Pissing Down Your Leg

Thoughts on Economics and Economic Policy

A Flat Tax Plus

with 3 comments

It’s that time of year again. Time to gather up our W-2s, 1099s, fire up TurboTax®, and hope for a refund. But don’t sweat it, more likely than not, you’re paying less of the tax bill now than you did 30 years ago. If the Democrats have the courage to suggest it, we could dramatically simplify our income tax structure, make it more representative of the current income distribution, and eliminate the corporate income tax, immediately making the U.S. much more competitive in the global market.

The Tax Foundation shows that the bottom half of all taxpayers paid less than 3% of federal income tax, down from almost 7.5% in Ronald Reagan’s first year in office. The story is the same for the bottom 90%. Meanwhile we are saddling the top with an ever larger piece of the tax pie. The top one percent paid almost two-fifths of all income taxes in 2008, more than double what they paid the year after we elected the Gipper to office. How could that be?

Back in 1981 the bottom half of workers were earning almost (but not quite) one dollar out of every five of taxable income. That number is now down to one dollar out of eight. According to the Census, the inflation-adjusted median family income has grown at a rate at which it will take a century to double. In 2081 our grandchildren will be living large.

According to tax data analyzed by economists Thomas Piketty and Emmanuel Saez, the income of the bottom 90% has fallen from almost two-thirds of total income in 1981 to just over half in 2008, hitting a low in 2007. It hasn’t been that low since 1928. Meanwhile the income share of the top 1% has more than doubled, as has their tax share.

But the top 0.01%, representing just 1 in 10,000 taxpayers, a little over 15,000 families in total, now receives over 5% of all income, one dollar out of every twenty, up from less than 1.4% in 1981 (how did they get by?). To get into the rarified air of that top 0.01% (and don’t we all really want to?), you have to earn over $9 million a year. But the top marginal tax rate begins at an income level of less than $400,000, about what would put you into only the top 1%. Should the merely rich be paying the same rate as the super-, hyper-, mega-rich? It simply doesn’t seem fair.

Table 1: Income Shares, 1981 and 2008 (Including capital gains)

Percentile Share of Income – 1981 Share of Income – 2008
Bottom 90% 65.5% 51.8%
90-95 11.5% 11.7%
95-99 13.0% 15.6%
99-99.5 2.8% 4.1%
99.5-99.9 3.7% 6.5%
99.9-99.99 2.2% 5.4%
Top 0.01% 1.4% 5.0%

 

We can make the tax structure both fairer and simpler while dramatically improving the competitiveness of the United States. I propose that those in the bottom 90% pay a flat marginal tax rate of 10% (with perhaps an exemption on the first $15,000 or a continuation of the earned-income tax credit to help out the poorest families). The next tax bracket, at 25%, would not begin until the household earned more than about $110,000 per year. The marginal tax rate would then increase by 5% increments at the 95th percentile, 99th, 99.5th, 99.9th, and top out at 50% for the top 0.01 percent.

Table 2: Proposed Marginal Tax Rates

Percentile Threshold Income Maximum Income Average Income Share of Income Marginal Tax Rate Average Tax Rate Percent of Taxes
0-90 109,062 31,244 51.8% 10% 10.0% 30.1%
90-95 109,062 152,726 127,184 11.7% 25% 12.1% 8.3%
95-99 152,726 368,238 211,476 15.6% 30% 18.7% 16.9%
99-99.5 368,238 558,726 443,102 4.1% 35% 25.4% 6.0%
99.5-99.9 558,726 1,695,136 878,139 6.5% 40% 32.0% 12.0%
99.9-99.99 1,695,136 9,141,190 3,238,386 5.4% 45% 40.2% 12.6%
99.99-100 9,141,190   27,342,212 5.0% 50% 47.8% 14.0%
Total $54,315 100% 17.2% 100%

 

The numbers here (courtesy of Emmanuel Saez’s website) include capital income, which is generally taxed at a lower rate. I believe we should tax capital income at the full rate, but do away with the double-taxation of corporate income by eliminating all corporate income taxes. As we saw in the New York Times recently, big companies like General Electric don’t pay their taxes anyway. This would automatically make the United States one of the most competitive places to place a business and eliminate the incentive for our multi-national firms to set up elaborate tax dodges.

