The Effect of Individual Income Tax Rates on the Economy, Part 1: 1901 – 1928

by Mike Kimel

The Effect of Individual Income Tax Rates on the Economy, Part 1: 1901 – 1928

In 1913, the 16th Amendment to the Constitution led to the income tax system we know and don’t love today. Since that time, in fact, since way before that time, people have been arguing about the effect of taxes on the economy. Over the next few posts, I will take a systematic look at the relationship between individual tax rates and the economy going as far back as the data allows in the United States.

In most of these posts, I will measure the effect of the economy using growth in real GDP per capita. However, that series only dates back to 1929. So in today’s post, which will focus on the period up to December 1928, I will look at the recessions (using official dates from the NBER and compare that to top individual marginal tax rates as published in the IRS’ statistics of income historical table 23.

The graph below shows the top marginal tax rate (black line) and periods in which the economy was in recession (gray bars) going back to January 1901. (Note – the economy was in a recession from June of 1899 to December 1900, so January 1901 is a nice “clean slate” date at which to start.)

Figure 1.

I think the graph above lends itself to be division into three more or less discrete periods. The first is the pre-tax period from 1901 until 1912. The second is the “rising tax” period from 1913 through 1918, and the third is the “falling tax” period from 1919 to 1928.

Now, if you asked the typical economics professor or politician or conservative to rank three periods – no individual income taxes, rising individual income tax rates, and falling individual income tax rates – in terms of time spent in recession, you’d probably hear this back, “The economy will spend less time in recession when there are no income taxes, and the most time in recession when tax rates are rising.”

But that isn’t what the data shows. The time spent in recession is pretty comparable. The percentage of months under recession in the pre-tax period is 43.8%. The percentage of months under recession in the rising tax period is 40.3%. The percentage of months under recession in the falling tax period is 42.5%.

Now let’s talk some nuance. A recession is not a recession is not a recession. For instance, the recession that began in 1907 was pretty severe, and is often referred to as the Panic of 1907. The recession of 1918 was caused by the end of WW2. And then there’s one more detail worth mentioning, the elephant not in the room so to speak. The graph doesn’t show what happened in 1929, following just over a decade of tax cuts (in which time the top marginal rate fell from 77% to 24%), we had the Great Depression.

Next post in the series: The Great Depression and the New Deal