The Sovereign Mind

Free thought on politics and real life

Posts Tagged ‘taxes

Reagan and the “Stinking Rich”

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In my last post I explained that the Bush tax cuts did not disproportionately favor the rich, as it commonly believed. The rich are paying a greater share of the total tax burden than they were before the Bush tax cuts, even when adjusting for the increase in their total share of wealth over the same period of time.

But it’s worth looking further back to see how the tax burden has shifted over time. So, I’ll do the same analysis going back to 1979. I’d go back further, but the numbers from the Congressional Budget Office only go that far. In any case, 1979 was just before the Reagan tax cuts which drastically reformed the tax code and greatly reduced the marginal tax rate on the highest income bracket. Therefore, we would expect for the Reagan tax cuts to have favored the rich by shifting more of the tax burden away from the rich to the middle and lower classes. But, before we investigate whether that’s true, it’s worth noting that there is a difference between the marginal tax rate and the effective tax rate. The effective tax rate is the portion of income that is actually paid in taxes. The amount that someone pays in taxes depends on the tax rate and brackets, but that is only part of the picture. If the tax brackets and rates were all the mattered in the tax code, it wouldn’t be several thousand pages long. I think we can agree that what really matters is what taxes people actually pay, not what taxes they theoretically would pay according to their tax bracket’s marginal rate. So, even though Reagan reduced the marginal tax rate on the rich, that doesn’t necessarily mean that the rich are paying less taxes.

I won’t go through the details of my process like I did last time. Here are some graphs representing how the tax burden and income are distributed, and how that has changed since 1979. Click on the graph to view a larger version.

Not coincidentally, the two graphs look very similar. The interesting thing to note is that the rich are paying a much greater share of the tax burden, but they also are making a greater share of the income. We have to adjust the tax share by the income share to determine if the Reagan tax cuts increased or reduced the tax burden on the rich. Here is the resulting graph:

This is a bit more interesting than the graph when looking at the Bush tax cuts that I discussed in the last post. The tax burden picture actually hasn’t changed very much, but there are some small changes. Firstly, the poor and most of the middle class (up to the 60th percentile) are paying a smaller share of taxes than before Reagan. Secondly, the upper-middle class and most of the rich (up to the 99.5th percentile) are paying a greater share of taxes. Lastly, the super-rich, those in the top half percentile, are paying a smaller share of taxes than before. These are the millionaires, or the “stinking rich” as Timothy Noah refers to them.

So, what can we conclude from this? First, that the Reagan and Bush tax cuts made the tax structure more progressive for the vast majority of the population, contrary to the prevailing wisdom that the opposite is the case. The exception, though, is that the super-rich benefited from Reagan’s cuts. With this in mind, it is interesting to note that Democrats may be backing off of the fight to let the Bush tax cuts expire on those making over $250,000, and are setting their sites on the millionares instead:

Part of the hesitancy with hiking taxes on the rich, I think, stems from the birth of this “lower upper class.” Americans do really want to soak the rich. But a household headed by a well-paid nurse and a police chief might make $250,000 a year, the income point at which President Obama wants to let taxes rise by letting the Bush tax cuts expire. My guess is that most Americans want to raise taxes on these guys, but not on that nurse and police chief, whose wealth seems reasonable and attainable.

Politically speaking, that sounds about right to me. And it also may be the right way to go in terms of “correcting” the trend that Reagan put in motion.

Again, the caveat to all of this is that “correcting” the trend is not the only way to look at the issue. We haven’t made the case, for example, that the trend needs “correcting” in the first place. There are many arguments for and against extending the tax cuts to the rich. I’m only addressing one angle of the argument: the one that argues that we should tax the rich more because they have gotten too good a deal over the past few decades. My conclusion is that this argument is overblown since the share of taxes that most families making over $250,000 has actually gone up, not down. However, the argument does make some sense when applied to the super-rich–those bringing in an income in the seven digits.

