A Short History of Modern Taxation in 4 Acts

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The last 30 years are often taken as one great experiment in tax cuts and bulging income inequality. In fact, the real story is much more spiky.

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The common story about modern taxes and the rich begins in 1981, when President Ronald Reagan took a sledgehammer to the tax code, and ends in 2012, with Republicans insisting that any tax increase on any sliver of the population amounts to an unforgivable assault on job creators. But, despite these notable bookends, the last 30 years aren't devoid of tax hikes. Actually, they're full of 'em.

President Reagan signed nine different tax bills in the 1980s. Seven of them raised tax revenue, according to the Office of Tax Analysis. Between 1986 and 1993, effective tax rates for the richest one percent didn't go down. They went up under bills passed under Reagan, Bush, and Clinton. That's two Republicans and a Democrat.

The era of lower and lower taxes -- the Great Tax Limbo -- launched in the mid-1990s, when President Clinton agreed to a balanced budget bill that included tax cuts. For the last 15 years, Republicans have used this moment as evidence that you can cut taxes and balance the budget at the same time. But their principle begins with a myth. The Balanced Budget Act of 1997 actually increased the deficit by $21 billion in 1998, according to the CBO. Tax cuts in 1997 didn't balance the budget. They slightly reduced revenue at a time when overall income tax revenue in the '90s was otherwise soaring.

This germ of misunderstanding has grown into a bipartisan tax cut fever. For the last 15 years, Democrats and Republicans have cut with routine gusto. We cut taxes in 2001, and again in 2003, and a bit more in 2009, and a bit more at the end of 2010, and finally extended all of that at the end of 2011. We've cut income taxes and investment taxes and payroll taxes. We've added tax credits. We've expanded the number of people who pay no federal income tax while simultaneously cutting taxes on the wealthiest 20 percent of the country (who pay about 90 percent of federal income taxes).

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The last 30 years are often taken as one great experiment in tax cuts and bulging income inequality. In fact, the real story is much more spiky.

There are many ways to take stock of the tax code. I'm going to introduce one that's new to me. It comes a very useful brief on the federal tax code by Michael Linden, an economist with the left-leaning Center for American Progress. This graph measures how much federal taxes reduce income inequality.

There are three acts in this play. In Act I, Reagan's big cut took a load off the rich. In Act II, the tax code regained some progressiveness between Reagan's tax reform of 1986 and Clinton's tax hike in 1993. In Act III, effective tax rates for the rich re-started their downward march.

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Welcome to Act IV. The 2012 election might not be the most important election in modern history, but it is a perfect crystallization of the debate over income inequality. To the left, you have President Obama, trying something without modern precedent: running for re-election while promising to raise taxes. (I can't find the last time a sitting president promised to raise taxes in an election). To the right, you have Mitt Romney, who has promised to cut tax rates by 20% across the board while endorsing Paul Ryan's ultraconservative budget.

The U.S. government reduces income inequality. That's not an aspiration. It's a fact. Market wages for the bottom 40% have declined in real terms since 1979. It's only thanks to government transfers (with or without counting health spending, which is controversial) that households are seeing even barely rising income over the last three decades.

For the last 30 years, the progressivity of the tax code went down, then up, and then down again for the last 15 years. Over the same time, we've learned that while the rich are getting richer from rising wages for extraordinary talent, the poor are falling behind. Taxes and transfers will never create anything like an even playing field, but it's very clear that progressive taxation and government spending make life easier for the bottom 40 percent of households, those tens of millions of people who's market wages are falling behind inflation.

Republicans say government should do less to mitigate the effects of income inequality. You might agree, or you might disagree. But if you find yourself arguing that job creators can't afford higher taxes, consider that the last time the tax code did this little to reduce inequality, we raised taxes. And then the 1990s happened.

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Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

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