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 Purpose of a Tax


Taxes* serve two purposes: the first is to provide governments with revenue, and the second is to deter or regulate activity i.e. sin tax on alcohol or trade tariffs.

Notice, neither purpose’s main role is to serve as a catalyst toward economic growth like Republicans believe. Republicans are confident, just so sure, that if we lower taxes the economy will prosper. But understanding the purpose of taxes, and just basic tax history, there is little evidence to support the Republican model. Tax rates have been consistently decreasing for decades, yet the economy has still had its ups and downs. The point is economic growth is not solely determined by tax rates – it’s not that simple.

I think Democrats better understand the purpose of taxes. Democrats do not argue higher taxes lead to economic growth (because it is true at a certain point when taxes go too high they will deter economic activity). When liberals reference the higher Clinton era tax rates, they are referring to the strong economic growth that went on during that time. The significance being high tax rates did not deter economic activity. They did, however, serve the role of raising revenue, which led to 4 years of a balanced budget.

So Republicans are framing the debate around taxes incorrectly. It’s not; we need to lower taxes because that will lead to economic growth. Instead it’s at what rate should taxes be set in order to maximize revenue, but at the same time not deter economic growth.  So the tax rate should not be viewed as an economic starter, but only an economic deterrent.

Given our current tax code, it’s hard to argue that it is high rates that are hindering economic growth. Taxes were slightly higher in the 90’s and drastically higher in pervious decades, and in both cases economic growth was much greater. If taxes now are lower than during an era of greater economic prosperity then there is no reason to believe lowering them more will solve the problem. So the basis of the Republican argument, taxes are too high, is really an unfounded claim.

Now, this is not an argument that government should try to squeeze every penny out of taxpayers it can without hurting the economy. But given the country’s increasing deficits, under funded schools, crumbling infrastructure, growing numbers of people living in poverty, a disappearing middle-class, and a slew of other problems, more revenue is not inherently bad.

The larger point in all this is Republicans’ answer to every problem is to cut taxes. That’s obviously not the solution. Tax rates are historically low, and there’s no evidence that further reducing them would spur on economic growth. Instead we should set tax rates so they can serve their purpose of raising revenue without being a drag on the economy.

We need to look at other ideas to promote economic growth outside of just ‘cut taxes!’ This could be rebuilding our infrastructure, investing in new infrastructure like high-speed rails, investing in new alternative forms of energy, or creating policies that promote hiring here in America rather than overseas. Here is where the Democrats have an edge, the stimulus package that was passed, and The American Jobs Act (that was not passed) were filled with ideas to boost economic activity. They were ideas that went beyond cutting taxes for the rich in the hopes the wealth will trickle down. Although some may disagree, most economists concur that the stimulus did work, and the American Jobs Act would have reduced unemployment.  Economic growth will not come from padding the pockets of the wealthy, but from investments aimed at putting people back to work.

*To make things simple, taxes in this post refers to individual tax rates

3 Reasons the Claim “Half of Americans Don’t Pay any Income Tax” is Bogus


In a recent post, a comment was made by ‘Chris,’ who makes the claim, “nearly 50% of Americans… do not pay an income tax.” This line has become a standard talking point for right-wing politicians, pundits, and Fox News enthusiasts. It has been circulating for a couple of years now, in part because it is ‘true’ (yes, the claim is technically true, not denying that), but also because it plays into the conservative narrative that the downfall of this country is due to free loaders who are dependent on government.

The first problem with this line is many times it leads to people, sometimes ‘important’ people like Sean Hannity, claiming that half of Americans pay no taxes at all.  That is just patently untrue – simply red meat for his conservative base.

This leads to a second problem because implying a certain group of people do not pay any taxes only perpetrates the belief that those in poverty just want handouts and are not paying their fair share. This false belief turns a blind eye to the fact that there are more taxes than just the income tax. The income tax happens to be a very progressive tax. So it does not affect low-income people as much as high earners, but by no means does it follow that they do not pay their fair share.

 

 

 

 

 

 

This graph shows the effective tax rate paid by each income group. We see even those at the bottom still pay an effective tax rate of 17.4 percent. Yes, higher earners pay more (not by much), but the idea that low-income people are free loaders is simply not true. Further, if you take into consideration the past few decades where those in the top income bracket saw their income rise by close to 275 percent, while others only saw modest income growth begs the question as to who is really not paying their fair share.

Third, this claim also seems to purport those not paying income tax are either not working or somehow cheating the system. Both of which are untrue.  A large group of those not paying any income tax are the elderly. Their main source of income is Social Security, which is not taxed as income.  The other main reason 48 percent of people do not pay any income tax is because they are living in poverty and do not earn enough.  The various exemptions and deductions all people receive make their income tax rate zero.

These are not people who aren’t working or cheating the system. In fact, according to Lindsey Graham, ‘It’s really American to avoid (paying) taxes.” Full Disclosure: That quote is taken out of context. What he meant was that it is American for rich people to avoid taxes, but for the less fortunate, avoiding taxes is being a free loader.

