Tuesday, November 8, 2011

No really, it's a revenue problem.

We have a spending problem in Washington not a revenue problem. That is one of the most common refrains uttered by virtually every neoconservative in the past 30 years. Is it correct? Does our government irresponsibly squander ample revenue? Perhaps in some cases, but largely I don't think that explains why we consistently have a budget deficit or a massive Federal debt. One of the direct causes for both is simply that US citizens are paying less taxes than ever. In this post, I will demonstrate two truths about taxes that are commonly misunderstood. I will go on to argue that federal taxes are important to society and that further decreasing tax revenue will realize consequences most people do not want.

  1. Across the board, everyone is paying less tax than at any other post-war time.
  2. Wealthy people especially are being taxed significantly less than at any other time.

To prove that people are being taxed less per year, I used tax bracket data found at The Tax Foundation. With that data, I wrote a small Python script to calculate marginal tax in inflation adjusted (Real) dollars. Then I compared the taxes owed by 3 different levels of tax payer. The first was someone whose Adjusted Gross Income (AGI) is $49,445. That number was the median individual income for 2010. The second income I chose was $250,000. I selected it because Obama's 2008 campaign used it as a definition of wealth. I also compared someone whose income is $1M since someone making that is part of the 1% protested against by Occupy Wall Street. For each income, I compared what the taxes owed would be or have been in 2011, 2001, 1991, 1981, 1971, 1961, and 1951. All comparisons were done with the individuals filing status as "Single".

As is the definition of Adjusted Gross Income, this comparison is only related to marginal tax after all deductions and exemptions have been calculated.

As is obvious from these charts, across the board, marginal taxes owed have been dropping steadily for years. For the higher income levels, that drop started in earnest around the late 70s to early 80s.

Let's look at our current (2011) tax brackets. They are split into 4 columns.

  1. Married Filing Jointly
  2. Married Filing Separately
  3. Single (This is what I am using for comparison)
  4. Head of the Household

These 4 columns have been around in their current form since 1971. Within each column are six brackets. Here's what the Single column brackets look like:

  • 10% > $0
  • 15% > $8,500
  • 25% > $34,500
  • 28% > $69,675
  • 33% > $106,150
  • 35% > $189,575

So your rates go up for each dollar you make above a bracketed amount. Our current 6 bracket system is progressive (in other words, not flat). However, in the past we have been a lot more progressive. Here's what the Single column brackets looked like in 1969.

  • 14% > $0
  • 15% > $3,057
  • 16% > $6,114
  • 17% > $9,171
  • 19% > $12,228
  • 22% > $24,456
  • 25% > $36,683
  • 28% > $48,911
  • 32% > $61,139
  • 36% > $73,367
  • 39% > $85,594
  • 42% > $97,822
  • 45% > $110,050
  • 48% > $1222,278
  • 50% > $134,505
  • 53% > $158,961
  • 55% > $195,644
  • 58% > $232,328
  • 60% > $269,011
  • 62% > $305,694
  • 64% > $366,833
  • 66% > $427,972
  • 68% > $489,11
  • 69% > $550,250
  • 70% > $611,389

Whoa, that's a lot of brackets.

In 2011, the highest marginal tax rate is 35%. That rate was set as part of the infamous Bush Tax Cuts which are set to end in 2011. In 2012, the rate will move to 39.8%. Still, 40% is significantly lower than the 70% we were paying in 1969. The highest rate we've ever had was 94% in 1945. Of course that was only on income greater than $2.4M (Real) which was $200K in 1945 nominal dollars. Since then, we have been moving increasingly towards a flatter tax structure. This trend has accelerated in past 30 years as conservative economics have become the dominant ideology.

Why are the neocons so in love with flat taxes? One answer is they want a tax code everyone can understand. Another is that they want to justify a way for the wealthy to pay less tax. Flat taxes justify that under the guise of fairness. In fact, often flat taxes are called fair taxes. Ostensibly, they are called that because they do not go up or down depending on your income level. However, effectively a flat tax will raise taxes on the poor and lower taxes on the rich. This is because any flat tax rate above the lowest progressive tax bracket will raise taxes on people under that bracket. Flat taxes also have the undesired effect1 of significantly lowering government revenue. This is because wealthy people under a flat tax will pay taxes on most of their income at a significantly lower rate. Herman Cain's 9-9-9 plan was laughably bad in this regard. The Washington Post presented a chart which shows that 9-9-9 would raise taxes for most people and significantly lower them for the richest few. Of course, part of Cain's plan involved a national sales tax which would also have the effect of raising the cost of living by 9%. Actually, the three 9s combined would raise the cost of living for the poorest Americans by 27%.

