The agreement reached this month to permanently settle income tax rates has been viewed by Democrats (and some conservative activists) as a watershed moment that has finally ended the post-Reagan political climate where tax raises were unachievable. Yet, nearly all of the tax cuts that George W. Bush pushed for in 2001 and 2003 were locked in, with mostly Democratic votes. This suggests that the politics of taxation are not as partisan—or predictable, as some would imagine.
For the rich, taxes were incredibly high from World War II until the 1980s. The rates that were set at the end of the war had a top rate of 91%. The amount needed to hit the top rate is the equivalent of $2.5 million today, so this is a higher threshold than the $400,000 that will be the new criteria for the top rate. But making nine out of every ten dollars liable to taxation made the wealthy extremely tax sensitive. The super high rates for the wealthy help to explain the mid-century strength of liberal Republicanism and was a major reason wealthy Southerners became Republican as early as the Eisenhower era.
The Kennedy and Johnson administrations cut taxes across the board, but even these revisions locked the top rate in at 70%. It would take Reagan to fundamentally change the taxation structure in the United States. Reagan was able to drop the top rate to 50% in his 1981 tax cuts. But the big change came with the Tax Reform Act of 1986. The Tax Reform Act, passed with nearly unanimous support from both parties, drastically lowered the top rate, all the way down to 28%. This was balanced by shifting much of the burden towards corporate taxation and lowering the top rate threshold much lower.
The Tax Reform Act of 1986 had far reaching effects on American politics. This was a significant long-term victory for conservatives who argued that lower taxes would lead towards economic growth. But as it is with politics, a conservative victory had a beneficial long-term impact for liberalism. Now that taxation was at very reasonable levels for the rich, they were no longer nearly as worried about their taxes. This freed the affluent to vote more based on a series of other issues, some of which they favored the Democratic Party on.
Republicans won five out of six presidential elections from 1968-1988, with the one narrow loss coming two years after Watergate. There was a clear Republican advantage in winning the White House in those years, and the tax issue was one of the reasons for this edge. But after Republicans were successful in achieving long-term tax relief, their edge in national elections disappeared. While there are many reasons that explain why Democrats won five of the past six presidential popular votes, relatively low income tax rates are an overlooked factor in this transformation.
This makes the politics of taxes more complicated than they would appear. Raising taxes on the top two percent of earners a few points is generally politically popular. But it is not clear that there is any desire for further hikes on rich or any tax increases on lower earners. After picking the low hanging fruit, top Democrats indicated that they were finished with attempts to raise rates on any segment of the population. This is a sign that the Democratic coalition now includes many wealthy people and further rate hikes could get them in trouble with some of their most influential supporters.
Will this tax increase change any immediate term politics? A hike of approximately 4.6% isn’t likely to change the voting habits of those who can shoulder these increases. Voters have become used to casting their votes on issues other than taxes and it isn’t likely that going back to where the highest rates were in the 1990s will trigger a backlash. But further tax hikes very well could upend the political arrangements of the past two decades. If there is not the appetite to increase revenues through taxation, it will be impossible to avoid the need for large cuts to entitlement programs to balance the budget. And this political climate could be as unpredictable as any in modern American history.
