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.