Making Sense of the Tax Debate

By Kevin D. Williamson

Tuesday, October 05, 2021

 

“We are going to tax the rich and make them pay their fair share!” Senator Manchin thunders the sentiment from his yacht, Senator Sanders from his lakeside dacha, Senator Warren from her gilded Cambridge retreat. Tesla-driving Met-gala debutante Alexandria Ocasio-Cortez insists that Democrats are going after the top 1 percent, not doctors, blissfully ignorant that doctors are more common among the top 1 percent than are members of any other occupation. Jonathan Chait, the dim and dishonest New York magazine typist, denounces the inconvenient facts about federal tax policy as — and I am not making this up — “deeply misleading” even though the figures in question are “literally true,” italics in original.

 

Here is some more literal truth about taxes you may find useful.

 

Fair share? The high-income already pay the majority of federal income tax, and the share of tax they pay is larger than their share of income. Their share of all taxes (income tax and other kinds of taxes) is also in excess of their share of income, though not as dramatically as is their share of federal income tax.

 

According to IRS data, the top 1 percent of taxpayers (which includes households making $540,000 a year or more) take home about 21 percent of all income and pay about 40 percent of federal income taxes — which is to say, their share of the income-tax burden is about twice their share of the income.

 

The top 10 percent earns about 48 percent of all income and pays about 71 percent of federal income taxes.

 

The top half of earners make about 88 percent of the income and pay virtually all of the income taxes — more than 97 percent.

 

The Tax Policy Center, a left-leaning advocacy group, calculates that 1 percenters pay an effective federal tax rate — on all taxes, not just income tax — of 29.4 percent, while the top 0.1 percent pays 30.1 percent — an effective rate higher than that of any other income group. Their federal tax rate is more than twice that of middle-income (third quintile) households.

 

Chait cites figures from the left-leaning Institute on Taxation and Economic Policy (ITEP). These figures model all taxes — federal, state, and local — and the findings are similar to what we see with federal income taxes, though less dramatically so. According to ITEP, the top 1 percent earns 20.9 percent of all income but pays 24.1 percent of all taxes — well more than their “fair share.”

 

ITEP calculates that the top 20 percent earns 61.9 percent of income but pays 66.5 percent of the taxes.

 

The great economic problem facing the poor and the middle classes is not that high-income Americans aren’t paying taxes that are proportional to their incomes. The great problem for the poor is that both incomes and mobility are stagnant for lower-skilled workers, with globalization and automation putting pressure on those jobs. The great problem for the middle class is rising prices of certain critical goods, namely housing in the markets where the best jobs are, health care, and education. The basic responsible progressive proposition (to the extent that there is such a thing) is that higher taxes on the wealthy would make funds available to subsidize these goods on behalf of those with lower incomes. The conservative response is that the worst housing, the worst health care, and the worst schools already are free, and that much of what is wrong with those markets is the result of earlier progressive efforts to fix them.

 

Conservatives also are right to point out that if American progressives want to build a Scandinavian-style welfare state, then they are going to need to impose Scandinavian-style taxes, meaning radically higher taxes on the middle classes. There isn’t enough leftover income at the top to fund what progressives dream of.

 

Tax rates are not the same thing as tax revenue. Progressives and conservatives are equally sentimental about the immediate post-war years, and progressive in particular like to point to sky-high federal tax rates in the Eisenhower era as evidence that the economy can thrive and produce widely shared prosperity with radically higher taxes.

 

But that is not really the lesson of the 1950s at all.

 

It is true that in 1950 and 1951, federal tax rates topped out at more than 90 percent, a number that is almost unthinkable in our time. But there is a considerable difference between the statutory marginal rate — the rate you theoretically pay on your last dollar — and the effective rate, the real overall rate.

 

In fact, very high-income households in the 1950s paid effective tax rates that were not much different from what they pay today — a bit higher in some cases, but not radically higher. That 91-percent rate was not applied to a lot of dollars.

 

More important, the overall tax burden — meaning actual tax revenue as a share of GDP — was lower in those years than it is in our time. In 2020, the federal government collected 16.4 percent of GDP in taxes, while in 1950 and 1951, it was 13.2 percent and 14.9 percent, respectively. In fact, Fed data show that for most of the post-war period, federal tax revenues have mostly stayed around a relatively narrow band of 15 percent to 18 percent of GDP, even as tax rates and other tax policies have changed significantly.

 

As always, please do consult the original data yourself if you think you’re not getting the whole story.

 

We should not, however, undervalue the difference a few percentage points makes when you are talking about something as large as U.S. GDP. The 19.8 percent the government collected in 2000 had the federal budget nominally in surplus. Four years later, tax cuts and economic weakness had that figure down to 15.4 percent of GDP, producing serious deficits. If you are serious about balancing the budget, or just reducing the deficit, then the most realistic path is getting tax collections and spending both back to turn-of-the-century levels.

