With the infamous Bush tax cuts* expiring at the end of the year, we are seeing a big argument as to what we should do. With the state of the economy a little dicey, should the cuts be extended for everybody or is the deficit so big (and the alleged unfairness so great) that we need to let them expire for the "rich," while extending them for everybody else?
E.J. Dionne is pretty clear what he thinks:
"The simple truth is that the wealthy in the United States -- the people who have made almost all the income gains in recent years -- are undertaxed compared with everyone else.
Consider two reports from the Center on Budget and Policy Priorities. One, issued last month, highlighted findings from the Congressional Budget Office showing that ‘the gaps in after-tax income between the richest 1 percent of Americans and the middle and poorest fifths of the country more than tripled between 1979 and 2007,’ the period for which figures are available.
The other, from February, used Internal Revenue Service data to show that the effective federal income tax rate for the 400 taxpayers with the very highest incomes declined by nearly half in just over a decade, even as their pre-tax incomes have grown five times larger.
The study found that the top 400 households ‘paid 16.6 percent of their income in federal individual income taxes in 2007, down from 30 percent in 1995.’ We are talking here about truly rich people: Using 2007 dollars, it took an adjusted gross income of at least $35 million to get into the top 400 in 1992, and $139 million in 2007."
That is one way to look at it. On the other hand, in April it was estimated that 47% of U.S. households would owe no federal income federal income tax for 2009 and that 10% of the earners would pay 73% of the income tax.
But David Leonhardt of The New York Times argues that the 47% number is misleading because it doesn’t include things like social security taxes and Medicare taxes.** If you want to look at the question of the overall rate for all federal taxes, consider these numbers from Greg Mankiw and the Congressional Budget Office:
"[H]ere are effective federal tax rates (total taxes divided by total income) for 2005:
Lowest quintile: 4.3 percent
Second quintile: 9.9 percent
Middle quintile: 14.2 percent
Fourth quintile: 17.4 percent
Percentiles 81-90: 20.3 percent
Percentiles 91-95: 22.4 percent
Percentiles 96-99: 25.7 percent
Percentiles 99.0-99.5: 29.7 percent
Percentiles 99.5-99.9: 31.2 percent
Percentiles 99.9-99.99: 32.1 percent
Top 0.01 Percentile: 31.5 percent
[T]hat is … the rich face average tax rates more than twice those of the middle class, and about seven times those of the lowest quintile."
So is that good enough? Is that enough for the rich to pay? Back to Mr. Leonhardt:
"[These] numbers exaggerate how much of the tax burden falls on the wealthy. These numbers fail to account for the income that is hidden from tax collectors – a practice, research shows, that is more common among affluent families. ‘Because higher-income people are understating their income,’ Joel Slemrod, a tax scholar at the University of Michigan, says, ‘We’ve been overstating their average tax rates.’"
Of course, if you really want to really see people hide income, raise the rates. (At lower levels, income hiding may be more a matter of opportunity {i.e., one’s job and how one gets paid} than the amount of income.)
Those who want to extend the 2003 tax cuts for all but the wealthy, i.e., those who want to raise taxes on the rich, give three main reasons for doing so: (i) inequality has greatly increased over the last 30 years; (ii) the rich aren’t paying their fair share of taxes (alternatively: the rich aren’t paying enough taxes); and (iii) we have a big budget deficit and we have to start reducing it by increasing tax revenue. While on the surface it might seem that raising taxes on the rich would address all three of these problems, I’m not so sure. Let’s look at these reasons in more detail, in reverse order.
We have a big budget deficit and we should raise taxes on the rich to get more tax revenue. However, as I said before, if you think people hide income (or their boats) now in order to not pay taxes, try raising tax rates and see what happens. First, the rich will hire more tax lawyers and accountants to figure out ways to avoid those taxes.
Next, income will disappear – or at least "taxable income" will disappear. Stocks won’t be sold as often, which will reduce the amount of capital gains, which will reduce the amount of capital gains taxes collected. In other cases, instead of investing in companies that pay dividends, investors may shift to other companies that don’t generate taxable income for their stockholders. Municipal bonds, with their tax-free income, will increase in popularity. Other people may not work as hard if the taxes on their income get too high; they may say, "The heck with it" (or something similar). The bottom line is that it is unlikely you will get as much tax revenue as some people predict.***
If increases in taxes on the wealthy are not going to raise as much money as predicted (or needed), why would we do it? If the most important thing is to get more tax revenue so we can reduce the deficit, then we ought to figure out how to use the tax system to raise the most money with the least interference with the economy. Fairness can count some, but if you are really worried about the deficits, efficiency needs to count for more because that is how you raise the most money and reduce the deficit the quickest.
At times, however, at least for some people, it seems that the point is less about raising tax revenue and more about taking money from the rich. For example, back in 2008, Charlie Gibson challenged then-Senator Obama on his proposal to raise the capital gains tax:
"Charles Gibson: Bill Clinton in 1997 signed legislation that dropped the capital gains tax to 20%.
Senator Obama: Right.
Charles Gibson: And George Bush has taken it down to 15%.
