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The Fiscal Cliff in History

1 min readBy: William McBride

Since it appears more likely than ever that we’ll go over the fiscal cliff, we might as well start cataloguing this historic achievement.

First, it will be the largest taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. increase since World War II, at about 3.5 percent of GDP.

Second, the fiscal cliff is a historic income tax cliff. As the chart below shows, it will result in the highest tax rate on individual income (39.6 percent) since 2000, the highest tax rate on capital gains (23.8 percent) since 1997, and the highest tax rate on dividends (43.4 percent) since 1986.

Economic theory and evidence indicates these are among the worst kind of tax increases for the economy. As a result, most economists, including those at the Federal Reserve and the Congressional Budget Office, think this will lead to a recessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. in the first half of 2013. Arguably, this would be the first recession created by a tax increase since 1969, or, before that, the Great Depression. (The recession of 1990 coincided with a tax increase that was too small to have such an impact on the economy.)

Lastly, the fiscal cliff will be the first major tax increase since World War II to occur under a Republican controlled House of Representatives. The only lesson that can be drawn from that is don't do temporary tax cuts, e.g. the Bush tax cuts, unless you want them to be temporary.

Update: Steve Entin reminds me that the 1990 income tax increase was probably a contributing factor in that year's recession, as was that year's payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. increase, and the economy was already weakened by the 1986 tax increase on capital and the 1988 payroll tax increase.

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