All the Fuss About Taxes

With the Presidential nomination sweepstakes and popularity contest already opening up, we’re all going to be treated to another year of claims and counterclaims, and, if the President’s recent remarks and the Republican candidates’ counter-claims are any indication, a good proportion of the rhetoric is likely to center around taxes.

As I understand the respective positions, the Democrats feel that, because wealth has become more and more concentrated, particularly in the last decade, the “wealthy” [however they’re defined] should pay a greater share in taxes, and that would be determined by closing various “loopholes” and creating a higher tax rate for the top income categories, roughly above $250,000.  The Republicans counter by saying that higher rates are counterproductive economically and that those who are above the “middle class” already pay a disproportionate amount of federal income tax.

While statistics need to be viewed with care, and I know, having spent many years as an economist, I decided to take yet another look at the IRS statistics in light of the present and likely the coming campaign charges, even though I know that few are likely to change their minds based on mere statistics.

According to IRS statistics, during the period from 1951 to 1980, the percentage of Americans who paid no federal income taxes essentially remained stable at between 21-22%.  Beginning in the 1980s, the percentage of taxpayers who paid no federal income tax began to rise, hitting 32% in 2004, 47% in 2009, and an estimated 53% in 2010.

At the same time, the percentage of tax revenues paid by the “middle class” also declined, with the percentage of total income taxes paid by the “middle class’ [defined as those taxpayers comprising those making more than the median wage, but less than the top 10%] declining from almost 40% of all income tax revenues to about one quarter of all tax revenues.  At the same time, the top ten percent of taxpayers went from paying roughly 45% of all income taxes to paying 70% of all income taxes.

Put another way, 53% of all taxpayers, largely those in the bottom fifty percent of taxpayers in income terms, paid no taxes.  The next third [37%, if we’re being more precise] paid 30% of all income tax revenue, and the top 10% [those with taxable incomes above $115,000] paid 70% of all federal income tax revenues.

At present, the current federal deficit is running close to one and a half trillion dollars annually, and federal income tax revenues are bringing in around $850 billon. The most obvious, and most bandied about, solution is to increase taxes on the rich, but there are a number of problems with this solution.

First, the reformers on the left confuse is “wealth” with “income,” and unless the Congress changes the tax law, the IRS and the Congress can only tax income, not wealth.  According to the latest IRS statistics, the eight thousand wealthiest Americans earned a combined total of $239 billion in 2009.  Assuming that Congress sees fit [which they won’t] to increase the marginal tax rate on millionaires and billionaires to 90%, and also assuming that they’re smart enough to get rid of all the deductions for these individuals, the total federal income tax revenues would total a little over $215 billion.  Given that this year’s federal deficit will be roughly $1.4 trillion, taxing those less wealthy would also be necessary to get rid of the deficit by taxing the “rich.” The 14,000 odd taxpayers who earned between five and ten million dollars a year had a total income of $95 billion, and a 90% cut of their income would raise $85 billion.  But since these taxpayers already pay close to $100 billion, the additional tax revenues would only be $200 billion. That’s still not enough.  In fact, if a 90% rate were applied to all taxpayers with an income above 1 million dollars, the total additional revenue raised would amount to $300 billion.  That leaves a short-fall of well over a trillion dollars… and the only people left to tax are those who are complaining the most about being overtaxed.  For the 81 million people who aren’t millionaires, to cover the remaining deficit through income taxes would require an average tax increase of over $12,000 a tax return.

Again, if one only wishes to tax the remaining “rich,” i.e., those making over $200,000 a year, that won’t work either, because taking all their taxable income would just barely cover that remaining trillion dollar deficit.

So… in essence, even a 90% tax rate on everyone earning over $200,000 won’t cover the current federal deficit. And, of course that would raise other problems, because, since most state income taxes run around 6% for those making over $200,000, a 90% federal income tax would bankrupt all but those millionaires making more than $5 million annually.