Senator Obama: Right.
Charles Gibson: And in each instance, when the rate dropped, revenues from the tax increased. The government took in more money.
Senator Obama: Well, Charlie, what I’ve said is that I would look at raising the capital gains tax for purposes of fairness. We saw an article today which showed that the top 50 hedge fund managers made $29 billion last year – $29 billion for 50 individuals. And part of what has happened is that those who are able to work the stock market and amass huge fortunes on capital gains are paying a lower tax rate than their secretaries. That’s not fair. …
Mr. Gibson: But history shows that when you drop the capital gains tax, the revenues go up.
Senator Obama: Well, that might happen or it might not happen. …"****
Which actually fits with President Obama’s comment earlier this year that "I do think at a certain point you’ve made enough money."
For a somewhat similar point, see James Surowiecki’s article in The New Yorker: "Soak the Very, Very Rich". Here are some excerpts:
"[M]ost of the privileged don’t feel all that privileged. Why is that? … [I]n a place like Manhattan, …your money doesn’t go as far. …
… People in the ninety-fifth to the ninety-ninth percentiles of income have represented a fairly constant share of the national income for twenty-five years now. But … the top one per cent has seen its share of national income double …. [A]t the same time that the rich have been pulling away from the middle class, the very rich have been pulling away from the pretty rich, and the very, very rich have been pulling away from the very rich.
… Our system sets the top bracket at three hundred and seventy-five thousand dollars, with a tax rate of thirty-five per cent. …
This makes no sense—there’s a yawning chasm between the professional and the plutocratic classes, and the tax system should reflect that. A better tax system would have more brackets, so that the super-rich pay higher rates. ... This would make the system fairer, since it would reflect the real stratification among high-income earners. A few extra brackets at the top could also bring in tens of billions of dollars in additional revenue. …
The explosion in wealth at the very top of the pyramid has given rise to what the commentator Matt Miller has called a ‘lower upper class’—doctors, lawyers, accountants, even some journalists, who make very good livings but enjoy nothing like the rewards that come to their peers in finance or in the executive suite."
While Mr. Surowiecki claims that "a few extra brackets at the top" could raise tens of billions of dollars, this claim is in the second position. (Note the "also" in the quotation above.) Keeping the super-rich from having as much money seems more important. Overall, Mr. Surowiecki’s article seems to contain a lot of envy of the very, very rich by those who are merely rich.
If the point is mainly to make the rich pay more of their money in taxes, regardless of whether the government actually collects more, I would ask why. Is it envy or is it inequality? If inequality is the concern, is raising income tax rates going to solve the problem? Is inequality just a question of income? Isn’t it wealth, too? Some people think one of the purposes of the estate tax is to reduce inequality by taxing a person’s wealth when he or she dies, thereby limiting one’s ability to pass on his or her wealth.*****
If inequality is the problem, do we need some kind of an annual wealth tax, too? It could be thought of as sort of an upfront estate tax. If, as President Obama told "Joe the plumber," the economy would be better how if the government takes a little extra of Joe’s income and "spreads the wealth around," why not spread around some of the rich people’s wealth, too?
Such an idea would, I think, never be passed in the United States, but it is scary how close the philosophical basis for such a proposal is to Mr. Surowiecki’s article or some of the things President Obama has said. And it is scary because I do not think the moral and philosophical basis of our tax system ought to be either (i) reducing inequality by just taking money away from people who we think have too much enough of it or (ii) one of the seven cardinal sins.
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* In fact, many people, including a large number of Democratic representatives and senators, were so opposed to these tax cuts, that they refused to accept them and calculated their taxes on the basis of the prior tax rates, paying the extra money to the IRS in protest. Oops, I’m sorry. I got confused. They may have complained, but they took the money.
** It is unclear how concept of considering the social security tax as just another tax fits with the Bill Clinton/Al Gore "lockbox" for social security taxes.
*** Democrats often talk about Bill Clinton’s tax increases in 1993 and the prosperity in the 1990s. What they don’t tell you is this: If look at the Dow Jones Industrial Average for first two years of President Clinton’s term, you will see it bounced around from 3241 on January 21, 1993, to 3830 on election day in November of 1994, when the Republicans won both houses of Congress (and as low as 3675 later in November). By the end of 1995, the Dow was 5117. Capital gains taxes were cut in 1997 and by December 31, 1999, the DIJA was at 11,497. (See DIJA numbers here.)
**** The Wall Street Journal, April 18, 2008.
***** While Warren Buffett says he supports the estate tax, as well as raising the capital gains tax, he has shown us how to avoid both of them. With respect to the estate tax, Mr. Buffett is giving the vast majority of his wealth to Bill Gates’ foundation, so his estate won’t be paying much of the tax he wants others to pay. Similarly, Mr. Buffett owns a lot of Berkshire Hathaway stock, a stock that never pays dividends. No tax there. And until Mr. Buffett actually sells shares in Berkshire Hathaway, it doesn’t matter what the capital gains tax rate is because he won’t have any capital gains for the government to tax.
Update (8/16/10 7:58 am): Fixed a typo in the last footnote.
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