 

Some will prefer mid-century levels. But it should be understood that the federal budget in the post-war years was radically different in its priorities from today’s budget: In the early 1950s, about 75 percent of federal spending was defense-related, while everything else added up to 25 percent. We spent four times as much on defense as on all “human resources” — education, welfare, etc. — programs combined. Today, we have cut military spending by two-thirds (from almost 10 percent of GDP in the 1950s to just over 3 percent now) while welfare spending has more than quadrupled (from 3.9 percent of GDP to more than 16 percent). The next time a lefty friend says he wants to go back to 1950s budgeting, make sure he knows the facts of the case.

 

Tax rates affect tax compliance/avoidance behavior. One of the reasons (though far from the only reason) that tax rates don’t line up in the expected way with tax revenue is that tax rates affect taxpayers’ behavior. The poster boy for Eisenhower-era tax-avoidance behavior is . . . Dwight Eisenhower, in fact. As a lifelong military man, Ike was far from wealthy, but, after the war, he was offered $1 million to write a memoir. With $1 million, he’d be pretty well-set — but with $99,550 after taxes, he would be far from that. So Eisenhower talked his publisher into structuring his deal in such a way as to have the income taxed at the lower capital-gains rate rather than at the confiscatory federal income-tax rate. He wasn’t alone: Tax avoidance drove all sorts of aspects of business compensation and affluent lifestyles in that era, with executives shifting all kinds of personal consumption onto the firm and well-off men acquiring rental properties and other businesses that threw off a lot of cash but managed to show on-paper losses.

 

A lot of that was straight-up tax fraud. But we have become more effective at detecting and prosecuting that sort of thing, and so, in our time, most tax-avoidance strategies are entirely legal. Private-equity operations structure their businesses the way they do largely for tax purposes, and a great vast sum of American corporate profits are exiled to Ireland, the United Kingdom, the Netherlands, and Switzerland for tax purposes. (Amsterdam and Zurich — some race to the bottom!) These are not “loopholes” — this is the tax law, operating as intended. It isn’t some bizarre accident that we treat investment income differently from salary income — that is a policy choice, partly intended to encourage investment and partly intended to account for the fact that we already tax corporate income before it gets paid out as dividends.

 

The U.S. tax system, far from being lax in this regard, is remarkably invasive compared with the tax regimes of other developed countries, and remarkably expansive in its interpretation of its taxing jurisdiction. And we have a slightly higher top corporate-tax rate than Sweden, in the same neighborhood as Denmark and Norway.

 

Businesses and, to a lesser extent, high-income people have a lot of choices — about how, when, and where they earn their income, about how that income is classified under tax law, etc. The Powers that Be in New York have been learning that the hard way, as ultra-high-income New Yorkers — who pay an enormously disproportionate share of state and local taxes — decamp for Florida.

 

Even if there were 100 percent compliance with the law — and there isn’t, and isn’t going to be — perfectly legal strategies for tax avoidance limit what class-war progressives can actually accomplish. And that matters, because . . .

 

Using the tax code to raise revenue for necessary government spending is different from using the tax code for social engineering and revenge. Conservatives well remember Barack Obama’s declaration that he would raise taxes on wealthy people and businesses even if doing so were economically destructive, simply because he believed it to be a moral imperative. The vindictive attitude toward taxation completely dominates progressive thinking — which is why Democrats such as Elizabeth Warren and Alexandria Ocasio-Cortez are always going on about how much money wealthy people have rather than focusing on the situation of the poor and how that might be alleviated. Barack Obama, in his own words, believes that morality calls for reducing the wealth of the wealthy, irrespective of other considerations.

 

We hear a lot of that when we are talking about inheritance taxes. From a fiscal point of view, the inheritance tax is an almost purely symbolic issue: It raises very little revenue, and it would raise very little revenue even if it were jacked up. Raising the inheritance tax is not about revenue — it is about resentment.

 

As usual, that resentment is misplaced. In reality, inherited assets make up a relatively small share of the wealth of wealthy Americans. According to the Bureau of Labor Statistics, inherited assets make up about 15 percent of the wealth of the top quintile if we are sorting by wealth, and about 13 percent of the wealth of the top quintile if we are sorting by income. As it turns out, inherited assets make up a much larger share of the wealth of those with lower incomes: 43 percent for the bottom quintile and 31 for the second quintile. (What that means more often than not is that these lower-income households inherited a house from parents or grandparents, and that this house accounts for a very large share of their wealth.) Most wealthy Americans earn most of their wealth, a few Waltons and Marses and billionaire dilettante magazine publishers notwithstanding.