(For data tables and calculations used in this post, see here: incomeinequalityFrom1979)

The Bush Tax Cuts for the Middle Class

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Since my last post on chart-truth was such a hit, I thought I’d come back for more and do another spin-off of Timothy Noah’s series on income inequality. Again, from the fifth installment, he dismisses the argument that tax policy is a contributing factor in the great divergence:

Reagan lowered top marginal tax rates a lot, but he lowered top effective tax rates much less—and certainly not enough to make income-tax policy a major cause of the Great Divergence….

The larger point is that you can’t really demonstrate that U.S. tax policy had a large impact on the three-decade income inequality trend one way or the other.

With the Bush tax cuts set to expire at the end of the year and politicians scrambling to figure out how to extend some or all of them, tax policy is bound to be a central issue in the coming months. I thought it was time to examine the question a little more.

Republicans want to extend the tax cuts for everyone, while Democrats want to extend them for only households making less than $250,000 and let the rest of the cuts expire as scheduled. Democrats say that the rich don’t need a tax cut; they aren’t paying their fair share. Republicans counter that the rich are already paying more than their fair share. We can’t investigate this question objectively, since the concept of “fair share” is a matter for philosophers, not economists or statisticians.

However, we can investigate the validity of certain specific claims. The one I wish to focus on is the claim that the Bush tax cuts disproportionately favored the rich, and so we should correct this injustice by not extending the tax cuts on the rich. The epitome of this claim is when the tax cuts are referred to as the “Bush tax cuts for the rich”, which implies not only that the cuts favored the rich, but that the rich were the only ones who benefited. Of course, this is a purposeful exaggeration intended to promote the view that the tax cuts disproportionately benefited the rich.

But, hyperbole aside, the question remains: did the Bush tax cuts disproportionately favor the rich? In other words, did the Bush tax cuts make the tax code more or less progressive? (For those who aren’t up with the lingo, a “progressive” tax simply means that the rich pay a greater portion of their income in taxes than others, and a tax is more progressive if the difference between the portion that the rich pay and the portion that everyone else pays is greater.) Republicans think that the tax code has become more progressive and therefore doesn’t need correcting to make it even more progressive. To support their position they point to numbers that show that the rich are paying an increasingly greater share of the total tax burden. This is true, as this graph based on numbers from the Congressional Budget Office shows:

(Here’s a little help on reading this graph and the subsequent graphs in this post: on the left I’ve charted the share of the tax burden for each income category over time. This chart gives a good overview of how the tax-burden pie is cut. But, it can be difficult to see how each individual slice is changing over time. So, I’ve also included the graph on the right which shows exactly how much each income category’s share of the tax burden has increased or decreased over the same period of time.)

On the surface, it seems like a straight-forward rebuttal: since the Bush tax cuts took effect, the rich have been paying an increasingly greater share of the total tax burden. The share of taxes paid by those in the top 5% has increased, while the share of taxes paid by the bottom 90% has decreased. Therefore, Republicans would argue, the Bush tax cuts must not have favored the rich. In fact, it appears they favored the poor and middle class at the expense of the rich. In other words, they made the tax code more progressive, not less progressive as Democrats argue.

But there is a problem with this analysis. Tax policy is not the only thing that can cause one income group to start paying a greater share of taxes. If that income group starts to gather a greater share of income, logically they will pay a greater share of taxes also, even if tax policy stays the same. As we know from reading Noah’s series, the income of the rich is increasing faster than the income of the poor and middle class, so it makes sense that they would also be paying a greater share of the taxes than before. Therefore, we must investigate whether the increase in taxes that the rich are paying is a result of the change in tax policy known as “the Bush tax cuts”, or the change in income distribution.

First, let’s see how the income distribution has changed since 2000:

The graph shows some increase in income inequality over this period, although it’s not as large as it has been in the past. Recessions tend to hit the rich hard in terms of the percentage of income lost, since the rich tend to get more of their income from fluctuating investments. The recession of 2001 was no exception and mostly explains why the rich didn’t get much richer through this period. The average income for the top 0.01% was cut almost in half between 2000 and 2002, but then rebounded by 2005. Still, there is some widening of the gap with the top 20% gaining income and the lower 80% mostly losing income.