Given a $1.4 trillion annual deficit, and the lowest tax rates in more than 70 years, the Republican alternative of continuing lower taxes and slashing federal programs doesn’t seem terribly workable, either, since to balance the federal budget would require cutting roughly 30% of all federal programs…which would translate into cutting more than a million jobs at a time of high unemployment… and given the fact that many of those programs can’t be cut without a massive overhaul in government, either way, neither side makes much sense.

 

17 Responses to “All the Fuss About Taxes”

  1. David says:

    “Put another way, 53% of all taxpayers, largely those in the bottom fifty percent of taxpayers in income terms, paid no taxes.” Really? I’m certainly in this group and if I’m not paying taxes, what’s deal with my pay check and these withholdings? I do get about $500 back each April, but that’s only about 1/4 of what I put in.

    See here: http://motherjones.com/kevin-drum/2011/07/51-zombie-lie for a basic take down of this bad idea.

    For the origin of Drum’s point see this one: http://www.taxfoundation.org/files/wp1.pdf

    There is certainly a discussion to be had about the size of the Federal government and expenditures, but this nonsense about people paying no taxes distracts from it.

    • You’re taking the statement out of context. I was referring to federal income taxes. All the taxes paid for FICA, Medicare and the like don’t pay for non-entitlement programs, such as defense, treasury, justice, agriculture, the FAA, FEMA, environmental protection, and the like. Besides, that wasn’t the point of the blog. Like it or not, we’re running a hell of a deficit, and it can’t be physically paid by the so-called “wealthy.” Also, you can’t make the point that those who pay other federal taxes, but not income taxes, shouldn’t be taxed on their income more in the future because they “really” do pay taxes, unless you concede that the “wealthy” also pay lots of taxes besides income taxes. Why should one group of citizens only pay taxes to fund part of government, while those who make more contribute not only more but pay taxes to support to all functions of government, and not just some?

      Drum’s article essentially implies that all taxes are equal in their sources and uses; they’re not, and that’s a large part of the problem.

  2. One clarification to look for on that “combined $239B” that is the reported income of the wealthy set…

    How does that $239B, which I presume is some form of “reported income for tax purposes”, compare to other reportings possible of their incomes?

    Suppose they are getting significant deductions from taxable income that don’t indicate things they actually paid for. There’s an obvious one of ~$3400/person, of the “personal exemption”; that one’s immaterial on $239B, but it’s doubtless not alone.

    Is it possible that they’re getting exemptions/deductions that would point to their “actual income” totaling to rather more than $239B? If they had some Notably Keen deductions, it’s not beyond imagination that perhaps, without those deductions, their taxable income would look more like $2T? That would certainly change the characterization of things.

    If that’s not possible, then I’d tend to think that the Republicans have things half-right:

    - They’d be right in asserting that the budget can’t be fixed by “taxing the rich;” the realistic answer involves cutting spending in pretty massive ways. Unfortunately, that would injure parts of the economy, but it’s not evident that there’s any further alternative.

    - On the other hand, cutting taxes, which means having to chop *even more* out of the budget to balance that, seems pretty near barking-dog-mad.

    The other factor I wonder about is whether or not there’s a “tail wagging the dog” here, where a huge chunk of deficit comes from the federal government accepting financial responsibility for an enormous set of financial market transactions.

    If the deficit is essentially the government’s bailing out of the financial industry, which tends to get taxed on a completely different basis (up here in Canada, the sections of our Income Tax Act that deal with banking transactions and insurance are in rather obscure sections where such income is treated *very* differently), and perhaps all of the above is focusing at the wrong sorts of things.

    • R. Hamilton says:

      Up to a certain point (I have no idea how to judge if we’re already there), cutting certain types of taxes (and I’m no expert on which sorts, either) can actually _increase_ revenues to the government by increasing the amount of taxable business going on.

      But that only works if it’s at the very least the right sorts of changes, and if the result (including other costs to employers, like the new health care program) are not increased, and no less important, are _predictable_.

