Chris Berry On The Net

When it comes to tax policy, both of our major parties are guilty of manipulating the facts to suit their political purposes. With every election cycle, new promises are made regarding tax breaks designed to appeal to specific voting blocs or to reward favored industries. Both sides resort to hyperbolic claims that intentionally distort the facts to inflame the passions of their core constituencies. Democrats rely on familiar refrains about wealthy individuals and greedy corporations paying their fair share, while Republicans make nonsensical claims about workers who pay no taxes. Voters who take the time to scrutinize these claims should come to realize that neither side is telling the truth.

A steeply progressive tax structure is a practical necessity for the simple reason that the government cannot extract sufficient revenues by other means without placing a crippling burden on those at the lower end of the income scale. When a large portion of the total national income is concentrated in the upper brackets, it is simply not reasonable to expect that a flattened rate structure will produce anything close to a revenue neutral outcome. Depending on your view of government spending in general, revenue neutrality may or may not be a desirable outcome, but unless we can find a way to substantially reduce government spending, increasing revenues will be a necessary evil.

Determining the “fair share” of the tax burden that should be borne by those in the upper income brackets has always been a subject of intense debate. Those who benefit politically by fomenting class warfare love to point out what they regard as inequality in the distribution of income. What they usually fail to mention is a far greater inequality in the collection of income taxes. The fact is that the people in the upper income brackets already pay the overwhelming majority of all federal income taxes. In 2006, the top 1% of income earners paid 39.89% of all income taxes, while the top 5% of earners carried over 60% of the burden. To look at it from a different perspective, the people who pocketed 22% of the income paid 40% of the income tax, and those who collected 37% of all wage and salary income paid over 60% of the income tax.

Advocates of a more steeply progressive rate structure frequently complain that tax cuts favor the rich. This in an unavoidable consequence of the fact that the so called rich are the ones who already pay the most into the system in the first place. When marginal rates are reduced, the people with the highest incomes will see the largest absolute reduction in their tax liability. In percentage terms, they will still pay more than taxpayers in lower brackets, and they will still carry the majority of the total income tax burden. The reductions enjoyed by the wealthy do not in any way diminish the impact of tax savings for those in lower income brackets.

Politicians are always evasive when asked what it means to be included among the rich. It’s easy to support higher taxes when faced with an us against them proposition. The difficulty lies in getting any politician to admit whether they consider you to be one of us or one of them. Most of us conjure up images of rock stars, professional athletes and hedge fund managers when we think of the rich, but the fact is that in 2006, an adjusted gross income of $388,806 would land you in the top 1% of income earners in the country. That’s a lot of money, but it’s not what a lot of people would consider rich. An AGI of $153,402 would have gotten you into the top 5% in 2006, and it only took $108,904 to crack the top 10%. A lot of ordinary two-income families fall into this category, and they would certainly never consider themselves rich. The people in this top 10% of income earners pay over 70% of the total federal income taxes collected.

After examining the evidence, most people will tend to agree that the so called rich are already paying a fair share when it comes to federal income taxes. Unfortunately, incomes taxes are only one part of the equation. Social Security and Medicare taxes represent a substantial burden for low and moderate income workers. Because earnings subject to the Social Security tax are capped, very high income earners pay a much lower effective rate than those with incomes below the maximum.

The typical wage earner isn’t concerned with the distinction between income and payroll taxes. All he cares about when he looks at his paycheck is that the government has withheld a substantial portion of his earnings. What he may not consider is that his real earnings are also reduced by an additional 7.65% that the employer is required to pay on his behalf. In reality, he is paying federal taxes on his wages at a rate of at least 15.3%, even if he pays no income taxes.

The total value of all federal income taxes collected is roughly equal to the total of payroll taxes. The difference is that while the bulk of the income tax burden falls on those in the upper income brackets, nearly 70% of the payroll tax burden falls on those earning $100,000 or less. The majority of households pay substantially more in Social Security and Medicare taxes than they do in federal income taxes. The fact that we continue to pretend that these payroll deductions represent a separate trust fund only serves to heighten the perceived inequalities on both sides.

One way to reform the system would be to eliminate the payroll tax altogether and adjust the income tax rate structure to reflect that change. This would also produce a significant increase in salaries and wages for most workers since employers would no longer be responsible for the 7.65% payroll tax contribution. Under such a plan, every wage earner would pay some income tax, but it may be at a lower rate than the current 15.3% payroll tax. Tax brackets would increase for every income level, but the rate curve would flatten out in the higher brackets to reflect the removal of the current cap on Social Security wages. Instead of paying 15.3% of the first $102,000 of income, high income earners would pay an additional 2 or 3 percent on their entire incomes.

Public support for any changes to the tax code will depend to a large extent on whether the underlying purpose is considered fair. Even those who would pay the largest increases would likely support the changes as long as they believed that the money was being spent on worthwhile services rather than large scale redistribution. One of the reasons that Americans from all walks of life oppose raising taxes for the purpose of redistribution is that we tend to believe in the American dream and we all aspire to be among the rich. Any scheme that ignores this basic reality is doomed to fail over the long-term.