So, we can conclude that this widening of the gap in the income distribution contributed to the widening of the tax burden gap. But we don’t yet know exactly how much. To get a picture of how tax policy affected the distribution of taxes, we have to adjust for the change in the distribution of income. In other words, we want to answer this question: If the income distribution had not changed, would the rich be paying more or less of the total share of taxes as a result of the Bush tax cuts? I won’t get into the details of that calculation (see attached document at the end of this post), but here is the result:

The graph shows that the distribution of taxes, when adjusting for the distribution of income, has changed in the direction of more progressivity, as Republicans argue. The top 5% are paying a slightly greater share of taxes and the bottom 90% are paying a slightly smaller share of taxes, even when adjusting for changes to the income distribution.

So, the Republicans ultimately are right about this, even if their argument is incomplete. The argument that the Bush tax cuts disproportionately favored the rich doesn’t hold up. This will be important to remember as the tax debate rolls on, but remember that this is just one part of the debate. You can still make arguments that rich should be paying more or less, independent of how the Bush tax cuts affected the distribution.

In fact, it may be worth doing this same analysis but going all the way back to 1979, before the Reagan tax cuts, to see how the tax distribution has changed since then. Has the tax code become more or less progressive since the days of Jimmy Carter? I’ll answer that another day, but here’s a hint: it’s a trick question.

(For data tables and calculations used in this post, see here: incomeinequalityFrom2000.pdf)

Written by Mike

September 16, 2010 at 9:49 pm

Cash For Clunkers: Simply Unsupportable

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For those who don’t know, the government will give you $4,500 to trade in your old clunker and buy a brand new car. Sounds like a good deal, but as far as public policy is concerned, the program is simply unsupportable.

There are two reasons that proponents give to support the program:

1) The program supposedly helps the environment by getting gas guzzlers off the road and replacing them with newer, more efficient cars. It is debatable whether the program has any positive impact on the environment at all. And even if it does, the minimal impact begs the question: what else could we have spent that money on that would have helped the environment much more? It’s a little like going out to an expensive restaurant, and then justifying the expense by saying, “Well, we had to eat, right?”

2) The program is supposed to help stimulate the economy by getting people to buy new cars. Even those who see through the environmental argument often agree that it has succeeded in that purpose. And I don’t disagree, but let’s look at the issue more closely.

First, let’s start with the basics: Every dollar that the government spends is a dollar out of the pockets of a tax-payer. That should be obvious, but it seems that we sometimes forget this basic fact, maybe because we don’t see our tax bill increase at the passage of these sorts of programs. But it is true, whether the money comes from tax-dollars directly, or is borrowed (and therefore will be paid by future generations of tax-payers), or is printed (which we pay for because of the inherent devaluation of existing currency). There is no escaping the fact that there is no such thing as free money.

With this is mind, can this program be considered as anything more than taking money away from people who don’t want to buy a new car, and giving it to someone who does? The government is essentially telling you, “If you aren’t going to buy a new car, we’ll take your money and give it to someone who will.” By doing this, the government subverts the dichotomy that, during a recession, it is in each individual’s best interest to save money, but it is in the economy’s interest that we spend. I don’t blame the government for attempting to find ways to stimulate the economy during a recession, but giving people the choice of spending money or losing it is beyond over-reach.

So we must ask ourself this question: is it more important to (slightly and artificially) stimulate a sector of the economy for a very short period of time, or is it more important to respect our freedom to save or spend our money as we please? Maybe some in congress may disagree, but it seems to me that the answer to that question is obvious.

Written by Mike

August 9, 2009 at 9:04 pm

Obama: “I Screwed Up”

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Robert Gibbs, Obama’s press secretary, says this about the withdrawl of Tom Daschle as the nominee for secretary of health and human services after it was revealed that he failed to pay hundreds of thousands in taxes:

Obama’s response, to his credit: “I screwed up”.