      My understanding is that a lot of businesses are sitting on a bunch of money because they’re not sure how hard they’re going to get hit for the bill on all the reckless government spending.

      Then too, those of the “rich” who didn’t just inherit it but actually participated in building their fortunes are usually responsible for creating a whole lot of jobs; increases of the taxes on them reduce their ability to do so.

      To me, the really scary part is that we’re over 50% paying zero _income_ tax (yes, I know they’re still paying FICA, Medicare, etc). That in effect means there’s a big lobby for the massive redistribution (and typically big government, since the redistribution isn’t mostly just by grants to po’ folk) approach, which has been demonstrated here and elsewhere not to be sustainable.

      I think we need to cut spending _before_ increasing any taxes (or other costs on businesses), just to establish some confidence that government for once won’t simply suck up any additional revenue for more vote-buying pandering, while of course talking out of the other side of its mouth about how bad the deficit is.

      We don’t need to eliminate the deficit right away, but we _do_ need to reduce the rate of growth of government spending below the rate of growth of either revenue or of the GDP. Once that’s done, and if we had the will to _stick_ to it, we’d eventually dig ourself out of the hole, as the line for revenue would eventually go above the line for spending. (I say that spending growth rate also shouldn’t exceed GDP growth rate because otherwise _somebody’s_ taxes would be going up, which, even if misguided cuts don’t help, almost certainly _would_ slow down the economy even more than reduced spending would – which is to day that $$ in people’s pockets do more for the economy than most $$ spent by government.)

      The real problem is two-fold: first, while the most extreme right-wing approach can be ruled out as unfeasible, that merely gives cover for almost all left-of-center or otherwise big government approaches being no less unfeasible. Second, given the over 50% not paying income taxes now, the already unlikely political will needed to consistently limit spending growth is even more likely – but cutting some of the deductions available to those 50%+ won’t be popular either, for the same reason.
      (Not to mention that third: even some superficially conservative Republicans are still big-government types, that like the patronage it gives them. Same stink, just different supporters. Thus, folks like the Tea Party aren’t necessarily that much more popular among career Republican politicians than they are among Democrats.)

      From my view, the left wanted to skew things like that to create a permanent dependent under-class and power base. Having succeeded they also created an unsustainable condition, but I think they either thought that power would let them do whatever they needed, or they didn’t understand, or they simply didn’t _care_ about anything but power.

      In views perhaps more extreme than mine, the left would just love to see some unrest preceding the upcoming election, and would claim that it justified their policies (and proceed to assume even more power – and Ron Paul seems to be implying that the recent drone strikes were an example of another step away from due process; I make no claim one way or the other on that – I like his consistency, but sometimes he takes it out into la-la land, although it’s not impossible for la-la land to be predictive in its own way, since both sides operate in their own separate sectors of it). Some on the far left have said things that could be interpreted that way, although in general the ones that are reasonably well known were careful to leave that open to interpretation, so they can always claim they’re being demagogued. But AFAIK, some of the real firebrands not visibly connected with anyone in elected office _have_ said that sort of thing, without leaving it open to interpretation.

    • R. Hamilton says:

      We had a pretty large deficit even before the bailouts, although it’s skyrocketed since then. A significant chunk of that was doubtless due to the Iraq conflict (which is not a comment on whether it was worthwhile; in principle, I like to see phone vids of any and eventually _every_ tyrant swinging from a rope, but there’s a time and a place and a cost and with _everything_, unintended consequences, and with armed conflicts, those must never be taken lightly because they’ll always be higher than estimated).

