National Debt (Interesting graph)

World War II

Even before the United States entered the Second World War, increasing defense spending and the need for monies to support the opponents of Axis aggression led to the passage in 1940 of two tax laws that increased individual and corporate taxes, which were followed by another tax hike in 1941. By the end of the war the nature of the income tax had been fundamentally altered. Reductions in exemption levels meant that taxpayers with taxable incomes of only $500 faced a bottom tax rate of 23 percent, while taxpayers with incomes over $1 million faced a top rate of 94 percent. These tax changes increased federal receipts from $8.7 billion in 1941 to $45.2 billion in 1945. Even with an economy stimulated by war-time production, federal taxes as a share of GDP grew from 7.6 percent in 1941 to 20.4 percent in 1945. Beyond the rates and revenues, however, another aspect about the income tax that changed was the increase in the number of income taxpayers from 4 million in 1939 to 43 million in 1945.

Another important feature of the income tax that changed was the return to income tax withholding as had been done during the Civil War. This greatly eased the collection of the tax for both the taxpayer and the Bureau of Internal Revenue. However, it also greatly reduced the taxpayer's awareness of the amount of tax being collected, i.e. it reduced the transparency of the tax, which made it easier to raise taxes in the future.

Developments after World War II

Tax cuts following the war reduced the Federal tax burden as a share of GDP from its wartime high of 20.9 percent in 1944 to 14.4 percent in 1950. However, the Korean War created a need for additional revenues which, combined with the extension of Social Security coverage to self-employed persons, meant that by 1952 the tax burden had returned to 19.0 percent of GDP.

In 1953 the Bureau of Internal Revenue was renamed the Internal Revenue Service (IRS), following a reorganization of its function. The new name was chosen to stress the service aspect of its work. By 1959, the IRS had become the world's largest accounting, collection, and forms-processing organization. Computers were introduced to automate and streamline its work and to improve service to taxpayers. In 1961, Congress passed a law requiring individual taxpayers to use their Social Security number as a means of tax form identification. By 1967, all business and personal tax returns were handled by computer systems, and by the late 1960s, the IRS had developed a computerized method for selecting tax returns to be examined. This made the selection of returns for audit fairer to the taxpayer and allowed the IRS to focus its audit resources on those returns most likely to require an audit.

Throughout the 1950s tax policy was increasingly seen as a tool for raising revenue and for changing the incentives in the economy, but also as a tool for stabilizing macroeconomic activity. The economy remained subject to frequent boom and bust cycles and many policymakers readily accepted the new economic policy of raising or lowering taxes and spending to adjust aggregate demand and thereby smooth the business cycle. Even so, however, the maximum tax rate in 1954 remained at 87 percent of taxable income. While the income tax underwent some manner of revision or amendment almost every year since the major reorganization of 1954, certain years marked especially significant changes. For example, the Tax Reform Act of 1969 reduced income tax rates for individuals and private foundations.

Beginning in the late 1960s and continuing through the 1970s the United States experienced persistent and rising inflation rates, ultimately reaching 13.3 percent in 1979. Inflation has a deleterious effect on many aspects of an economy, but it also can play havoc with an income tax system unless appropriate precautions are taken. Specifically, unless the tax system's parameters, i.e. its brackets and its fixed exemptions, deductions, and credits, are indexed for inflation, a rising price level will steadily shift taxpayers into ever higher tax brackets by reducing the value of those exemptions and deductions.

During this time, the income tax was not indexed for inflation and so, driven by a rising inflation, and despite repeated legislated tax cuts, the tax burden rose from 19.4 percent of GDP to 20.8 percent of GDP. Combined with high marginal tax rates, rising inflation, and a heavy regulatory burden, this high tax burden caused the economy to under-perform badly, all of which laid the groundwork for the Reagan tax cut, also known as the Economic Recovery Tax Act of 1981.

The Reagan Tax Cut

The Economic Recovery Tax Act of 1981, which enjoyed strong bi-partisan support in the Congress, represented a fundamental shift in the course of federal income tax policy. Championed in principle for many years by then-Congressman Jack Kemp (R-NY) and then-Senator Bill Roth (R- DE), it featured a 25 percent reduction in individual tax brackets, phased in over 3 years, and indexed for inflation thereafter. This brought the top tax bracket down to 50 percent.

The 1981 Act also featured a dramatic departure in the treatment of business outlays for plant and equipment, i.e. capital cost recovery, or tax depreciation. Heretofore, capital cost recovery had attempted roughly to follow a concept known as economic depreciation, which refers to the decline in the market value of a producing asset over a specified period of time. The 1981 Act explicitly displaced the notion of economic depreciation, instituting instead the Accelerated Cost Recovery System which greatly reduced the disincentive facing business investment and ultimately prepared the way for the subsequent boom in capital formation. In addition to accelerated cost recovery, the 1981 Act also instituted a 10 percent Investment Tax Credit to spur additional capital formation.

