Posts Tagged Fairness

Deflating Conservative Arguments: The Flat Tax

My neighbor in the apartment across the way is a good-natured centerist who is very interested in issues of taxation. He and I often get into discussions related to our tax system and he’s brought up the idea of a Flat Tax. It sure sounds like a good idea: everyone pays the same percentage of their income. After all, he argues, why should someone making a lot of money pay a higher percentage?

The problem with this idea, of course, is that it’s ultimately regressive, taking a more meaningful chunk of money from the least fortunate in our society. The counter question being, why should someone making only a little money pay the same percentage of their income as someone making much more and is it fair to tax them at the same rate?

Follow me below the fold where I level the Flat Tax in my continuing series Deflating Conservative Arguments.

I’ve found that a lot of people don’t understand how our current progressive income tax system works. Many people think that the tax bracket you reach on your last dollar in income is the one you pay on all your income. I’ve heard people say things like “I got a $2000 raise, but it bumps me into a higher tax bracket” with a disparaging tone in their voice that belies the fact that they’ll be making more money. Fortunately, they won’t really be paying the higher rate on all their income. For example, a single person pays 10% on their first $8500, 15% on their next $26,000, 25% on their next $49,100, and so on. So if you make $34,000 and get a $2000 raise, you’ll be in a new tax bracket, but you only pay the new tax rate (25%) on your last $1500, and your total tax liability will be $5125. This computes to an effective tax rate of 14.23% ($5125/$36,000).

Okay, so now that that’s all cleared up, what about the flat tax? Even some of my more liberal leaning friends have been suckered in by this one. The proposal is that everyone pays the same percentage in federal income tax on all of their income, though proposals vary as to what the percentage should be. In 2008 Senator Lamar Alexander (R-Tenn.) proposed a 17% flat tax rate. Let’s use this as our example because there is simply no concrete proposed rate that flat taxers are rallying around.

As you can already see by looking up at the previous example, a 17% rate is higher than the 14.23% rate that someone making a modest $36,000 pays today. The break even point is $48,438, meaning everyone making less than that gets a tax increase under a flat tax and everyone making more than that gets a tax break. Let’s look at the lower and upper end of the spectrum for greater relief. Billionaire hedge fund manager John Paulson (unrelated to former Goldman Sachs CEO and Treasury Secretary Henry Paulson) raked in $4.9 Billion ($4,900,000,000) in 2010. Though I know this is investment income and therefore subject to the capital gains rate, let’s pretend that it was counted as regular income taxed at the normal income tax rates. If this were the case, Mr. Paulson would be paying an effective rate of 35% under our current system or around $1.715 Billion. If his taxes were slashed to 17%, he would be paying around $833 Million, a savings of around $882 Million. On the other hand, a single person with no children living at the 2010 poverty threshold of $11,344 pays $1277 in federal income tax for an effective rate of 11.25%. If we instate the 17% flat tax, that would raise their taxes to $1928, a hike of $651.

So the question of fairness arises. What is fair? Is it just to lower billionaires’ taxes by half, but increase taxes on the poorest? Is it just? To me, the issue always come back to these simple questions.

So, what is a fair and just way to pay for our society? I believe that those who make the most money have benefited from the system much more than those who make the least. The poor tend to stay poor because they have the deck stacked against them from the get go. If both parents are working and struggling to make ends meet, children are not as able to succeed. If they live in an economically depressed area, they are likely going to schools that don’t have the resources to hire the best teachers or have the equipment necessary to prepare children for college. If you live somewhere where your life is in constant danger due to high crime (due to poverty), it makes it pretty darn hard to study. Conversely, the well off tend to become richer because they have safe places to grow up and don’t have the added stresses of poverty. They go to the best schools with the best teachers and the top of the line equipment, live in the cleanest, safest neighborhoods, and have parents who have the resources to help them achieve. The disproportionate amount of money spent on all of the services that our society provides such as schools and public safety go to the wealthier areas. This is because their local tax base (or private donations) keep their areas nice because they, as anyone, care deeply for their children and want them to succeed. The problem is that not everybody starts out at the same place, so to pretend that is the case is just fantasy.

The reality is that we’re all in this together and we need each other to succeed. Because the wealthy benefit more from our society, and the safety and security it affords them, they should pay more to keep our society (and the government that administers it) strong. It’s the only just thing to do.

Cross Posted on Daily Kos

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Deflating Conservative Arguments: Tax Increases Hurt the Economy

While listening to NPR on our drive home on Tuesday, my wife and I heard Rep. Tom Price (R-GA) say (emphasis mine):

Well we, we believe that tax increases, by and large, and, and for the most part, decrease the economic vitality and, and ability for this economy to recover. Uh, if you tax, uh, something you get less of it, and right now if we tax productivity or if we tax, uh, businesses to a greater degree, we think that you stymie and, and stifle the economy’s ability to grow.