That’s really the issue here; Republicans demonize the poor while putting the rich on a pedestal. They use this line as evidence the rich are already supporting the lower class through high taxes and taxing them more would be economic suicide. Republicans want us to believe that hiding and sheltering income to avoid taxes is patriotic, but when low-income households use standard deductions to decrease their tax burden they are leeches on society. It’s interesting we never hear about the 20,000 plus Americans who make over $200,000 a year and pay zero in income tax. That’s because those are the ‘job creators’ and we don’t attack them.

Paying taxes is about paying your fair share – both parties believe that. Republicans are just going after the wrong group of people.

The Refutation of the “Republican Revolution” – Part 4


 

 

 

 

 

 

 

 

 

 

 

 

 

 

Let’s just dig right into this one.  The attack on The Affordable Care Act as socialized medicine is a tired line by the right.  The thing is The Affordable Care Act simply mandates having insurance.  It is more about insurance than actual healthcare.  So it is not government run medicine. There are not going to be government doctors.  “Obamacare” is actually modeled off the Heritage Foundation’s healthcare plan.  It is a right-wing idea.  Also, why is socialized medicine bad? I would love socialized medicine. We are one of the few modern countries who do not have a single payer type system… and what’s the result?  We have higher costs with poorer results.

The other line of attack on the President is that he redistributes the wealth. The main way government redistributes wealth is through taxation, which is allowed by the Constitution.  The problem is the President hasn’t raised taxes! The right really wants to believe Mr. Obama has raised taxes but the thing is he extended the Bush era tax cuts and instituted the payroll tax cut. Just yesterday he put out a plan to lower corporate taxes. So, at what point did the President take money from the rich to give it to the poor?

Liberals hate guns! (sarcasm)  Now, yes Liberals believe in gun control more so than conservatives but they do not want to ban guns.  Too be honest there needs to be a balance on this issue.  No judge wants to abolish the second amendment nor does any judge believe any gun should be made available to any person.  The Supreme Court is supposed to be representative of the population, therefore; there needs to be judges on the bench who are not entirely pro gun

I love how Republicans deem the President as pro-illegal-immigration.  Fact: The President has deported more illegals per year than President Bush.  The criticism is just absurd.

Finally, the President is not engaging in class warfare! That is just a line made up by the right so they can deem a tax increase as divisive.  I’ve written on this issue before, here.

Finally Congress Got it Right


Although not official, it is looking like Congress is going to extend the payroll tax cut.  The fact it’s going to pass is not all that surprising, but how it’s going to pass is surprising.  Unlike every other Congressional decision this one was not made at the last minute and it was done with little to no controversy. It seems Congress, particularly House Republicans, learned their lesson from December when they took the decision to extend the payroll tax cut down to the wire. Ezra Klein argues this sudden change of strategy by the GOP is due to the President’s increasing approval rating and the better-than-expected economic numbers.  Mr. Klein believes the lack luster Republican field has made top Republican leaders begin to re-think their political futures. Republican leaders are recognizing the country is more in agreement with the Democrats than themselves.

This is also evident in the payroll tax cut extension being passed without it being paid for.  The once Republican deficit hawks would have never let this tax cut pass without it being funded or requiring some other political gain.  They have come to realize the majority of the country is not as concerned with the national debt as they are.  Republicans wanted the national debt to be the central issue of this election, but they failed to understand the average person cares more about having a job than paying down the debt.  We once again see the tide shifting towards the Democrats.

Also, economically speaking a paid-for-tax-cut has no effect on the economy.  It is robbing Peter to pay Paul with the end result being zero increase in aggregate demand.  This is something Republicans either failed to understand or to admit.

Congress seems to have finally gotten it right.  Specifically, Republicans have got it right that fighting the payroll tax cut extension is not a popular stance.  And Congress got it right that during times of recession it is not necessary to pay for a tax cut.  This extension will not only benefit the average American, but it is sign of what’s to come in November.

An Interesting Correlation


The conservative movement rally cry in recent years has been two-fold: lower taxes and decrease the debt.  They argue taxes are too high and government spending is too much. The combination of the two, they claim, is crippling the economy, sky rocketing our debt and preventing job creators from doing their job.

Their thinking is flawed on a few levels.  First, there is no doubt the economy is ailing.  Therefore, the national debt should not be a first concern. The number one concern needs to be the unemployment rate. Republicans should be worried about decreasing that rate not the national debt. In a recession government spending is necessary in order to boost aggregate demand which will in turn boost the economy.

Second, it seems odd to be so worried about the national debt and at the same time want to continue lowering taxes.  Common sense would say to decease the national debt the government needs to raise more funds and they do that by collecting taxes.  So raising taxes seems in line with the Republican view point. By merely ending the Bush-era tax cuts the debt would be reduced by 680 billion dollars in 10 years.  Although that does not come close to solving the problem it still reduces the debt with minimal consequences.

Republicans counter this logic by saying lowering taxes promotes job growth and consumption. The increased consumption will result in increased tax revenues therefore offsetting the tax revenue lost from the lower taxes.  Historically that logic just doesn’t work.

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Here we see since 1980 the national debt has been constantly on the rise. Now what is interesting is the corresponding top marginal tax rate during this time.

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Since 1980 the top marginal tax rate (job creators) has been decreasing.  So the Republican platform to lower taxes in order to tackle the debt doesn’t seem to make sense.  Now I understand these two graphs do not solve the debate but it is an interesting correlation.