My inconvenient question: If Daschle’s nomination was a screw up, why wasn’t also the nomination of Timothy Geithner, who also had to pay back taxes, as treasury secretary? He was recently confirmed. If Obama thinks the Daschle pick was a screw up, does he think that of the Geithner pick as well? I can only assume so, considering if any nominee deserved scrutiny for tax issues, it should be the guy who will head up the IRS. So what is he going to do about it?

Written by Mike

February 3, 2009 at 10:08 pm

For Sale to the Highest Bidder: My Vote

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I don’t believe in voting for self-interest. For one thing, it’s selfish. But for another, what’s in my self-interest is not always as simple to figure out as some try to make it. Some people can’t understanding why anyone in the middle class wouldn’t vote for Obama. Don’t they know they will get a tax break (assuming he does as he has promised, and ignoring the fact that he would not unilaterally write the laws)?

No, we don’t all exist in a vacuum. The poor do benefit, to some extent, from cutting taxes on the rich. After all, it does increase the chance of finding work. On the other hand, the rich do benefit from cutting taxes on the poor and middle class, since it gives the rich more customers. Clearly, our economic system is intertwined, so determining what is in my best interest (even if I were to vote that way) is not so easy to figure out and certainly involves more than a simple calculator.

But, as an experiment, I decided to suspend whatever intellectualism I have and determine how I would vote if I truly were to yield to my most primal instincts (give me more money!). I don’t wish to disclose the details of my financial situation to the world, but if is sufficient to say that I am doing pretty well. I am one (of the apparently few) that is actually better off than I was four years ago. But I am still solidly middle-class, and certainly not anywhere close to Obama’s definition of rich (which he says is $250,000).

So, with that in mind, I expected Obama to win my auctioned vote, given that he has championed the cause of the middle class, and has painted McCain as only caring about the rich. I had heard of a tax calculator on Obama’s website, so I checked it out. Sure enough, I would get 9 times more of a tax cut with Obama than McCain. Hmm… maybe there is something to this “vote for my own self-interest” after all.

But then of course, I couldn’t resist yielding to at least a little bit of intelligence in my decisions process. So I decided to see if there were any more independent calculators. I found this one which is promoting Obama, but at least claims to be based on independent numbers. I filled out the form and found out that apparently I will be getting even more with Obama than even Obama’s website claimed! Cha-ching! But…

…I would get even more with McCain.

Apparently I would get 14 times more under McCain than what Obama’s website told me I would. Let me repeat that: Obama misrepresented McCain’s tax cut by 14 times! Of course I shouldn’t be surprised by that, but it is appalling.

It’s bad enough that Obama tries to appeal to my selfish side by putting up a tax calculator. But to make matters worse, he blatantly lies about the tax cut I would see under McCain, in order to make his tax cut appear more appealing. In my opinion, this is more than just a typical politician who misrepresents the facts. He directly lied to me in order to persuade me to vote for him.

Beware, self-interested voters.

(By the way, I already know McCain frequent misrepresents Obama’s tax policy. I had given Obama the advantage in terms of honesty on tax policy. No longer.)

Written by Mike

November 1, 2008 at 10:18 pm

The Rhetoric of Tax Policy: A Moderate View

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The rhetoric has heated up recently in the debate over tax policy. Should we tax the rich in order to reduce taxes on the poor (or even write them a check, in some cases)? Or should we cut taxes on the rich? I think it’s a very interesting debate, but I’m disturbed by some extreme comments I’ve heard from supporters of both candidates, and echoed by the candidates themselves.

“The rich can afford to pay more taxes”

True. One simple but reasonable definition of rich might be “someone who can afford more than they need.” In other words, someone is rich if he has excess wealth. Therefore, rich people, by definition, can afford a lot of things, including paying more taxes. However, by that logic we should always increase taxes on the rich, as long as there are rich people to tax. As long as there is a rich person, that person can afford more taxes, so we should tax him more. People who perpetuate this logic don’t intend it, but the logical conclusion of the argument is that there would be no rich people left, because they would have all been taxed to the point where they could not afford more taxes (which, be definition, means they are no longer rich).