This is a very typical conservative view of the effect of taxation. The only problem is that it’s, “by and large, and, and for the most part,” not true. Join me below the fold as I pop another conservative balloon with the needle of truth in my ongoing series, Deflating Conservative Arguments.

The conservative argument goes like this: increasing taxes takes money out of hands of regular people who would spend that money (as they see fit) and therefore stimulate the economy. There is a grain of truth in this if the government is taking money that would otherwise be spent on consumer goods and services or invested into productive capacity (as opposed to being used for debt reduction, speculative investment, or savings).

Even President Kennedy was for tax cuts and spoke in favor of lowering the tax rate throughout his Presidency. However, when Kennedy took office in 1961, the tax rates, were much higher than they are today. The argument that taxing income at this level would take money out of the economy made a lot more sense and led to the Tax Reform Act of 1964 which lowered all tax rates over two years in a somewhat regressive manner. Note: For purposes of illustration, I am using the rates for Single taxpayers, no exemptions, deductions or credits, and not adjusting for inflation.

The lowest marginal rate fell from 20% in 1963 to to 14% in 1965 (on your first $2000 in income) and the highest marginal rate went from 91% on income over $200,000 in ’63 to 77% in ’64 and then the top bracket was eliminated and the next bracket, income over $100,000, became the new top and was lowered to 70% in ’65. While the richest Americans certainly got the lion’s share of the tax break, the money that those in the lower classes would have gotten would be spent on consumer goods and services and therefore, would have a stimulating effect on the economy. It could even be argued that those in the top income brackets would spend more because the previous tax rates were a large bite of any income over $200,000, so even a millionaire would purchase more things or even perhaps put money into a new American business.

By contrast, today the top tax bracket (35% on income over $379,150) is the lowest it’s been since 1916, the 4th year of the federal income tax. This fact means that much more income is staying in the hands of the rich rather than feeding the governments coffers. If you made a million dollars in 1963, you’d have had a tax liability of $880,680, but if you made a million dollars today, you’d have a tax liability of $326,558. Okay, so you’d have 554,122 more dollars to spend. Great, but how much can someone really spend on consumer goods and services? How many American businesses can one person start and actually handle? How much demand can any one of us actually create?

Nobody knows the answer to that for sure and it is certain to vary to a great extent, but there is a limit somewhere. Once that limit is reached, any income over that amount is excess income that will be saved or put into non-productive (speculative) investments. Therein lies the answer to the eternal question of taxation, (ie. What is the appropriate level of taxation?) The appropriate amount to tax, in the sense of generating the most economic activity, would be the amount that puts any excess income to productive use. This level is probably somewhere closer to the 1963 tax rates than the 2011 rates.

The conservative argument that increasing taxes is bad for the economy assumes that all money that is in the hands of the income earner will be spent in the most economically productive way. This is plainly not true. After someone has reached the limit on their own consumer spending and has started as many businesses in America as they can, they will either use their money to speculate or sit on it. While investing in American businesses does increase our economy’s demand for supplies, equipment and labor in the US, speculation does not. It is merely a bet that such and such business will do well. Speculation adds no demand to the system and those dollars could therefore be used more wisely to do so. Clearly the same is true for savings although some savings is obviously necessary to have a personal cushion and be able to live with dignity in ones old age.

In contrast to the conservative argument, increasing taxation rates on top income earners, such as in the proposed Fairness in Taxation Act, which would implement new brackets of 45-49% for millionaires and billionaires, would actually increase economic activity. Rep. Jan Schakowsky, the author of the bill estimates that if it was enacted in 2011, it would generate $78 billion in new revenue. This would then get spent by the government on goods and services, generating more demand for goods, supplies, equipment and labor (read: jobs). This is money that is currently unproductive and would be put to good use.

I would even go so far as to say that lowering (or perhaps eliminating) taxes on the lowest income earners while raising taxes (even drastically) on top income earners will generate the most economic activity as it will simultaneously put more money into the hands of people who will spend it immediately and put money that is currently unproductive back into the economy. Although the People’s Budget does not include lowering taxes on low income earners, it would allow us to balance our budget without cutting needed programs, or endangering social security or medicare and medicaid and put our fiscal house on the path to sanity.

The grain of truth in the argument that tax increases hurt the economy can only be true as far as the assumption that all money that is not taxed is being put to its most economically beneficial use. Raising taxes on top income earners will not hurt the wealthy and it will not hurt the economy. It is a simple matter of fairness and justice.

Cross Posted on Daily Kos

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