The Saeculum Decoded
A Blog by Neil Howe
Nov 022010
 

In the U.S., we’re raising our top marginal rate up past 50%–but without any of the huge spending cuts.  In 2010, the typical top marginal tax rate on ordinary income in America was about 44% (35% federal, plus 2.8 in uncapped Medicare tax, plus an average of maybe 6% for state taxes).  By 2013, due to the expiration of the Bush tax cuts, a hike in the Medicare tax (thanks to Obama’s health-care reform), and a phase-out of itemized deductions, this top rate will rise by about 7 percentage points—to just around 50%.  The top rate in New York City and California will be well over 50%.

A 50%+ top marginal tax rate is today high even by European standards.  So you might be wondering… if marginal rates on ordinary income are approaching (or even exceeding) Europe’s, why has Europe always been able to extract a much greater share of GDP out of its economy in the form of government revenues?  The answer is that Europe’s *inframarginal* rates have always been much higher—meaning that Europe taxes its middle and lower-middle classes much more heavily than we do.  The bulk of their welfare state, after all, is paid for by one-rate-fits-all value-added taxes and payroll taxes.  The U.S. federal income tax code, by contrast, leaves the middle class pretty much untouched, while ramping up steeply at higher incomes.

Europe is not cutting its high personal tax rates and in the UK David Cameron is even boosting them.  On the other hand, both Europe and the UK continue to cut their tax rates on *capital* income, so that over the last decade the U.S. has come to be regarded as a punitive outlier in its treatment of capital income.  (Case in point, Cameron’s proposed hike in the capital gains tax rate is the one hike that is not likely to be enacted.)  In this new “age of austerity,” Europe is following the brutal law of “efficient taxation,” to use the economists’ lingo.  To wit, you raise tax rates on those who don’t have a choice about whether or where to earn their income… and you lower tax rates on those who do.  As the age of austerity worsens, European voters may insist that governments pin down and regulate the wealth and income of capital owners more rigorously so that they can tax capital at higher rates.  We’ll see.  I can easily envision this happening in America.  Even if the GOP wins big, I doubt that a more populist GOP party will make big cuts in capital gains or estate taxes a big priority.

As for the bond markets, it is true that the U.S. can borrow freely at very low interest rates and will probably continue to be able to do so unless or until the global economic situation becomes truly catastrophic.  The reason is that, due to America’s unique superpower status, bad news anywhere in the world (even here in the U.S.) causes people around the world to invest in U.S. bonds as a safe haven.  So even our own bad decisions cause only others to suffer.  Valéry Giscard d’Estaing (former Finance Minister of France), in a closely related context, once called this America’s “exorbitant privilege.”  Other countries do not have this privilege.  So the UK, Japan, France, and Germany all have to take bold measures against the specter of fiscal insolvency lest the same thing happens to them (sudden hikes in interest rates, and a bond market crash) that has happened now to several of the PIIGS countries.

This explains why—to bring the discussion back around to turnings—America may be the last place in the world to experience the “age of austerity,” that is, to experience the 4T mood in its full economic brutality.  To America, and to America alone, there seems to be no penalty at all to endless borrowing at zero interest rates… and if that is so, then why do any of us need to worry?  Of course, I may be mistaking here the opinions of America’s elites (e.g., Paul Krugman) for the opinions of ordinary citizens.  The midterms may be very revealing in this regard.  I’ve had several opportunities in the last few months to visit cities in the Midwest.  In each of them, I ask my hosts, what issues really concern local voters in the midterms?  And they say, the huge and growing federal deficit.  And then I say, yes, of course, sure, but what do they *really* worry about?  And then the hosts say, no, honestly, they are *really* worried about the country going bankrupt.  I found these conversations very ominous and very [4T].  Bankruptcy is all in the eye of the beholder.  If most people come to view an institution or government as insolvent, a landslide of distrust, hedging, aversion, falling confidence, and nonparticipation begins to feed on itself until, in the end, the institution or government does indeed become insolvent.  Most Americans believe that their government cannot continue to borrow for long without toppling off the brink.  That becomes an important social fact, regardless of the opinion of the Council of Economic Advisors.

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  • Michael Shores

    I’m unconvinced that high marginal tax rates are characteristic of a fourth turning. I’m old enough to remember a time when the marginal tax rates were much higher, but that was during the heady days when we were rebuilding the nation and paying for it as we did so. n Not deficits per se, but the kind of deficits we have now seem to be a better marker. We are going deeper in debt not to invest in our future, but to just get to the next fix. Neither liberals or conservatives are willing to be the wet blanket that calls an end to the party, so the combination of tax cuts and additional entitlements just keeps the binge going. Once we as a nation are in the gutter wondering what happened, we will be deep into the next fourth turning.

  • Cohort74

    Actually, high taxes and a fourth turning go together, because America tends to fight wars during fourth turnings. This is true everywhere from New England in the 1672-74 “King William’s War” to the Revolution, Civil War, WWII and now, who knows.rnrnGiven high government expenditure, marginal rates tend to rise. Consider that in 1932 top marginal income tax rates were about 20%, by the time the era was over in 1951, they were 91%.rnrnSticking with the strict Generational cutoffs of Strauss and Howe, taxes were “only” 86% in 1943 (though Americans received a tax holiday for all of 1942 as the country shifted from an arrears tax system to the “current tax” system in which taxes were withheld, rather than paid in arrears. Recognizing that most poeple saved in the first months of the new year to pay their tax bills on April 15, and that it was impossible to withhold tax for 1943 and have enough discretionary income for people to save to pay 1942 tax, the government declared no taxes due for 1942! And GI generation people always complain about how much they contributed …. they have no idea).

  • Wally

    Marginal tax rates matter less than the structural unemployment in crisis periods.

  • David Kaiser

        Both higher taxes and higher borrowing are characteristic of a 4T, when they are needed to mobilize society and deal with some large internal or external threat (or both.)  But an emphasis on deficit reduction is totally characteristic of a 1T, after the crisis is over.  Thanks largely to the Bush tax cuts and the wars in Iraq and Afghanistan, the federal government now not only lacks the resources to cope with the economic crisis, but is focused, from the President on down, on cutting the deficit.  This is why I am still inclined to believe that the 4T is now ten years old and that we will move into a very disappointing 1T if Obama is re-elected and the Republicans decide they have to give up total obstructionism.  If the Republicans take over I expect the crisis to continue–in the form of a continuing attack on government at all levels.

    • Anonymous

      I agree that a short Fourth Turning is NOT a good direction, but I am also not convinced that we are all that far into the Fourth Turning yet. If you look back at the last short 4T (Civil War) the level of trauma that cut short the turning was immense. I don’t think we are there yet in terms of the level of the crisis. It feels more like a slow roll towards some icky destination that we don’t yet perceive…