Who Pays Taxes?

Another canard of the Left that is endlessly perpetuated in the MSM revolves around tax fairness. At the mere mention of tax cuts the Left gets apoplectic. “The rich get richer,” they like to say, “while the poor get poorer.” Is this just political rhetoric, or is there something to their assertion?

I’m no economist, but it’s really not all that complex.

According to the latest available tax data, the richest 1% of Americans pay about 40% of all income taxes collected. If we look at the top 5% of earners, we see that they paid about 61% of all taxes. Overall, the top 10% of taxpayers are responsible for 71% of all tax revenue. Let that soak in for a moment: The top 10% of taxpayers are responsible for 71% of all tax revenue. Got that? OK. Meanwhile, the bottom half of all American households account for just 3% of tax revenue, with roughly 122 million Americans -- 44 percent of our population -- having no tax liability whatsoever. None. Zero. Nada.

Remember these numbers the next time you hear the Left braying about “tax cuts for the rich.” The top 50% of taxpayers pay 97% of the taxes, and the bottom half essentially pay nothing. Is that fair? Not to muddy the waters too much, but here’s something else to ponder: Rich or Poor, doesn’t it follow that, in order to get a tax cut, you have to be a tax payer to begin with?

Speaking of taxpayers, noted economist Arthur Laffer has written extensively on the trade-off between tax rates and tax revenues: The eponymous “Laffer Curve” clearly illustrates that, as tax rates increase, tax revenue collected by the government also increases, but it also shows that tax rates increasing after a certain point would cause people not to work as hard or not at all, thereby reducing tax revenue. For example, if tax rates reached 100%, then everyone would choose not to work because everything they earned would go to the government.

In a 2007 article in The Wall Street Journal, Mr. Laffer addressed this very point. It turns out that the top 1% of taxpayers have increased their contributions from 17.58% of all federal income taxes in 1981, to 39.38% of all income taxes in 2005. Meanwhile, over the same 25 year period (17 of which were presided over by a Republican POTUS, by the way), the tax burden for the low- and middle-income earners (the bottom 75%) has tumbled, from 27.71% of all tax revenues collected to 14.01%.

Of more interest is that the effective average tax rate for the very top earners has remained relatively the same. How can that be? The somewhat simplistic answer is that higher income folks tend to have more avenues available to reduce their tax liabilities, such as 401(k), IRAs, Keough plans, itemized deductions, lifetime gifts, charitable gifts, trusts, tax free bonds, and all sorts of deferred income compensation plans. By controlling their reportable income they are able to control the amount of taxes they pay, which is why their effective average tax rate is so stable. However, their total tax payments are “incredibly volatile.” What does this mean? If taxes are raised beyond what “the rich” think is fair, they will report less income to compensate for it.

The bottom line is, when you raise taxes on upper-income earners, and lower taxes on the low- and middle-income earners, you will see huge revenue losses from both accounts: The top earners will simply restructure their income to report less of it, and the bottom 75% will pay less in taxes as a matter of the reduced rate.

This is the essence of why tax policy is so critical, and why it should be set as a matter of national interest instead of being used as rhetoric or talking points that play on the ignorance of a certain political constituency. Consider, for example, the 2003 capital gains tax cut. In 2002, the tax rate on capital gains was 20%. The capital gains reported by income-tax filers (the gains “realized” by investors) was $269 billion, and the government’s revenues from those gains was $49 billion; by 2005, the reported gains were $690 billion, with revenues of $101 billion going to the Treasury. The Congressional Budget Office estimated the 2007 numbers to be $863 billion realized and $127 billion collected.

What are we to make of this? On the one hand, we could say that the stock market rose during that period, along with the larger economy. But doesn’t that fly in the face of the constant harping in the MSM about how terrible the economy was during the Bush administration? How, then, do we explain this conundrum? Did the capital gains tax cut result in more revenue as a result of sound economic policy or was it simply due to a growing economy? The Left spent a lot of time talking about how mediocre the economy was during this period, and they are adamantly against tax cuts -- for “The Rich,” of course -- so which one of their beloved talking points are they willing to abandon?

The simple, economic reality is that the lower tax rate made it more appealing to investors to unlock their gains, cash out of profitable investments and reinvest the net proceeds. This resulted in a powerful windfall for Uncle Sam.

Ah, ha! But wouldn’t we have seen an even more dramatic increase in revenue had we left the capital gains tax at 20%?

No.

If we examine the CBO estimates for revenues from 2003-2007, assuming a 20% tax rate, the prediction was $260 billion. Instead, the revenues will top out at $470 billion over that same period. That 5% reduction is more than made up for because there are many more transactions to tax, this being the result of conditions favorable to profit-taking and reinvestment.

Perhaps one of the more interesting things to note is that during the heart of this period (2005), nearly 80% of the tax returns reporting capital gains were from filers earning less than $100,000 a year. So much for “Tax cuts for the rich.”