      But the conditions that led to the bailouts have been brewing for 30 years and more perhaps: encouraging making home loans not just to diverse people, but to people who were a worse risk under less than ideal conditions, encouraging the balance of power between unions and for example the car companies to tilt too far toward the unions, and the auto CEOs not having the guts to compare the quarterly hit for hanging tough against the long-term hit for unsustainable levels of pensions and benefits. And probably other conditions too: no doubt there are plenty of regulatory loopholes that people profited by overlooking. But I look at the latter cautiously, because money usually finds its way around regulations, if at a cost. Regulations intended to limit unsound practices need to be carefully crafted to avoid excessive costs _or_ unintended consequences…which is very difficult given the number of interests that will oppose or seek to modify (or support certain portions while being pointedly silent about others) of any proposed changes. That is one risk of even the best of regulations: that it increases the entanglement between government and private interests, which _always_ goes both ways, following the concentrations of wealth and influence, thereby making it constantly harder to keep any needed future regulatory changes from being corrupted.

  3. Wayne Kernochan says:

    Oddly enough, having disagreed with you about whether $250,000 is the right point to up the marginal tax rate, I find myself mostly in agreement with the points you make. However, I do think that a couple of further points also need to be considered:

    First, I agree strongly with your distinction of wealth vs. income. The data to add is that 85-90% of the wealth of the very wealthy is in investments. Asssume that this is mostly in stocks. Studies have shown that over the long run, the geometric mean (the right measure) rate of return when you subtract inflation and taxes (including all of them) is 6.8% for a Vanguard S&P 500 index fund.
    Now suppose you have $15 million in stocks and withdraw 4% per year ($600,000) — netting about $500,000 after taxes. Your net worth will still increase by $250,000 after taxes. In effect, you will be doing as well as a millionaire (earn $750,000 after taxes, spend $500,000, save $250,000) — and you haven’t done a lick of work.

    The predominant reason for the increasing income/wealth gap, then, is the failure to capture some of that increase in net worth of the very rich invested in stocks. A much smaller reason (estimated at 20% of the rise in the wealth gap) is the failure to make capital gains/dividend tax rates equal to top marginal income tax rates. To put it another way, some of the huge increase in the share of the very wealthy comes from not taxing their investment income enough, and some comes from not taxing their existing wealth (their holdings of stocks and bonds) enough.

    I realize the problems with a simple tax of 2% on household stock/bond holdings per year (for holdings above about $350K), but I guesstimate it would return about $500 billion/year. A doubling of the capital gains/dividend rate would probably yield $50-$100 billion, and a 10-20 point rise in the marginal tax rate for income would, as you note, yield another $50-100 billion. So we’re now up to about $600-700 billion — 1/2 the deficit.

    Second, at this point, we ought to ask, why are we in deficit in the first place? Clearly, one reason, despite your figures on who pays income taxes, is that real unemployment has risen by 5-10% over the last few years, and the median household income of those who are employed is $48,000 (or, if you prefer, the median wage is about $30-33,000), while over the last 30 years pre-tax income for the bottom 40% appears to have fallen. In other words, a significant chunk of the loss of tax revenue has come from a large gap between real and potential GDP, including as a large component loss of jobs (and decrease in pay) at the $60,000 and below level.

    The obvious short-term answer is job stimulus for those types of jobs, as those folks are more likely to spend for economic takeoff, while in the long run their permanent employment (and the rise in the median income) will remove possibly 1/2 of the remaining $700 billion in deficit. And at that point (again assuming that, like you, I should leave Federal taxes for other purposes out of it), we should treat a $350 billion level as an appropriate level of deficit for the government, as it has been in the past (more precisely, an appropriate percent of the Federal budget).

    • Heh. Your premise assumes that there is a Keynesian multiplier, whose value is significantly different from zero!

      There seems to be a significant set of folk in political places that hew to the doctrine that such spending is valueless, in effect, with a multiplier of 0.

      I’m not sure what the multiplier ought to be; I’d be concerned that spending huge sums on job stimulus might increase the deficit and debt, leaving a bigger “hole” to dig out of later.

      Even having a fairly large Keynesian multiplier doesn’t establish that things improve; supposing there’s a multiplier of 2, which I imagine is high, that means that spending $1T stimulates $2T of activity. That worsens the budget unless the tax rate effective for those being stimulated is somewhere pretty near to 50%.

