Return Of The 75% Tax Rate

Have you noticed the streak of contrarian philosophy that occasionally runs through France’s political leadership?

In March 1966, for instance, President Charles de Gaulle withdrew his military forces from NATO, an alliance that was created to protect the European democracies from a Soviet invasion. Although Soviet army tanks rolled into Czechoslovakia just two years later to crush a pro-democracy movement, the French army remained independent and clung to a go it alone strategy.

Conversely, France assumed a leading role last year in persuading a hesitant NATO to employ military force to support protestors in Libya. Although the British joined the French in leading the campaign, other nations were content to remain in secondary roles, with the American military adopting the role of leading from behind.

Last week, the French tendency towards contrarian philosophy emerged in the field of taxation policy as well. At a time when nations from America to Singapore are competing for global business by maintaining low rates of taxation, France’s leading candidate for President announced a policy that favored a 75% income tax rate.

“A Patriotic Act”

Socialist Presidential candidate Francois Hollande, who has been leading in the polls to topple current President Nicolas Sarkozy, surprised many of his own advisers by advocating a 75% top marginal rate on personal income taxes. He explained his position by noting that it is patriotic to agree to pay a supplementary tax to get the country back on its feet.

Regardless of our position on tax policy, we can all certainly agree that the French economy could use a boost. Some believe that its persistent weakness in the wake of the recent global recession, particularly in comparison with the economic strength of Germany, has destabilized the European Union.

Germany’s current economic strength is usually attributed to its decision, codified in its Agenda 2010 legislation, to reduce the constraints that its government had placed on the private sector and to permit its labor market to adopt a more free market oriented model. The implementation of a 75% rate of taxation in France, though, would appear to shift the French economy in the opposite direction.

The American Experience

It’s safe to say that the top marginal tax rate in the United States will remain below 40% for the foreseeable future. It has remained at 35% since the Bush administration modified the Clinton era rate of 39.6% in 2003; more recently, Republican Presidential candidates have advocated for rates as low as 9%.

Throughout the decades of American prosperity in the 1950s and 1960s, though, the top tax rate never dropped below 70%. And even when the Tax Reform Act of 1986 briefly arranged for the top rate to drop to 28% during the final years of the Reagan administration, the Act offset the historically low rate by eliminating many tax deductions and establishing a complementary capital gains rate at a relatively high “matching” level of 28%.

Advocates of low marginal rates in the United States, though, repeatedly point to the Reagan era to support their case. On the other hand, advocates of high rates point to the prosperous decades after World War Two, as well as the Clinton era, to justify their own positions. Clearly, they cannot both be correct …

… or can they?

A Question of Proportion

Let’s take a closer look at the history of America’s top marginal tax rates from the time of the initial imposition of the income tax in 1913 to the current day. But instead of looking at the top rates in absolute terms, let’s look at annual swings in proportional terms.

The increase in tax rates from 31% in 1992 to 39.6% in 1993, for instance, increased the rate by a bit more than a quarter of its 1992 value. That was the only time, subsequent to the Great Depression, that the top rate had increased by such a large proportion.  Even though the change in absolute terms was “only” 8.6%, the 1992 rate was so relatively low that the proportional increase was arithmetically very large.

Conversely, although the reduction in tax rates from 38.5% in 1987 to 28% in 1988 may have “only” represented a 10.5% decrease in absolute terms, it represented a decrease of more than a quarter of its 1987 value in proportional terms. And it followed similar proportional drops of over a quarter in 1982 (i.e. from 69.13% to 50%) and almost a quarter (i.e. from 50% to 38.5%) in 1987.

A Quarter At A Time

In other words, both President Reagan and President Clinton appeared to opt for incremental changes of roughly a quarter (proportionately speaking) per annum. Even though the two political leaders shifted the rate in opposite directions, their modifications each helped trigger periods of great prosperity.

What should Francois Hollande conclude about the American experience? Considering France’s current marginal tax rate of 40%, an increase of a quarter of its proportional value may prove effective, but it would leave the rate at a level below 50%. In other words, a leap to a rate of 75% in a single year would be unprecedented in scope, at least by modern American standards.

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