Another point that is crucial to any discussion of economic standing is economic mobility. What the Left doesn’t like to admit (and is never acknowledged in MSM stories about “impoverished Americans”) is that Americans rarely stay in the same economic stratus. We are quite fluid and we often move between classes. In other words, the rich don’t necessarily stay rich, and the poor certainly don’t stay poor. Remember: Just because you are rich, or poor, you won't necessarily stay that way.

The fact is the demographics of economic mobility paint a far more intriguing picture than what we see on the nightly news. For example, more than half of the people in the top 1% in 1996 were no longer there in 2005. Statistics show their average incomes actually dropped by 26%. How can that be? There are a variety of reasons, but often these people were “just visiting” this particular high-income bracket, and it was usually the result of a one-time event such as the sale of home, or some other unexpected spike in income. The point is, many of these people do not make up an enduring class of “elites,” any more than lower income Americans are likely to remain “lower income.” (Of the latter, their incomes nearly doubled over the same time period, increasing by an average of 91%.)

So, let’s answer the accusation: Are the rich getting richer? Yes. Absolutely. The rich Democrats and the rich Republicans are, indeed, getting richer. So, too, are the poor Democrats, and the poor Republicans (as are the poor Libertarians, the poor Greenies, the poor Socialists, and the poor of every other political stripe). In fact, across every stratum imaginable, we -- all of us -- are getting richer. A recent study released by the Economic Mobility Project shows that the median family income has increased from $55,600 in 1968 (measured in inflation-adjusted 2006 dollars) to $71,900 today. That’s a nearly 30 percent increase, but it’s even more staggering when you consider that there were 3.1 persons per family in 1968 and only 2.1 persons per family today (owing to an increase in childless couples and single parents). The net result is that the average family’s income today is spread among fewer people and is, therefore, far more potent.

But that’s the average family. What about the Rich, and the Poor? The Economic Mobility study found that income for all quintiles have risen. In truth, the study shows that the higher the economic standing, the higher the increase in income, but doesn’t that make sense? If someone invests $10,000 and their rate of return is 10%, they will make $1,000 from that investment. If another person invests $1,000, and gets the same return on their money, they will make “only” $100 from their investment. The reality is, both have benefited by the exact same percentage, relative to their ability to invest, yet some decry the “unfair advantage” realized by the person who could afford to invest more.

The percentage increase for each quintile is as follows: 52 percent for the top fifth, 39 percent for the second fifth, 29 percent for the middle fifth, 22 percent for the second lowest, and 18 percent for the bottom fifth. An interesting side-note to the study found that “children born into the bottom fifth are more likely to surpass their parents’ income than are children from any other group.” There's that "mobility" thing, again.

Abraham Lincoln said, “I don’t believe in a law to prevent a man from getting rich; it would do more harm than good.” He understood the most basic of economic realities: Most of us don’t start off rich, nor do we have to stay poor. “When one starts poor, as most do in the race of life,” he said, “free society is such that he knows he can better his condition; he knows there is no fixed condition of labor for his whole life.” This precept, this simple proclamation about America’s promise to its citizens, is called Lincoln’s “True American System.” Most of us have probably heard this sentiment by a slightly different term: The American Dream.

When we examine the facts about taxes, and income, it becomes increasingly obvious that we as a nation continue to be better off economically than previous generations, and that for most of us our overall standard of living continues to improve throughout our lives. Why, then, does the Left feel so compelled to bury or distort this extraordinarily good news and perpetuate a sort of class envy, pitting the (currently) wealthy against the (currently) poor?

The Left persists in the intellectually vacuous and divisive notions of “two Americas” and of “fighting for economic equality” because the rhetoric of class warfare is too valuable and far too effective, politically, to ever abandon it. It is also in line with their larger narrative. After all, what would they do without their carefully crafted pretext of “standing up for the little guy”?

REFERENCES & ADDITIONAL READING

“The Laffer Curve: Past, Present, and Future” by Arthur B. Laffer, 6/1/04
www.heritage.org/Research/Taxes/bg1765.cfm
“Taxes and Income” Review and Outlook, The Wall Street Journal, 12/10/07
The Congressional Budget Office http://www.cbo.gov/
“Congressional and Leftist Lies” by Walter E. Williams, 11/14/07
“That ‘Top One Percent’” by Thomas Sowell, 11/27/07
“Turning Good News Into Bad” by Linda Chavez, 11/30/07
The Economic Mobility Study http://www.economicmobility.org/
The Panel Study of Income Dynamics psidonline.isr.umich.edu
“The Tax Threat to Prosperity” by Arthur B. Laffer, The Wall Street Journal, 1/25/07
www.investopedia.com/terms/l/laffercurve.asp
“The Inequality Myth” by Brad Schiller, The Wall Street Journal, 3/10/08