Don't Worry, Be Happy

NY Times says many Americans won't be affected by the bailouts because relatively few of them pay any taxes:

http://economix.blogs.nytimes.com/2008/10/20/americans-shouldnt-worry-about-the-bailout/

Who Pays Taxes?

The WSJ (A25, October 7, 2008) had more statistics on the tax debate:

The top 20% pay 67% of all federal taxes--including not just income taxes, but payroll taxes, corporate taxes, and death/estate taxes. The top 1% of earners pay 26% of all federal taxes.

If Republicans want a return to the Reagan era, pointing out raw numbers isn't the way to get there. The average American knows the rich make the lion's share of money in this country. He also knows that no matter what the percentages and numbers are, unlike the average American, the rich don't have to worry about housing, food, or health care. Despite this knowledge, taxes have continued to come down for years in this country because the average American doesn't hate most rich people. In modern-day America, the majority of super-rich people don't inherit their wealth--they earn it, which gives them some immunity from European-style envy. Thus, the key goal of low-taxation advocates shouldn't be fairness per se. Instead, the goal should be to assure that everyone's tax contributions--no matter what the amount--are spent improving access to health care, infrastructure, and other quality-of-life services as well as cutting wasteful spending. A single dollar collected that goes towards more laws, more useless agencies, more unnecessary subsidies, and more lobbyist requests will damage everyone's faith in the system. In short, low-tax advocates must convince everyone that all taxes collected are going towards necessary services.

Americans want to be rich, so bashing the rich won't work in America as a primary political platform. The average American probably cares more about a) whether his or her tax dollars are spent for necessary services rather than special-interest spending; and b) whether taxes are enough to cover necessary services. Thus, the debate should be about what services are necessary, how the government can best deliver them, and whether the government is the best entity to deliver those services.

More on Taxes and Paying Your Fair Share

The WSJ published an article on taxes I somehow missed. See

http://online.wsj.com/article/SB121659695380368965.html

Here's an interesting statement from the article:

Taxes paid by millionaire households more than doubled to $274 billion in 2006 from $136 billion in 2003. No President has ever plied more money from the rich than George W. Bush did with his 2003 tax cuts.

To that I say, "Pfffff." If you bring in an extra billion but increase spending by two billion, I am not patting you on the back.

The article's failure to incorporate Pres. Bush's expenditures reduces the impact of its other cited statistics:

1. In 2006, the top 1% of Americans (making $388,806+) paid 40% of all income taxes; and

2. The top 10% (making $108,904+) paid 71%. That means 90% of all Americans only paid 29% of all income taxes, indicating their income tax burden is relatively low (compared to the affluent). (Note: the income tax is less than half of federal taxes and only one-fifth of taxes at all levels of government.)

The article states that "Americans with an income below the median paid a record low 2.9% of all income taxes" in 2006. Some argue such a relatively low tax burden creates a moral hazard, because poor and low income residents receive similar benefits as the rich--police and fire protection, schools, access to courts, FDA protection (food and drugs), FAA protection (air travel), and so on--but pay almost nothing for it. Consequently, some people have argued that the lower income brackets should pay more taxes to create a more fair understanding of the high costs of government and public services.

My opinions on this issue of "fair taxation" is evolving, but I support Obama's stated plan to raise the payroll tax threshold. While the poor don't get taxed much on their income, their income is still taxed relatively high if you factor in the the payroll tax and other taxes. The payroll tax is used to finance Social Security and other social programs, but it taxes income only up to a certain amount of wages/salary. In 2007, if you made more than $95,000, you paid the same amount in payroll taxes as the hedge fund manager who made $1 billion. And if you made $1 billion, your wages were deducted the same percentage in payroll taxes as the person who made $30,000. That scenario doesn't appear equitable when the Social Security program is underfunded.

One idea might be to increase the payroll tax threshold (thereby helping save Social Security) while also instituting a national sales tax (which would affect poor and rich alike). This way, current income tax rates would be maintained, and the poor would have an incentive to spend less, perhaps saving more of their money and moving up. I remember telling a friend who protested the sales tax because it disproportionately hurt the poor, "Get the tap water (pointing to my free glass of water), not the Coke." In other words, at least the sales tax is a tax people can avoid most of the time. I realize this makes me sound like Marie Antoinette, but I don't see too many other potential compromises, and such a national sales tax should go into a "lockbox" the government couldn't tap for anything other than benefit payments. [Update on September 18, 2012: my views on sales taxes is not fully formed, but I believe taxes in general should come from predictable and diverse revenue streams.]

Still, reading an article like the one below inspires me to try harder to think of a more equitable and effective scenario:

http://www.washingtonpost.com/wp-dyn/content/article/2008/08/02/AR2008080201672.html?referrer=emailarticle
(Thanks to creditslips.org for the tip; see http://www.creditslips.org/creditslips/2008/08/no-cushion.html#more)

It's no secret that the poor and middle class spend their money, while the rich save it and try to live off their interest and dividends, which are taxed at a lower rate (now 15%). As a result, any decent economist is going to want to try to get as much money into the hands of the poor and middle class as possible.

At the same time, as a Californian, I want more people outside the state to pay their fair share. It is not unusual in Santa Clara County to see people making 109,000 dollars or more (top 10% income bracket nationwide). It's incredible to think Californians pay so much in federal taxes, basically subsidizing Middle America, and yet are looked down upon by so many of our compatriots. For example, Texas took money from (robbed?) California through Enron. New Yorkers consider Californians soft. Dan Gable, from Iowa, reportedly refused to enroll California wrestlers because they were lazy. I dislike the status quo, which breeds resentment among the states and pits classes against one another while government spending runs amok. There has to be a better way.