      • R. Hamilton says:

        Personally, if your example indicates the meaning of a Keynesian multiplier as basically increase in activity due to government spending divided by government spending, I think the multiplier is less than one, e.g. 1 unit spending maybe gets somewhere between 0.3 and 0.7 units of GDP growth, depending on the type of spending, much of which does _not_ leave long-term improvements in productivity in its wake.

        (I would suppose that low capital gains taxes allow _private_ investments to have a much higher analogous multiplier, since they usually are in something expected to be productive – to the point that even from the government revenue perspective, they’re more than break-even; and for everyone else’s prosperity, even those that don’t directly own stock (but their pension fund probably does), private investments create more opportunity than government spending.)

        I don’t think the value could be _zero_ unless it was 100% for foreign aid or something like that. But I don’t see how, except in very unusual cases, it could exceed 1 (break-even for the economy, but still increased deficits unless the increase was taxed at 100%). The government is _not_ efficient – I ought to know, having been there long enough. And there are too many pressures as well as too many incompetents keeping it from being able to be efficient in most cases.

        BTW, if we don’t start getting realistic about our expectations for increasing benefits or the current low retirement age (compared to increasing lifespans), not only will Social Security get hammered by baby-boomer retirement, but we’ll have another concealed semi-private collapse waiting due to pension funds both private and public. They’re better off, since over the long run they earn interest rather than IOUs, but that doesn’t mean that they’re immune. The states are already seeing that with their pension funds, I think…but they probably rob theirs with IOUs too from time to time.

    • R. Hamilton says:

      The whole reason for encouraging investments (by keeping the capital gains rate low) is that unlike much government spending, investments actually build the economy, generally creating more taxable wealth than they shield from the higher rate.

      OTOH, I can maybe see how one might argue for taxing offshore investments, or investments in companies that export a lot of jobs, higher than investments with a high enough domestic content. Except then the rich would just move their entire fortunes offshore, get a villa somewhere, and live here less than six months out of the year.

      Once someone has enough money to be able to make significant investments, no matter how you try to go after it, they have more options to protect it than anything short of a police state has in options to tax it.

  4. I am not sure I agree with your stats and all, but EXACTLY!

    neither team has an idea that makes you happy, so…

    So what is your idea?

    • I’ve had plenty of ideas and posted them over the past years, but the essence of my beliefs lies in moderation. No government can fix all the problems for all the people, and no single solution will work. That means a moderate “safety net”; educational opportunities, but not entitlements; a strong defense but not an “empire”; etc.

      • STI says:

        Mr. Modesitt:

        I’m not entirely thrilled with either party’s “solutions,” but I have to give the left credit for understanding that spending cuts *can’t* fix the overall debt, whereas the solution on the right is simply illogical (cut spending/raise taxes merely to allow businesses/the wealthy to make more money).

        That said, Social Security is not a fundamental part of the problem; it needs at most modest changes to remain solvent for a long time to come. As I see it, there are three main problems:

        (1) Health care costs. We need to have a national conversation on the actual costs and benefits of our healthcare system; it seems unconscionable that we should have the world’s highest costs and NOT have the best healthcare system in the world, plus have a large percentage of uninsured people.

        Unfortunately, the right decided to poison that particular well with their talk of “death panels” and the like. [Any candidate who spouts such nonsense automatically forfeits my vote.]

        (2) Military spending. There is no logical reason, as you suggested, for military spending at “empire” levels. I’m not sure how much we as a nation do need to spend, but I find it hard to believe that we need to spend $750B+.

        (3) Unemployment. As others have noted above, if we had full employment, we’d have a larger tax base, and more revenues. Unfortunately, the right seems unwilling to do anything to help solve that problem, and actually seems willing to harm our future for short-term political gains (e.g., drastic cuts to education and demonizing the teaching profession, which seems unfathomably short-sighted, and refusing to do anything about climate change, when such actions would actually be likely to net jobs created, rather than lost).

