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Ultrapolis Weekly Forecast & Review

Wednesday, March 10, 2010

Do the Rich Pay Too Much or Too Little in Taxes?

The Truth about Income & Taxes Each Side Will Not Explain

We all often hear the repeated seemingly contradictory claims, each backed by apparently solid statistics. Conservative talk show hosts like Rush Limbaugh and Sean Hannity will frequently point out with moral outrage and frustration that the rich pay more than their fare of taxes, that taxes collected from the rich have gone up much faster than on the rest of the income groups, and that the rich pay a disproportionate share of the total income taxes collected from all Americans. On the other side, from the now-defunct liberal Air America, from liberal left-wing pundits like Bill Moyers and Paul Krugman, and even from one of the richest men in the world, Warren Buffet, we’ve heard that that the rich are richer than ever, and that often the middle class folks pay a higher tax rate than the rich . So, who’s lying? Nobody is. The truth is it is rare for nationally-syndicated commentators of any kind, or major public figures, to knowingly blatantly lie about any documentable facts, no matter how much their haters on the opposite side of the spectrum want you to believe it (or want to believe it themselves).

The apparent contraction is more a manifestation of the natural tendency of hard-core ideologues, especially those who are the most marketable and entertaining precisely because of their rabble-rousing advocacy, to ignore facts that undermine their arguments, and tout those that serve their cause. Then again, that bad habit really applies to some degree to all of us. Of course, there are those who are smart enough to be truly consciously aware of the contradictory facts, and still disingenuously choose to not disclose – so, what else is new?

The Rich Are Richer, but Unless You’re Them, You’re Not

Nonetheless, all the above facts pan out. Let’s start with ‘the rich are getting richer, while the rest of us are not!’ proposition. That’s true. Income inequalities have been growing since 1973, after previous decades that saw inequalities decrease. In the period after World War II, the gap between the rich (specifically, those at the top 20% ) and the rest became smaller, with the poor and middle class seeing incomes rise faster than those at the top, producing an increasingly egalitarian distribution of wealth. In fact, those at the very bottom experienced the highest rate of income growth. And so, through this period, real poverty was in retreat in the United States. But, after 1973, the tables began to turn, at first slowly, then more aggressively, with those at the bottom now with the smallest growth rate in income, and those at the top with the highest. More so, especially since 2000, the middle class has seen no growth in wages (after accounting for inflation), and the working poor have actually lost ground. Only those at the top have seen their incomes continue to rise, and at ever faster rates.

It is noteworthy that since the introduction of the generous welfare programs introduced in the mid to late 1960’s, the percentage of people under the poverty line has barely budged in either direction, after previous decades of steady progress. In short, the trillions of dollars diverted away from education, defense, and research towards health & welfare have changed nothing, and given the retreat of poverty prior to that period, may have actually made things worse.*

How did this economic turnabout happen? Economist argue about the cause, but one thing we do know, is that executive pay has skyrocketed at the same time that pay for entry-level wages has dropped. In 1973, the ratio of CEO pay to the average worker was a relatively modest 27 to 1, and had been steady for several decades. So, if the average worker got $10,000 in annual pay, the average CEO got $270,000. In the 1980’s that ratio began to rise every year, growing nearly three-fold by 1990. Then it grew even more dramatically in the 1990’s, culminating with the dot-com bubble that burst in 2000, where we reached a ratio of CEO pay to the average worker of a whopping 300 to 1. After the bust, the ratio dropped temporarily to a less astronomical 148 to 1, only to quickly bounce right back up to the same pre-bust levels during the housing bubble (the trend here is that economic bubbles that are catastrophic to everyone else are good for CEO pay). ). In fact, pay for the banking and investment professionals who brought us the housing bubble is now higher than ever.**

In summary, in the last thirty years, in contrast to the previous thirty, income derived by productivity gains in the economy have been almost entirely been allocated to those at the top, and since 2000, in toto. Conservatives and libertarians are not going to rush to point this out, less it cause the average Joe to question the freedom of the unfettered marketplace. On the other hand, the liberal progressives on the left would rather not make clear that despite all the taxes you have paid to improve the lot of the needy, things are actually relatively worse than before their social programs started.

*To put this in perspective, we have spent, in 2009 dollars, something like $25,000,000,000 (that’s $25 Trillion), or about $100,000 per person (counting children) alive in the U.S. during that period, on trying to improve people’s lives (this includes state programs, but does not include Social Security payments), with less effect on the future than what we did before the big social programs began. In fiscal 2009 alone, the total on health and welfare payments exceeded $1,800,000,000,000, or about $6,000 for every man, woman, and child in the U.S. Put another way, that was $13,000-plus for every tax return. Furthermore, keep in mind that many tax returns are filed with no tax due. As we did last week, we again invite the reader to look at their Form 1040, and their state income tax returns, and ask themselves how all this is paid for, and still pay for defense, infrastructure, etc.

