Tax the Rich

President Obama and Governor Brown of California want us to increase the Federal and State taxes on the rich people, so that they "pay their fair share."

I have written in the past about the real unfairness of the tax code.  [Taxes, Taxes, Taxes, July 18,  2011] 

For a while, though, I found the "pay their fair share" mantra extremely seductive.  It's easy and attractive to go after the 1%.  It's so attractive that the supporters who ride the "tax the rich bandwagon" either don't bother to check the math, or they don't believe the facts, or they don't want to hear the facts.  If taxing the rich does not solve our governments' debt problems, we will have to come up with more complex and painful solutions.

First, to increase the taxes on the rich will not solve the problem. If we tax the top 1% of our income earners at a rate of 100%, it will not solve our problem.  There are not enough people in the top 1%, and their total annual income would not significantly reduce the debt.

Second, the rich people (with a few notable exceptions) are already paying more than their fair share of taxes:

• The top 20% of taxpayers earned 51% of the nation's personal income, but in 2009 they paid 68% of the total federal taxes.  That's more than their fair share.
• The top 1% of taxpayers earned 13% of the income, but paid 29% of all federal taxes.  That's more than twice their fair share.
• The bottom 20% of taxpayers earned only 5% of the income, but paid only 0.3% of all federal taxes.  That's not a fair share, but most of us concede that the very poorest should not have to bear a tax burden.

Some simple arithmetic shows that the middle 60% of filers earn 44% of the income and pay slightly less than 32% of the taxes.  That's certainly not a fair share, but our politicians are wooing this middle 60% for their votes. 

Remember, too, that 46% of tax filers pay no federal taxes at all.   That's not just poor people.  Almost 7,000 people in the top 1% pay no federal taxes.   Many more of that middle 60% also pay no federal tax as well, but a lot of people are falling hook, line and sinker for the "tax the rich" slogan.

Some people consider taxes just to be a fee for the services the government provides.  If that is the case, then 46% of our people are gettting all those govenment services free of charge, while the rest of us are over-paying for them.

Reducing government spending by itself will not reduce the nation's annual deficit.  Some tax increases will be necessary.  But, like it or not, some of the freeloading 41% will have to chip in, including some of that middle 60% who are not paying their fair share.
 
Our Congressmen don't want to tell us that.  They do not want to propose specific, realistic debt reduction plans.  If they do, we the people won't re-elect them.  So instead, they throw us the "make the rich people pay their fair share" slogan.   Don't fall for it.

Taxes, Taxes, Taxes

The Democrats tell me, "Tax the rich people."

The Republicans tell me, "No new taxes."

It would seem there is no middle ground, no compromise. But I believe that there is a middle ground. I just look at the facts and "loosen" the definition of 'new taxes.'

First, some facts, quoted from Bruce Bartlett at NYTimes.com:

• 46 per cent of tax filers pay no federal income taxes.
• 78,000 households with incomes of $211,000 to $533,000 will pay no income taxes this year.
• 24,000 filers with incomes of $533,000 to $2.2 million will also pay zero.
• 3,000 filers with incomes of over $2.2 million will also pay zero.
• Many households with incomes under the median income could, by foregoing some luxuries, afford to pay a small tax.
• Finally, I read elsewhere that 67% of American Corporations pay no federal taxes--I am sure that not all of those are without profit of some kind.

Let's make it clear: I do not feel the need to extract tax from a household that does not make, or barely makes, sufficient income to house and feed themselves and transport themselves to work. Likewise, I do not believe that a business that lost money, or did not make a net profit before taxes, should be forced to pay. But the folks who are paying their taxes are paying as much as 25%, or more, of their income, and so probably should most of those 105,000 filers who plan to pay none.
I said I want to 'loosen' a definition. By that I mean I do not accept the position of some conservatives that the elimination of an existing tax credit, loophole, or federal subsidy constitutes a new tax. We should be able to eliminate loopholes. A company that makes a multi-million dollar profit after taxes does not need loopholes, tax credits or subsidies to stay in business.
So, as I see it, the middle ground is to close as many as possible loopholes in the code, and eliminate tax credits and federal subsides for businesses that can make a profit without them.
There are 105,00 households and many corporations out there that need to step up and pay their fair share of the federal taxes that are already part of the law. It probably is not enough to balance the budget, but it would help significantly. Our legislative and executive branches of government need to look at it this way, and act accordingly.

Economic Food for Thought

I recently read an article proposing a “progressive consumption tax.” It made me look at economics and taxation from a totally different viewpoint. On the surface the ideas have merit, but I am a little concerned about the possible unforeseen consequences.

