Understanding a Progressive Tax Code


FeaturedImageAs confusion over tax rates and the fiscal cliff dominates the conversation in Washington, it is becoming apparent people do not understand how a progressive tax code works. . A progressive tax code increases a person’s tax rate as their income increases unlike more regressive taxes, which set a uniform rate regardless of income. The federal income tax, being the most progressive tax, has 5 different brackets or tiers. As an individual earns more, that income is taxed at a higher rate with rates set at 10%, 25%, 28%, 33%, 35%. The top rate of 35%, which gets all the attention, is only paid on income over $200,000 for an individual or over $250,000 for a couple.

Now, if a person makes $251,000 a year, all that income is not then taxed at 35%. Only $1,000 (the amount over $250,000) is taxed at 35%. Everybody, from business owners to the working poor, pays the same amount in taxes on the same amount of income. Whether it’s a CEO who makes a million dollars a year or a factory workers who makes $50,000 a year, both pay the same tax rate on the first $50,000 they earn. The difference is the CEO goes on to make much more, and that money, and only that money, is taxed at a higher rate.

Understanding people will not all of a sudden be forced to pay exorbitantly more in taxes because they make more money has important implications for a lot of the arguments thrown around in tax rate discussions.

It seriously weakens the argument that raising taxes will disincentivize people to make more money – the “why work harder if Uncle Sam is just gonna take my money” people.  This argument falsely assumes if you make too much money then you will be bumped up into the next tax bracket and therefore have a greater tax burden. As noted before, it is only those dollars above the set limits that are taxed at the higher rate; it’s only the dollars greater than $250,000 that are taxed at 35%.

This also has important implications for the debate over whether or not to let the Bush tax cuts expire. The Bush tax cuts were across the board cuts for every income bracket. If they do expire the 10%, 25%, 28%, 33%, and 35% rates will increase to 15%, 28%, 31%, 36%, and 39.6% respectively. It is unlikely we will see all these rates go up, but what is likely to happen is the top two rates will go up (33% to 36% and 35% to 39.6%).  This has prompted rage from the Republican Party, and is the basis for the claim that the President is engaging in class warfare.  The richest Americans will pay higher taxes on some of their income, but as Ezra Klein has pointed out, “It’s an under appreciated fact that extending the Bush tax cuts on income up to $250,000 cuts taxes for rich people, too.”

Republicans also defend low rates on the top 2 percent of people by deeming it as an attack on small businesses citing those that file their earnings as personal income.  Small businesses, ones that pay their taxes on an individual basis and make more than $250,000 would see a higher tax burden if those top rates expired. But, those businesses still receive a tax cut on their income up to $250,000. And 97 percent of small businesses do not fall into this upper echelon.

So as the parties continue to wage debates over tax rates and the Bush tax cuts remember the importance of a progressive tax code in all these discussions.

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The Bush Tax Cuts Are Just Bad Policy


The upcoming election should help settle some of the debate in Washington, but one issue that will not be resolved November 6th, is what is known as the fiscal cliff. In December, when we bring in the New Year, it will be accompanied by sequestration (big spending cuts), and a spattering of tax increases.  One of the tax increases causing a lot of controversy is the expiration of the Bush tax cuts.

Republicans want to extend the cuts for everyone, while Democrats want to extend them for everyone except those making above $250,000.  This would return the top marginal tax rate to the Clinton era rate of 39 percent.  To those who read this blog often, it may not come as a surprise that I am in agreement with the Democrats on this issue, but for different reasons than you may think.

Republicans have called the Democrat’s idea just another form of class warfare. Democrats believe their plan works to even the playing field by ensuring everyone pay their fair share.

I think it’s much simpler than that – the Bush tax cuts are bad policy. Conservatives want to believe so badly that tax cuts for the rich are the solution to any and all economic problems. However, all those who claim lower taxes will increase growth, lower unemployment, and stabilize the debt are simply mistaken. The 1990’s and 2000’s provided a natural experiment on how tax rates affect the economy.

In 1993, when President Clinton raised taxes, the resulting years had much better GDP growth than the Bush years.

Similarly, the unemployment rate dropped every year after 1993. That trend was put to an end when Bush took office. Bush did see unemployment drop during his second term, but never to Clinton levels. Also, the decrease in unemployment, in part, was due to the housing bubble, and a massively over-leveraged financial system – 2 of the main drivers of this most current recession.

Finally, contrary to the belief that lower taxes will actually increase government revenue, Bush’s tenure was a mirror opposite of the Clinton years. While Clinton saw government debt to GDP decrease each year, Bush saw it rise. So much for tax cuts paying for themselves.

This is not to say higher taxes caused the good times of the 90’s, but clearly they were not a hindrance. The right’s insistence that lower taxes are the only path to recovery is misguided at best.  If tax cuts really are the solution then the economic climate of the 2000’s should have been much different. In other words, these graphs should look a lot different. The Bush tax cuts didn’t help with unemployment, didn’t boost growth, but did add substantially to the debt.

I know an economy is complex and not all these measures can be chalked up to tax rates. With that said, we can see that higher taxes are not necessarily detrimental, and lower taxes do not automatically equal growth. So all the big-idea-guys on the right have to come up with something else besides tax cuts.

Now, you might say, “if the Bush tax cuts are so bad then why not end them for all income levels?” Well, I believe that should be the goal. However, the Bush tax cuts have proved difficult to kill. Although the President pledged to let them expire in 2010, Republicans forced his hand and they were extended. The fact is ending all the Bush tax cuts is not feasible in the current political climate.

Ending them one step at a time provides the best chance to ending them in their entirety.  Also, let’s not forget, this recession is being driven by a lack of demand. Meaning increasing taxes on those who supply demand, middle-class families, may not be good policy for a struggling economy. Conversely, a tax increase on top earners, as we saw during the Clinton years, does not necessarily act as a drain to the economy.

The Bush tax cuts are bad policy.  They did not accomplish what they were supposed to and Congress should let them expire. Ending them on the high earners first makes ending them for everyone in the future more realistic, politically speaking. And ending them for the wealthy will not have the counterproductive economic impact that could arise from ending them on the middle-class.