  5. Oh and having read your response to the first blog, I would say that while defense is still large, FICA medicare and the like are a very large portion of the budget. So while the number of programs you listed afterwards make a long list, the numbers potentially evade your argument there. No?

  6. Brian says:

    I’m not an economist, but I’m going to suggest a couple ideas for comment.

    One, government spending needs to be reduced. I’m not in a position of knowledge to suggest what should be cut, but spending cannot continue at current levels.

    Second, don’t tax income. Tax consumption instead. I believe it was New Zealand in the 1980′s that introduced a Goods and Services Tax (GST) to stave off bankruptcy. Canada followed suit in the late 80′s and for both it worked and continues to work. This way everyone shares the tax burden, but only if they choose to buy those applicable goods and services. The bureaucrats needed to administer this may offset those let go as a result of spending cuts, too.

    I hate taxes, but sometimes reality means ‘taking some bad tasting medicine’. After a while you get used to it. :) Finally, if America fails to solve its financial challenges, then your allies, friends and neighbours are going to be dragged down into the abyss with you.

  7. Brian says:

    Back again to make an additional comment to my one above. Forbes has released its list of the best countries for business. Canada is first and New Zealand is second best. I leave it you to decide if the correlation is a coincidence. Here`s the link if anyone is interested:

    http://www.forbes.com/sites/kurtbadenhausen/2011/10/03/the-best-countries-for-business/

  8. Brian, I’ll comment “as a Canadian”…

    One of the notable implications of our GST was that it provided an extra way of evaluating the correctness of assessments of other kinds of taxes, which led to decreases in tax evasion across the board.

    I’ll take a bit of an opposite tack on “don’t tax income.” Rather, having a tax base that covers as broad a set of kinds of things as possible, and taxing it not super-heavily, seems like the most sustainable thing to do.

    There’s a problem with applying heavy levels of consumption taxes, namely that it encourages evasion to the point of creating and sustaining an industry of smuggling. We found that when tobacco taxes got set high enough, it brought cross-border smuggling industry into existence.

    If you try to get all the taxation on one thing, then that one thing will be the focus of all evasion, and will twist the economy in pretty evil ways.

    So I’d point rather at taxation being a “death of a thousand paper cuts,” where what’s wiser is to apply it lightly but broadly, in such a way that none of the taxes are sufficiently worth evading to warrant building smuggling and similar industries.

    • Brian says:

      I was not clear about income taxes and that is my fault. :( Income taxes are here to stay and when I said ‘don’t tax income’ I didn’t mean to eliminate them altogether. But they must not be so burdensome as to stop the consumer from consuming.

      I agree Christopher that there are potential problems with any solution that is tried. Human beings are very creative in avoiding things like taxes and that will never stop. One example besides smuggling is the ‘underground’ economy where services are provided ‘in kind’. (ie. Joe does a plumbing job for Steve who shingles Joe’s home–no money changes hands and therefore no taxation).

      Income taxes plus a reasonable consumption tax (along with other prudent fiscal policies like reduced spending), if done properly, would make the burden of paying down the debt, hopefully, a little less painful overall by spreading it out like you say. Totally agree.

      Finance Minister Paul Martin turned a 1994 deficit (credit rating by Moody’s–Aa1) into a surplus by the turn of the century (credit rating by Moody’s in 2002–AAA). The GST was ONE of several methods used to raise sufficient revenue to do this. Did it hurt? Yes. It did because it also involved deep spending cuts to social programs (ie. health care). Once the books were balanced, prudent spending resumed and income tax cuts followed. Clearly our fiscal policy has left us in a better position to weather the current crisis. The current government of PM Steven Harper vows to rebalance the books by 2014. :)

      What made the Roman world last so long is they were not afraid to borrow what worked from their neighbours and enemies, for that matter. America you are not alone. What worked for an economy a tenth your size may work for you.
      After all, the current situation is intolerable for you and for your friends and neighbours.

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