The author, Professor Frank, suggests that the Feds tax consumption rather than the income. You report your total income, the amount you saved, and the amount you spent. Both the amount saved and a pre-determined portion of the amount you spent are not taxed. The “excess” spending is taxed at a progressive rate. To me, it seems a lot more fair than the "fair tax."

The populist side of me has always sought a way to tax the super-wealthy. The article reminded me of Thorstein Veblen’s writings about “conspicuous consumption.” And it occurred to me that if we really want to “soak the rich,” we should find a way that does not penalize earning, but instead punishes wasteful consumption and enables and encourages spending of money on things for the common good. Theoretically, government revenue increases. With this approach, the economy is not driven by an "invisible hand," but by a very visible government.

The article does bother me a little because I believe that the purpose of taxation is to fund government operations, not to control human behavior.

I am including a link to the article. It is fun to see the (almost fanatic) comments it drew from the (somewhat conservative) Cornell alumni.

http://cornellalumnimagazine.com/index.php?option=com_content&task=view&id=483

If you are too dogmatic a conservative to read this with an open mind, please don't append knee-jerk tyrades in your comment. I am looking for calm analytic discussion of the merits and potential dangers of the concept.

The "Fair Tax" is NOT Fair

I will be the first to admit that I have not read a detailed proposal for the so-called "Fair Tax." I understand that the concept is to replace the Federal Income Tax with a Federal Consumption (or sales) Tax.

Its proponents may call it a Consumption Tax, if they wish, but I can think of two reasons that it should not be called a "Fair Tax."

• First, a personal one -- a significant portion of my income comprises my contributions to company pension, on which I have already paid Federal Income taxes. That income is reported, but not taxed a second time. If a consumption tax were implemented, I would be paying consumption tax on money that was already subjected to the income tax.
• Second, it appears to me that a consumption tax unfairly benefits high wage earners over lower wage earners.

To illustrate the second point look at two simple examples: one a laborer who earns $50,000 per year; the second an executive who earns $5,000,000 per year.

• The laborer now pays 15% of his earnings ($7,500) in income taxes. If he is frugal, he saves about 10% of the after tax money and spends the rest, $38,500 to live on. Under the so-called "Fair Tax," the laborer will still put $4,250 into savings. He will spend the remaining on goods taxed at a 23% rate ($37,195 in goods and services, $8,555 in federal tax). That means his tax bill has gone up from $7,500 to $8,555)
• The executive now pays about 24% of his earnings ($1,200,000) in Federal income tax, invests about $2,800,000 in savings, and spends the last 1,000,000 to live on. Under the so-called "Fair Tax," the executive will still live on 1,000,000 worth of goods and services, on which he will pay $230,000 in Federal Consumption tax, and he will invest the remaining $3,770,000 in savings, which will earn him even more money next year. His taxes decrease by $970,000. [Now, you rich guys can explain to me that you just can't get by on a measely $1,000,000 per year. But even if you significantly change the spending to investment ratio, the taxes still go down. Moreover, the laborer does not have the latitude to make that kind of adjustment.]

So the Consumption Tax is NOT a fair tax! It benefits the wealthy at the expense of the poor. Most tax laws are written this way because they are written by wealthy people. Then they present the tax in such a way that it appears to be "fair."

Most people will agree that any tax on a person who earns less than "the poverty level" is not really fair. Many will agree that at some point one's earnings are such that he can live comfortably, build his savings, and still have a LOT of money "left over." Just ask Bill Gates or Warren Buffet.

A flat tax on income, or a somewhat progressive variant thereof, is probably the only way to approach fairness in taxation. The variation I suggest is a tax on ALL personal income (regardless of source, no deductions, no adjustments, no credits) -- approximately the first $33,000 of income to be tax-free; from $33,001 to $200,000 of income to be taxed at 12%, and from $200,000 up be taxed at 25%. The break points should be adjusted annualy for inflation. The actual rates can be calculated to make sure that the structural change is "revenue neutral."

A few notes: (1) I said personal income. Taxes on corporations are never paid by the corporations; they are passed on to the consumers in the form of higher prices. (2) The highest rate of 25% may seem low to some ultra-liberals, but remember it applies to ALL income (i.e. no more 15% rate for capital gains). (3) ALL income may be hard to determine, because some people receive many types of income and do not report portions of it that are not salary, wages, or interest. (4) The consumption tax is even more cruel to the poorest of wage earners who now pay no income tax. Suddenly, they will see their buying power decrease by 23%.

I know this is all overly-simplified. The discussion is meant to be conceptual, as opposed to specific. But one of the keys to solving the tax problem is to simplify it. One important concept is that taxation should be used to fund the operations of government, not to control people's behavior. A typical governmental abuse of "consumption" taxes is to increase the consumption tax on "undesirable" products and services. A tax that is simply based on total personal income avoids that kind of abuse.