“The rich should pay their fair share”

I agree. No one is arguing that anyone should pay more or less than their fair share. But to those who espouse this argument, I ask: How much is their fair share? Obama wants to change the tax highest tax bracket to 39% instead of 36%, as well as increase the capital gains tax. So I ask, Is that their fair share? Can you honestly tell me that if that were the current tax rate, you wouldn’t be arguing for higher taxes on the rich right now? How am I supposed to believe that after Obama implements his tax policy, there won’t be calls for more “fairness” in the tax system? After all, there will still be CEOs that make many times more than their mail-room workers. Are tax increases on the rich always fair, and tax decreases on the rich always unfair?

“Obama’s tax cut is socialism and/or income redistribution”

If any proposed tax policy that favors the poor is considered socialism, then any tax policy that favors the rich should be considered feudalism. Clearly, those are two extremes. Yes, perhaps it could be considered a step toward socialism, in the same way that a step down a mountain can be considered a step toward falling off a cliff. Clearly, if we label any tax policy proposal that cuts taxes to the non-rich at the expense of the rich as “socialism”, we have gone too far.

But many would point to the fact that Obama’s tax cut is really a tax credit which can go to people who don’t even pay taxes, or who pay very little. That is true, but that is really not that exceptional. Many people receive more from the government than they contribute to it, not only in the form of tax credits, but also public services. We would never adopt a system where a person is limited to getting no more benefit from the government than the amount of taxes they pay. That would defeat the purpose of government providing services (for the common good). Imagine if your house caught on fire and the fire department told you they could only fight the fire for a half hour, because you only paid enough taxes for that amount.

What really matters

So let’s get down to what really matters. To me, that means what tax policy is most likely to help our economy recover.

Conservatives argue (in addition to the rhetoric described above) that cutting taxes on the wealthy helps create jobs as rich people have more money to expand businesses and invest in other businesses. Liberals argue (in addition to the rhetoric above), that cutting taxes on the poor and middle class allows them more money to buy goods and services, which also helps grow business. So who’s right? They both are.

The key to both arguments is that money flows. The flaw of so called “class warfare” is that it does not recognize that wealth does not exist in a vacuum. Money is only worth something because it can be transferred, and most money is immediately transferred when it is acquired. When you get paid, you will use that money to spend (transferring to businesses), or save and invest (which again makes that money available to businesses and other individuals). How much money do you have just sitting around in a checking account or your wallet? That is the only real money you hold. The rest of your wealth you’ve either spent or loaned to others.

So wealth flows both from rich to poor and from poor to rich. So both trickle-down and bubble-up are valid economic philosophies. But which one is best for us now? Well, the answer to that question is above my pay grade. You didn’t really think I was going to solve that question in this post, did you? If I could do that… well… I’d be rich.

But one thing I do know: We can debate who to cut taxes on, but raising taxes on anyone during a recession is a bad idea. Obama, to his credit, has said that he will delay raising taxes on the rich until the economy recovers. But it doesn’t seem like a much better idea to raise taxes just as we are recovering. And, since he will not delay his massive tax credit to the poor and middle-class, that will run up the deficit greatly, which somewhat negates his argument that his tax plan is more fiscally responsible.

McCain proposes to cut taxes across the board, with a more modest tax cut to the middle-class than Obama is proposing. This seems more reasonable during a recession. However, my problem with McCain is that he has promised to balance the budget in four years, which seems like wishful thinking. Cutting taxes combined with a slowing economy mean much less revenue for the government, and as much as I like McCain’s commitment to lower government spending, I just don’t think it’s possible to cut that much so fast.

So there’s our choice, rhetoric free. I hope we choose well.

Written by Mike

October 21, 2008 at 9:35 pm