The benefit of this proposal is that it should raise almost enough revenue (if my calculations are correct) to cover the revenue of both the personal and corporate income tax. Of course, we will need to either raise taxes or cut spending in the not too distant future if we are ever to balance the federal budget. We would have to raise the rates in Table 2 by approximately 3 percentage points at each level to bring total income tax receipts to the same percent of GDP as during the last four years of the Clinton administration, the last time we had a balanced budget.

So how does this compare with current tax rates? In the table below I’ve listed the marginal and average tax rates for a number of income levels for both the current system and my proposal. As you can see, at each income level until you get above $1 million, the marginal and average tax rates would be lower than under the current system. In practice this proposal may result in higher taxes at the low end of the spectrum and I would certainly support the continuation and possible expansion of the earned income tax credit.

Table 3: Comparison with Current Tax Rates

Adjusted Gross Income Current Rates Proposed Rates
Marginal Tax Rate Average Tax Rate Tax Bill Marginal Tax Rate Average Tax Rate Tax Bill
$30,000 15% 12% $3,663 10% 10% $3,000
$50,000 15% 13% $6,663 10% 10% $5,000
$100,000 25% 17% $17,362 10% 10% $10,000
$200,000 28% 22% $44,244 30% 18% $36,004
$500,000 35% 30% $148,904 35% 27% $132,593
$1,000,000 35% 32% $323,904 40% 33% $329,656
$5,000,000 35% 34% $1,723,904 45% 42% $2,094,899
$10,000,000 35% 35% $3,473,904 50% 44% $4,387,840
$25,000,000 35% 35% $8,723,904 50% 48% $11,887,840

 

Would taxes actually be lower in practice? I’m not sure (how do we get the CBO to score this?), mainly because this proposal would get rid of all deductions. No mortgage interest deduction, no child deduction, no educational expense deductions, no health insurance deduction, no standard deduction. So a family earning $200,000 but only paying income tax on $150,000 after deductions would probably see only a small change (positive or negative) in their tax bill. But this should get rid of some of the most complicated portions of the tax code while making it more representative of how income is actually distributed. As you can see from Table 4, my proposal relies heavily on the hyper-rich paying their fair share.

Table 4: Income and Tax Shares

Income Group 2008 Share of Income 2008 Share of Taxes Proposed Share of Taxes
Bottom 90% 51.8% 30.1% 30.1%
90-95% 11.7% 11.2% 8.3%
95-99% 15.6% 20.7% 16.9%
99-99.9% 10.5% 19.6% 18.1%
Top 0.1% 10.4% 18.5% 26.6%

 

And that’s the catch. How can we keep the same or lower taxes for almost everybody while raising more revenue? It depends on whether or not the stinking rich will actually pay. While some economists will argue that we shouldn’t increase taxes on the rich because it will make them work less, the probable result is just the opposite. The most likely outcome of my proposal is that it will make the super-rich work more – at avoiding taxes. It will make it more likely that they will try to engage in tax schemes and dodges that allow them to hide their income from the IRS to avoid paying 50% of all their income over $9 million to the Feds. I have two suggestions that might help avoid that.

The first has already been made. Simplify the tax code as much as possible so that there are no places to hide that income. Don’t allow the mega-rich to hide their income as corporation profits. Don’t let them set up tax shelters overseas. Increase the likelihood of an audit for those top 150,000 earners and increase the penalties for avoidance. If they earn it here, they pay taxes here. End of story.

My second suggestion would be the carrot to that stick. Make it a point of pride for those top taxpayers to support the government. They’re paying for our national defense and veterans benefits, research supported by the NIH and NSF, and everything else the federal government does. Publish their names (if they’d like), give them a medal, invite them to meet the President or members of Congress. They can feel proud that they are paying the taxes with which we can “buy civilization.”

And when the mega-rich complain about the share of taxes they must pay, there can be but one answer: The rest of us will gladly pay more taxes when we receive more income.

 

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Written by Liam C Malloy

April 13, 2011 at 8:00 pm

Posted in Inequality, Policy, Taxes

3 Responses

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  1. […] earning over $17 million) that growth-maximizing marginal tax rate is over 70%. In an earlier post I showed that we could eliminate the corporate income tax by raising top rates to only 50% (maybe a […]

  2. […] I’ve pointed out before, the income for the top 1% and the top 0.01% has been growing out of control for the last […]

  3. […] amounted to $2,173 for a tax rate of 1.0%. His take: Thanks a lot, but this is insane. Under my proposal he would have paid $43,147 in taxes, for a tax rate of 20.8%. Now, if that were the case he might […]


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