So what's the problem with lowering the tax rate for the wealthy? Another common conservative argument is that paradoxically lowering the tax rate for the wealthy raises tax revenue. The theory goes this way: Instead of collecting a tax dollar from the rich, allow the rich to invest that dollar into the economy. This dollar investment could be turned into two dollars. Thus, two dollars will produce more tax revenue than one dollar. Thirty years of data suggests that this doesn't magically happen. This theory2 goes by a variety of names: It has been called supply-side or "trickle down" economics. Later, it was also called "Reagonomics."3 Currently, we are being warned not to tax the "Job Creators."

Allow me to get up on a soapbox. Given conversations I've had or overheard, my experience is that most people are clueless as to why paying less tax often hurts society in the long run. Our current policies have the effect of moving tax revenue to zero while increasingly turning our society in a private ownership society. This comes with a lot of unintended consequences.

For one, private, for profit, entities can only be enjoyed by people with money. So privatizing everything works to exacerbate inequality by stratifying access to resources and services.

Secondly, public money pays for common infrastructure (eg Roads). Private money can not and should not be responsible for infrastructure. There is just too much opportunity for special interest abuse. Consider the Interstate Highway System. It was built between the 1940s and 1960s. At the time, it was the largest public works project in the history of mankind. Everyone benefits from it. Because of it food and goods are cheaper because they can be distributed less expensively. So a modest tax investment can create public infrastructure with lasting economic benefits for everyone.

Thirdly, taxing the middle and upper classes allows for redistribution of wealth. In other words, it can mitigate aristocracies. For example, taxes pay for Medicaid which gives poor people access to healthcare. Devoid of this, poor people could have health concerns preventing them from participating in larger society, bettering themselves, and competing against wealthier people. Taxes can also be used to fix those kind of competitive imbalances.

My theory is that regular people want a balance in society. They want public works. They want lower income people to have a chance at a better life. They just don't understand the government's role in providing these things. I recently overheard coworkers of mine lamenting the condition of our highways. Said one coworker, "With all these people out of work, couldn't they be employed to fix up the highways?". I casually interjected that infrastructure improvements are a big part of the American Jobs Act. Both of these colleagues call themselves conservatives. Both dislike Obama. Yet they unknowingly made a liberal argument. I suspect a lot of conservatives, that is those whose minds haven't been warped by Fox News or Grover Norquist, would make similar arguments. So my theory is that average people know a balance should be struck between laissez-faire capitalism, central planing, and redistribution of wealth. Given the popular narrative that the Federal Government is at best inefficient and at worse incompetent, they are unsure about what role it should play in realizing this balance.

Given our current budget deficit and Federal debt, now is not the time to delude ourselves into thinking we can get something for nothing. Furthermore, since most individuals are paying less tax than ever and since rich individuals are paying significantly less tax than ever, most middle to upper class people can afford to pay more taxes. That is, of course, if you believe that Medicare, Medicaid, VA services, Social Security, public works, and the military are worth paying for. I do.


1 Flat taxes can increase government revenue in cases where compliance is an issue (former eastern bloc countries are an example) and can increase revenue depending on how income is distributed amongst the country, ex: if everyone has a similar income, flat taxes may not decrease revenue when compared with a progressive system.

2 Perhaps the genesis of this theory comes from the Laffer Curve. The original Laffer Curve was symmetrical. That is its peak, or highest tax rate before diminishing returns, was 50%. However, many believe that Laffer is really asymmetrical and its peak is really between 60% or 70%. This is a lot closer to what our marginal rates were in the 1940s - 1960s.

3 A lot of Reagon's actual tax policies (especially in the beginning) were progressive. For example, his administration raised the capital gains tax to 28%