Prior to, and in many circles even after the 1981 tax cut, the prevailing view was that tax policy is most effective in modulating aggregate demand whenever demand and supply become mismatched, i.e. whenever the economy went in to recession or became "over-heated". The 1981 tax cut represented a new way of looking at tax policy, though it was in fact a return to a more traditional, or neoclassical, economic perspective. The essential idea was that taxes have their first and primary effect on the economic incentives facing individuals and businesses. Thus, the tax rate on the last dollar earned, i.e. the marginal dollar, is much more important to economic activity than the tax rate facing the first dollar earned or than the average tax rate. By reducing marginal tax rates it was believed the natural forces of economic growth would be less restrained. The most productive individuals would then shift more of their energies to productive activities rather than leisure and businesses would take advantage of many more now profitable opportunities. It was also thought that reducing marginal tax rates would significantly expand the tax base as individuals shifted more of their income and activities into taxable forms and out of tax-exempt forms.

The 1981 tax cut actually represented two departures from previous tax policy philosophies, one explicit and intended and the second by implication. The first change was the new focus on marginal tax rates and incentives as the key factors in how the tax system affects economic activity. The second policy departure was the de facto shift away from income taxation and toward taxing consumption. Accelerated cost recovery was one manifestation of this shift on the business side, but the individual side also saw a significant shift in the enactment of various provisions to reduce the multiple taxation of individual saving. The Individual Retirement Account, for example, was enacted in 1981.

Simultaneously with the enactment of the tax cuts in 1981 the Federal Reserve Board, with the full support of the Reagan Administration, altered monetary policy so as to bring inflation under control. The Federal Reserve's actions brought inflation down faster and further than was anticipated at the time, and one consequence was that the economy fell into a deep recession in 1982. Another consequence of the collapse in inflation was that federal spending levels, which had been predicated on a higher level of expected inflation, were suddenly much higher in inflation-adjusted terms. The combination of the tax cuts, the recession, and the one-time increase in inflation-adjusted federal spending produced historically high budget deficits which, in turn, led to a tax increase in 1984 that pared back some of the tax cuts enacted in 1981, especially on the business side.

As inflation came down and as more and more of the tax cuts from the 1981 Act went into effect, the economic began a strong and sustained pattern of growth. Though the painful medicine of disinflation slowed and initially hid the process, the beneficial effects of marginal rate cuts and reductions in the disincentives to invest took hold as promised.

I don't buy the inflation argument.

If inflation is to blame, you'd see a steady increase in national debt. There is a steady increase, and it's small. But then in the nineteen eighties, it balloons massively, shooting up at an alarming rate compared to all the years previously.

I don't see why the rate of inflation would go up that much, in that short an amount of time.

I know school children and monkeys like pictures but adults should be able to look at pictures and see a deeper meaning. A simple chart does not supply a satisfactory explaination, unless you are dense enough to want it to.

I know school children and monkeys like pictures but adults should be able to look at pictures and see a deeper meaning. A simple chart does not supply a satisfactory explaination, unless you are dense enough to want it to.

Nice to post a chart with no information.

The answer to your question is inflation. The dollar in 1950 will only buy 13 cents of what the dollar of today will buy. Think about 4% inflation over 55 years. It is a nice effort to oversimplfy an issue, but people with common sense and a little education can see right through it.
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Interesting graph. As it looked like you produced it yourself

Nice to post a chart with no information.

No I did not make this graph. I posted a link to the site of the guy that (I presume) did. Its something I came across while cruising the web.



I knew y'all would come along with lots of good supporting information.

I felt it might spark some interesting conversation... and it looks like I was correct.

-Ghoti

Well I thought it was good. Nice one Ghoti... (Ugh, so bored and tired, can't drag fingers over keys no more....)

Can we in the UK demand our cash back from the USA, and fleece them for some cash? We could have an "America pays" day, where everyone in the UK gets £10 because the USA have paid back their debt.

Or not. But nevermind I'm bored and I want a house.

The following graph shows how the National Debt has grown year by year since 1940 in actual dollar amounts, uncorrected for inflation:



This data was gathered from the U.S. Treasury department's web site.

From time to time, I've gotten e-mail saying that the above graph is flawed -- it's just showing normal inflation. Well, I took the Debt numbers from the above graph and converted them all to 2000 dollars. Picking a different year would not have changed the shape of the graph below, just its height:



As you can see, except for a rise at the end of World War II, the Debt remained remarkably constant for nearly forty years when inflationary forces are taken into account. After 1983 however, with the notable exception of the Fiscal Years ending in September of 2000 and 2001, the trend has been upward even when inflation is taken into account.

More wonderful charts from

so clinton was reducing the debt according to inflation corrected figures?

Then he worked with what could be characterized as the most hostel [sic] Congress in history for the last six years of his administration, yet he still managed to get the growth of the debt down to 0.32% (one third of one percent) his last year in office. Had his policies been followed for one more year the debt would have been reduced for the first time since the first year of the Kennedy administration.

The debt totals in Encarta show the actual amount of money borrowed by the United States in a given year. This total is often different, and typically larger than the total a given budget might have stated. Budgets are planning documents; the borrowed totals given here are what actually happen. That is why even though the proposed budget was balanced during Bill Clinton’s last few years, the debt shown here shows an increase. The budget was balanced but the nation still borrowed more money than the budget predicted, or the treasury brought in.

so clinton was reducing the debt according to inflation corrected figures?

Someone is wrong, but who and why?

I notice no one said, "So George Bush lowered the debt in his first couple years in office?"</fuel on the fire>

As you can see, except for a rise at the end of World War II, the Debt remained remarkably constant for nearly forty years when inflationary forces are taken into account. After 1983 however, with the notable exception of the Fiscal Years ending in September of 2000 and 2001, the trend has been upward even when inflation is taken into account.