also slashed taxes on corporations. Their rate plummeted from 35% to the present 21% — the lowest in 80 years.
With the help of corporate lobbyists, companies have found ways to cut their share of taxes even more by exploiting rules deep in the dense thicket of the Internal Revenue Code.
Many corporate tax provisions are so complex as to be indecipherable to the average person, and even to most lawmakers. A change in one percentage point here, an addition of a word there, the insertion of a date — any one of those can be worth millions of dollars to a corporation by giving it permission to do something previously prohibited.
The section on taxing the foreign income of U.S. companies is full of gifts negotiated by lobbyists. Here, thanks to Congress, multinational corporations enjoy a special status: They can offset their U.S. income with credits and other write-offs generated by their foreign operations. One economist estimated that the U.S. Treasury in one year alone — 2008 — lost upwards of $90 billion in revenue as a result.
The top corporate tax rate was once 35% on income earned anywhere in the world. But U.S. corporations such as Procter & Gamble, Pfizer and Hewlett-Packard had long avoided paying that rate on overseas income by stashing profits in offshore tax havens.
As billions and billions of corporate profits piled up offshore and began to approach $1 trillion, the companies fretted. A group that included Microsoft, Intel, Apple and Coca-Cola formed a lobby called the Homeland Investment Coalition to pressure Congress to change the law so they could bring that money back to the U.S. — at a lower tax rate than domestic corporations pay.
For example, while a local construction company in Des Moines might pay 35% on profits from building a high school in Iowa, the coalition proposed in 2003 that multinationals with foreign earnings would pay only 5.25% in U.S. taxes on profits earned from selling products or services outside the country.
Lawmakers were happy to help.
“We want job creation,” Sen. Gordon Smith, a Republican from Oregon, said when the American Jobs Creation Act of 2004 was being considered with a provision he helped insert to make the tax holiday happen. “We want this to get to the shop floor, not to the corporate boardroom. … We want it to go to those things that will improve the productive capacity of American industry and the rehiring of American workers. We don’t want it to be part of some financial flimflam.”
But flimflam it was. After the bargain-basement tax break became law, companies did bring money back to the U.S. Nearly half the repatriated $312 billion came from just 15 companies, including Hewlett-Packard, Pfizer and Merck. The U.S. Treasury later estimated that the tax break benefited only 4% of American corporations.
How many jobs were created by the American Jobs Creation Act of 2004?
None.