**Some uber-free market supporters will say executives earn what they deserve. This opens us to the following questions: 1) were the CEOs of the 1970’s inferior and less competent, and that’s why they got paid less, or are the new executives genetically engineered to be superior? 2) How is it that larger Asian companies are faring much better, but pay much smaller salaries? 3) Why have markets crashed with increasing frequency and severity, in tandem with skyrocketing executive pay?

Rich do Pay More Taxes, but Unless You’re Them, You Pay More Still

As for taxes, do the rich pay more, or less, than the middle class taxpayer? Is the rich’s share of the tax burden increasing, or decreasing, in relation to everyone else? Yes, yes, yes, and yes. It all depends on what one chooses to include in one’s calculations. The rich (the top 1% 5%, and 20%) do pay a larger share of the total tax burden collected by the IRS. In fact, according to the IRS, the top 10% now pay 70% of the income taxes, and that share has grown 29% from 1986 to 2006. However, during that same time, the top ten percent’s share of income grew even faster, at 34%. So, the cut the top ten percent take from the gross economic pie has gotten bigger by 34% in the last twenty years, while the cut taken by the bottom 75% (that’s anyone making less than a quarter-million), shrunk 23% in that same period. So, yes the rich do pay a bigger share of taxes, but that’s because they have gained an even bigger share of the national income.

Warren Buffet says his secretary pays 31% of her income in taxes, while he only pays 17%. Other numbers from the IRS and elsewhere seemingly contradict that by noting that the rich pay a higher percentage of their taxable income in taxes, than do all other folks. Once again, both scenarios are likely true. Very rich people who earn most of their income from investments will very likely pay a lower overall tax rate than a middle and upper-middle class worker with few exemptions. That is because capital gains and dividends are currently taxed at 15%, while a middle class wage-earner’s wages would be subject to cross-section of rates from 10% to 25% (rates topped out at 35% for 2009), averaging out at somewhere between 12% and 22%. Some free market economists like to include the corporate taxes paid on behalf executives as part of the income taxes counted as paid by the rich, which then raises the rich tax total in relationship to the rest of us. Then again, there is one more tax that decidedly throws the numbers back in favor of the middle and upper middle class as those paying the highest income tax rates, but normally NOT included in these discussions: The Social Security and Medicare (FICA) taxes.

The FICA taxes are truly regressive, in that unlike income taxes, they tax the very first dollar you earn and do not tax any dollars you earn above a taxable wage limit (last year, that limit was $106,800). So, for a rich person earning far more than that, their effective FICA tax rate increasingly approaches zero while for the rest of us it is a fixed 7.65%. Except that it’s not really 7.65%. It’s actually 15.3%, when including the employer share of that tax. These taxes are a very real subtraction of money from the company that would otherwise be paid to you as wages. It does not matter that your employer pays it before you see it, the net effect of reducing your disposable income is just as real, and is exactly the same as if the tax were simply deducted after it was paid to you first. Those who are self-employed understand this very well.

FICA & Income Taxes: Six of One, Half a Dozen of the Other

But wait, some might argue, isn’t it wrong to include into these income tax rate calculations a tax that is actually defined as a ‘contribution’ for future retirement and medical benefits on which we will later collect, while income taxes are levied for the general purposes of government? No because, while the terminology seems to suggest that, that is not what actually happens. In reality, the FICA taxes collected are not saved for anyone’s future benefit: they are disbursed for current beneficiaries in a way no different than we hand out welfare payments or other government assistance. Secondly, the surplus FICA taxes collected that are not needed to pay current beneficiaries are used for general budget items like defense, regular welfare, NASA, roads, community swimming pools, farm subsidies to millionaires and big corporations, and all sorts of pork barrel projects. The surplus that is on paper supposed to be set aside to pay future beneficiaries is actually spent as soon as it comes in (this is a scandal in itself, and if anyone other than the government ran a scheme like this, they would end up in prison – but that is a topic for another day). Lastly, nobody is guaranteed any returns of any kind, like you would with a normal pension or private retirement program. Your 401K savings and investments, as well, cannot be confiscated by the government. But, Social Security and Medicare benefits can be cut or abolished at anytime. And, they will be. The bottom line is that FICA taxes go into the general fund, just like regular income taxes, and pay for the same things, and reduce the deficits, plus the related interest payments, we would otherwise have without them. The interest rate major (read rich) investors pay on investment loans are lower, thanks to these FICA ‘contributions.’

Of course, pro-business conservatives on the right don’t point this out because it undermines their argument that the rich already pay more than their fair share. But, why do the liberal progressives on the left not make a bigger point of including FICA taxes when discussing this issue? Because it undermines support for the Social Security and Medicare programs, and others like it, that are dear to them and very much of their making.

Where does this leave us? For the rich who earn their money through investments, they do pay a lower overall income tax rate than the average middle class American. For the working rich (those who get most of their income from huge salaries and bonuses), it might be a closer call, but it would be a close call. Either way, this is true: the proportionate share of tax they pay on what they earn has not grown, and in many cases, has actually declined; and most of the economic gains of the last thirty years have accrued to them.

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