Tax Rates Should Be Low: Historical Evidence

from an article by Burt Folsom:

What happened in the U.S. the two times we raised tax rates to 75 percent? Bad things. The first time was during World War I, and in the aftermath of the war the top marginal tax rate was 73 percent. American investors tucked their cash away, and unemployment skyrocketed to 11.7% in 1921. President Warren Harding and Vice-President Calvin Coolidge came into office in 1921 and immediately campaigned to lower the tax rate and bring investments back to the U.S. Within five years, the top tax rate was down to 25 percent, and in less than three years, unemployment had plummeted to 2.4% The recession was over by 1923.

The second example came in 1935 when FDR persuaded Congress to raise the top marginal tax rate to 79% on very large incomes. In the four years following FDR’s tax hike, unemployment ranged from 14 to 21%. The Great Depression persisted. Why should entrepreneurs make new investments when the government promised to confiscate most of their income? Only in 1945, after World War II, when tax rates were cut on both income and corporate earnings, did businessmen rush to invest in the American economy. Unemployment in 1946 and 1947 was only 3.9 percent under the new lower tax rates.