Taxes and Income

Over the past two years, there’s been an incredible furor over income and wealth inequality, which has been compounded by the fact that the U.S. government has been running huge deficits, because Congress doesn’t want to tax people enough to pay for what Congress wants the federal government to do. Then add to this the fact that the incomes of most American families, i.e., those in at least the bottom sixty percent of all families, have on average stagnated or declined. Add to that the fact that government inflation measures don’t include all costs of living.

As a result, liberal politicians are pushing for programs to benefit those hurt most by stagnant or declining incomes, pressing for increasing taxes on the rich and especially the “super rich.” Those proposals include higher tax rates on those with incomes over, say, $10 million annually, or even annual wealth taxes.

Conservatives, in response, cite figures that show that the top ten percent of all earners pay 70% of all income taxes and that the top one percent of earners pay more total taxes than the bottom ninety percent combined.

And both sides are wrong, in a number of different ways. First, both sides are either not understanding the tax system or misrepresenting it, if not both. Second, concentrating on taxable income ignores the fact that the rich have ways of legally under-reporting their actual income, ways that are not open to taxpayers less well-off, as well as the effect of vast wealth. Even without taking into account that under-reporting, the top one percent, on average, only pay effective federal income tax rates of about 23%.

The 70% marginal tax rate on incomes over ten million dollars means just that. After you’ve made ten million, you would only get to keep $300,000 out of every subsequent million. It doesn’t mean that the government gets 70% of your first ten million, although a lot of people on both left and right, from what I’ve read, seem to think that’s what it means.

More important, a lot of that purported revenue won’t get collected. Why not? Because if the income arrives through capital gains or qualified dividend checks, the tax rate is still only a maximum of 20%. Or if the income qualifies as “carried interest,” or… [a good tax accountant can fill in all the other exceptions, but that’s the idea].

Right now, the tax code is riddled with so many exceptions, variable rates for different sources of income, and credits for various types of investments [often justified under the dubious rationale that such investments create jobs that wouldn’t otherwise exist] that changing rates will do very little to affect the income taxes paid by the top one percent. They will have an effect on well-paid professionals in the top five percent who are moderately well-off, but not well-off enough to benefit much from the tax avoidance available to the super rich.

What tends to get overlooked in concentrating on income and tax rates is the impact of wealth. In the last thirty years the share of wealth held by the lower 90% of the population has dropped by ten percent, so that now the top ten percent hold almost eighty percent of the nation’s wealth, while the top one percent hold half of that, forty percent. That stock of wealth is held in various means, but it all produces, over time, income that is taxed at a far lower rate than income earned by working. This is one of the principal [pun intended] reasons behind the old saying that the rich get richer. If you make more money than anyone else and you’re taxed at a lower effective rate than the hard-working professionals in your company… of course, you’re going to get richer.

But the bottom line is simple. Under the current tax structure, fiddling with rates won’t raise that much more money, and that includes lowering them, Laffer Curve enthusiasts to the contrary. The only thing that will increase tax revenue is eliminating all the subsidies and loopholes, and varied rates for the same amount of income (based on its source)… and then see what happens. Right now, no one really knows just how much tax revenues have been bled off through those devices, but it’s definitely substantial.

But until Congress actually works on the tax structure by eliminating all the special treatments of various types of income and by eliminating all of the exemptions and tax credits, merely changing marginal tax rates won’t address the real problems or the deficits, no matter what the rhetoric is.

2 thoughts on “Taxes and Income”

  1. Tom says:

    Apparently no one knows how many laws there are in the United States. Apparently, no one can count that high. They’ve been accumulating, of course, for more than 200 years. When federal laws were first codified in 1927, they fit into a single volume. By the 1980s, there were 50 volumes of more than 23,000 pages each. Congress passes new laws and Congress does not delete any old laws.

    Perhaps, if we are to have small government, Congress might start by getting rid of what has not worked or is out dated for Governing of the US.

    One place to start whittling might be the US Tax Code. That will require staff: too bad that we have achieved small government by reduction of staff (but then manpower is the costliest part of any business).

  2. R. Hamilton says:

    The wealthy can afford at the last resort, to move to some offshore tax haven; together, they could probably buy or control some entirely. NO attempt to squeeze substantially more out of them can really succeed. And IMO, it shouldn’t be attempted. Redistribution beyond services such as decent schooling (which requires NOT babysitting all those disruptive to learning together with those who aren’t), except perhaps for VERY time limited circumstances, is simply doomed to failure (certainly the trillions wasted on the war on poverty haven’t reduced tensions or improved attitudes or mobility), or, at most, to providing an assortment of bureaucratically rationed services and very modest stipends. It will very rarely convert the unproductive to productive, and all the world’s rich people together do not constitute a magic free stuff machine; and I’d argue that even if there were one, say a government monopoly on Mr. Fusion (Back to the Future II) and replicators (ST/TNG etc), it would still be an immense mistake to make it possible to on a large scale separate survival permanently from usefulness.

    It is quite plausible however that debt is greatly excessive (even if an argument can be made that some debt is ok, when the interest is as big a portion of the budget as it is now, that’s too much), and that law (including but not limited to tax law) is far too complex (leading among other things to inconsistent, discretionary enforcement). A modified flat tax (one where the first 1.2 x poverty level or so is not subject to income tax) is still progressive, gradually enough so at the low end so as not to discourage moving up, but simple enough to avoid being indignantly punitive (but with so many loopholes as to be if not meaningless, at least unpredictable by outsiders) at the high end.

    Phasing down or out most services and benefits and minimum wage, might actually _improve_ upward mobility at the low end – $15/hr is killing entry-level and low-end jobs in some locations – (although some precaution to restrict modern robber barons like Amazon from treating employees like property would likely be needed, but whether there’s a practical way of doing that without similar problems as with other interventions, is an open question); and would almost certainly reduce the incentive for economically driven illegal immigration, if only by demonstrating to the rest of the continent that something closer to laissez-faire than to socialism would, if corruption were kept in check, fix their economies too.

    Even with 19th century robber barons, there were those who made it from abject poverty to at least very comfortable by the standards of the time. Not everyone can do that, but without disincentives, a lot more could than currently do.

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