Raising Taxes on the Rich, or Effective Public Policy?

Over the last few weeks and months, the progressive rhetoric supporting raising taxes on the wealthy has shifted. While the claim used to be that deficit reduction and economic growth could only happen in tandem with raising taxes now the claim is that raising taxes on upper-income earners is the fair thing to do.

For example, in the 2012 State of the Union address, President Obama used this rhetoric when talking about the “Buffett Rule”:

“Tax reform should follow the Buffett Rule. If you make more than $1 million a year, you should not pay less than 30 percent in taxes… Now, you can call this class warfare all you want. But asking a billionaire to pay at least as much as his secretary in taxes? Most Americans would call that common sense.”

One of the problems of the “tax the rich to pay their fair share” movement has been the failure to define fairness. What is the fair share of the wealthy to pay? What is the fair share of the common man to pay for that matter? By what framework do we determine how taxes should be paid (income, consumption, etc.) much less how much should be paid?

Obama in the State of the Union has now at least offered a definition to debate about. It is reflective of the rhetoric repeated elsewhere in the media echo chamber (see Daily Kos, The Washington Post and The New York Times) and it essentially says that at least $300,000 of every $1,000,000 earned is a fair tax rate, no matter how that income is earned.

Note: We will set aside for now the question of what types of income should be taxed if any, since that is a debate for another day, and focus on the numbers argument.

What would happen if we went back to the Clinton-era tax rates on the wealthy, with a top tax bracket of 39.6 percent? According to CBO’s static analyses, $70 billion would be collected annually (or $700 billion over 10 years). This is less than 2 percent of the fiscal year 2011 federal budget, and about 5.38 percent of the FY2011 deficit.

More importantly, what would happen if we listened to the President and taxed millionaires at 30 percent? We’d bring in less than $250 billion, which is less than 1% more than what the average millionaire currently pays. For those that still think taxing the rich more to reduce deficits is the answer, this millionaire tax means less than $10 billion more in federal revenues. It simply would not be enough to make a difference in our massive budget holes.

Meanwhile, the reality is that upper-income earners already pay more federal taxes than lower-income Americans both as a percentage of income and as a percentage of the total taxes collected. This has been true since 1979. And according to a summary of a Congressional Budget Office report, in 2005 “The top 1 percent of all households got 18 percent of all personal income and paid nearly 28 percent of all federal taxes in 2005, according to the Congressional Budget Office (CBO). The top 1 percent now pay a significantly larger share of taxes than before President Bush’s tax cuts, and also have a larger share of income.” Let us repeat: the 1 percent paid more in taxes in 2005 after the Bush tax cuts took effect than before they were enacted.

We would suggest that tax loopholes and federal subsidies are objectively unfair. By nature they single out specific classes, individuals, or businesses and give them advantages that others do not have (usually for social policy reasons). Two things we could do to make the tax code actually fairer while increasing both federal revenues and economic growth would be:

  1. 1. Cutting out federal tax loopholes. According to William Galston of The Brookings Institution, the top ten tax code loopholes (consisting of over half of the loopholes in Fiscal Year 2011) are expected to cost $4.337 trillion from 2012 through 2016.
  2. 2. Cutting out federal subsidies. According to Chris Edwards of The Cato Institute, federal subsidies topped 2,000 in January 2010. Energy subsidies totaled $37 billion in 2010, and corporate welfare equaled $92 billion, for just two examples.

The federal tax code needs a complete revamp, and the ideal solution would be to end all income taxes and replace them with some kind of consumption tax system. However, as pointed out by Robert Samuelson in Newsweek, “It’s easy to imagine a better income tax… Don’t hold your breath. Tax simplicity sounds good, but—politically—complexity wins hands down.”