 

Of course people with rich parents enjoy an unearned advantage in life. So do people who are tall, good-looking, or born with a relatively high IQ. (In fact, a great deal of our Kulturkampf politics is driven by the bile and hatred of people who enjoy one sort of unearned advantage directed at people who enjoy another.) But the important ways that rich parents provide their children with advantages mostly happen earlier in life and have nothing to do with inheritance: Rich parents see to it that their kids get the sort of education that makes the most of their talents, including all sorts of help outside of school; they make sure that college is paid for and that their kids have only their studies and interests to worry about; they subsidize their participation in unpaid internships or low-paying entry-level jobs in elite professions; they make sure that unexpected setbacks or bad decisions do not produce debilitating long-term financial burdens; they help them get on the home-equity escalator earlier and more substantially; they have networks of friends and associates who can help their children connect with opportunities that they aren’t going to see on Monster.com. And, because wealthy people tend to be long-lived, when they leave money to their children, those “children” are often in their 60s, having made lives and careers of their own — which is why those inherited assets often make up a small portion of their wealth.

 

If you want to reform taxes in order to fund necessary government programs in the least economically and socially disruptive way, that’s one conversation. If you want to reform taxes because you’re a horrifying ghoul living out some ghastly perverse “Harrison Bergeron” fantasy, that’s a different conversation. What works best for one is not generally what works best for the other.

 

But maybe none of this matters, because in a real economic sense, taxes are paid jointly.  The old proverb about businesses just passing along tax increases to consumers isn’t entirely right, but it isn’t entirely wrong. Many businesses, including very large ones such as Walmart and McDonald’s, have very little negotiating power vis-à-vis their customers. Walmart’s business model is based on low prices, and, if Walmart raises prices too much, its customers just go elsewhere — Target, Amazon, HEB, whatever. But firms such as Walmart and McDonald’s do tend to have a great deal of negotiating power with their vendors and other business partners, with service providers, and, in many cases, with their employees. Shareholders — the people who own these companies — are going to do their best to push off expenses onto anybody else they can rather than go into their own pockets. That can mean lower incomes for everybody from farmers to truck drivers to store clerks, to people who work in paper-goods factories or unloading goods at ports.

 

Just how much and to whom tax costs get pushed around is a matter of some dispute and much study in economics, but the basic answer is: They get redistributed quite a bit, generally to those with the least negotiating power in the market. Which is what you’d expect. Economists have spent years studying the payroll tax, one part of which is notionally paid by employees and one part of which is notionally paid by employers. The general consensus is that employees pay both their share and much of the employer’s share, which is passed on to them in the form of lower wages.

 

It matters where a tax legally and formally falls. But, ultimately, we all end up on the hook for taxes that are not legally our burden, because there is a world of difference between statutory fiction and economic reality. That is why it matters to all of us that government use our money in a prudent and responsible way and that it collect taxes in such a way as to minimize economic damage and distortions. In the end, that is more important than whether the top statutory income-tax rate is 39.9 percent or 36.5 percent.

 

The main obstacles to radical tax reform are conservative inertia, which is generally healthy, and progressive rapacity, which is generally destructive. If we had no tax system at all and were looking to create one from scratch, we probably wouldn’t settle on anything like the system we have. If I were god-emperor for a day, we wouldn’t tax work or investment directly at all but would instead rely on consumption taxes. We could fund the entirety of the federal government with a VAT or a carbon tax, if we were starting from a blank slate — but we aren’t.

 

Put another way, the main argument for income taxes from a conservative point of view is that we already have them, and they more or less work, whereas replacing them in toto with a new and untried system is bound to bring about unintended consequences and involve risks we had not accounted for. Conservatives are pulled in two directions: in one by our skepticism of radical social change and in another by our appreciation that the current tax code and overall fiscal practice is seriously defective, which eventually will produce catastrophic consequences.

 

Democrats are pulled in two directions, too: They are the party of people who say they want to tax the rich, but they also increasingly are the party of the rich, from Wall Street to Silicon Valley, and they emphatically do not want to raise taxes on their rich. Our friends at the lefty ITEP are once again on the case, noting that Democratic proposals to end caps on state and local tax (SALT) deductions would undo almost all of the new taxes on the rich in the Build Back Better bill. The SALT deduction overwhelmingly benefits high-income people in high-tax states — which is to say, the same Platinum Card progressives whose preferred tax burden is the $100 corkage at Quince.

 

There are lots of reasons not to reformulate our taxes in such a way as to rely even more heavily on the wealthy: a healthy sense of proportionality, the republican sense that citizenship brings with it burdens and responsibilities as well as benefits and privileges, political complications, etc. But in addition to the big economic reason — that the fantasy progressive tax strategy is unlikely to realize the promised benefits — there is the always-underappreciated matter of risk: The more heavily concentrated the tax burden is on a few taxpayers, the more real power those taxpayers have over a dependent political class and an unstable political situation. It is politically difficult, but the best, reasonably stable means of increasing tax revenue in a big way is increasing the tax base — meaning higher taxes on everybody.

 

If that’s a price you are unwilling to pay, then you aren’t serious about your progressive utopia. And that’s okay! You shouldn’t be serious about it — it was never a good idea to begin with.