More below on taxation.

McCain on Social Security (from http://www.csmonitor.com):

Americans have got to understand that we are paying present-day retirees with the taxes paid by young workers in America today. And that's a disgrace. It's an absolute disgrace, and it's got to be fixed.

An Example re: What Happens When You Tax One Group Too Much (taken from internet comment board):
Suppose that every day, ten men go out for tea and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.
So, that’s what they decided to do. The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. ‘Since you are all such good customers, he said, ‘I’m going to reduce the cost of your daily tea by $20. Drinks for the ten now cost just $80.
The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. What happens to the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his ‘fair share?’ They realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his tea. So, the bar owner suggested that it would be fair to reduce each man’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay.
And so:
The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33% savings).
The seventh now pay $5 instead of $7 (28% savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).
Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.
‘I only got a dollar out of the $20,’ declared the sixth man. He pointed to the tenth man, ‘But he got $10!’
‘Yeah, that’s right,’ exclaimed the fifth man. ‘I only saved a dollar, too. It’s unfair that he got ten times more than I!’
‘That’s true!!’ shouted the seventh man. ‘Why should he get $10 back when I got only two? The wealthy get all the breaks!’
‘Wait a minute,’ yelled the first four men in unison. ‘We didn’t get anything at all. The system exploits the poor!’
The nine men surrounded the tenth and beat him up.
The next night the tenth man didn’t show up for drinks, so the nine sat down and had tea without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!
And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

Update on April 13, 2009: Ari Fleischer has more income tax stats in today's WSJ (A15):

A very small number of taxpayers -- the 10% of the country that makes more than $92,400 a year -- pay 72.4% of the nation's income taxes.

Deficits Come Home to Roost

I was talking to a friend of mine today, and she, a life-long Democrat, was showing me that she paid 35% in taxes. She said she did not mind paying 35% to the government and favors maintaining existing welfare programs as well as entitlement programs. I suddenly realized how dire our spending habits are--just maintaining existing programs would cost future generations trillions of dollars more than we can afford and would bring our nation closer to defaulting on government issued debt (bonds, Treasuries) or requiring foreign capital injections (e.g., Citigroup, Merrill Lynch and MGM Grand).

I then realized something unsavory--the money would be coming from my friend and I to cover the existing entitlement/spending programs, and the only way the government could get it was by taking more money from us and our children. I told my friend her 35% rate was an inaccurate indicator of how much government spending programs cost. In reality, unless the government wants to default on our debt, her tax rate should be 50%, and sales taxes would have to increase every year to cover government spending. I tried to tell my friend her support for existing spending programs means that my children and her children would eventually be subject to an income tax rate of around 50% and a California sales tax rate of around 10% to maintain the programs she likes. That's when I realized if you're an American, and you care about this country's future, you must support cutting government spending. The only question should be where the cuts come from, not whether they should be made. Even supporting the maintenance of current spending programs is wrongheaded.

I gave my friend a link to Richard Fisher's recent speech, which I've posted elsewhere on this blog:

http://www.dallasfed.org/news/speeches/fisher/2008/fs080528.cfm

I asked her to read it, because if she, a very smart law school graduate, could not understand that even maintaining existing spending programs required higher sales taxes and her children to pay 50% in income taxes or risk Zimbabwe-type inflation, we had little hope as a country of exiting our financial morass.

I facetiously pretended to be Uncle Sam with a spending problem. I told her I had been using my credit card and spending trillions of dollars of her money and now I needed more, or I'd go bankrupt. I said I had taken loans from the Chinese, Japanese, and British, and I had to pay them interest every single month. The 35% I was taking from her wasn't enough. I couldn't take too much from the poor--it would not be enough, even if I raised their taxes to 50%. The top 25% already pay 85% of taxes (see http://willworkforjustice.blogspot.com/2008/07/top-25-of-earners-paid-85-of-all-taxes.html) to support my spending habits, and it isn't enough. My friend and her children had to pay more.

I racked up a list of expenses I had--the war in Iraq, Fannie Mae, Freddie Mac, welfare, military, payroll, Social Security, Medicare, and Medicaid. I told her I had overused my credit card for the past ten years and was spending money I didn't have, while paying only the minimum balance each month. To make matters worse, I had little actual savings--I was living paycheck to paycheck, surviving on my friend's 35% injections. Thus, any spending was going to have to come from more loans and more debt. I said I was now having a hard time meeting interest payments on my loans, and she had to pay me more money so I could take it outside of our country to pay my foreign creditors. I explained if there was any other way of getting the money, I'd avoid raising taxes. Please, I begged her, show me a way to get the money without taking it from you and your children but also maintaining my spending habits. (And no, massive inflation is not an option--as Zimbabwe shows, if everyone's rich, no one is.)

That's when it hit me. There's no other way for Uncle Sam to get the money without cutting spending, except by raising taxes. For example, California will probably raise sales taxes to balance its budget, which will hurt the poor. (The sales tax is a "regressive" tax, a fancy way of saying it falls disproportionately on the poor.) California's spending, if it results in a higher sales tax, will cause the poor to save less money, because now they have to pay higher taxes when buying food, drinks, clothing, and cars. Thus, to maintain government programs that help the poor, California is going to raise a tax that will hurt them, so the government can make the poor more reliant on their programs. Confused? You should be. Like you, I didn't study Infinite Loop Economics.

And that's the harshest lesson of all--in part because we have tried to help the poor by spending money we don't have, we've destroyed our ability to help them. The poor don't have a lot of political power, so most likely, we will have a higher sales tax before a higher income tax (which falls disproportionately on the aspiring middle class and affluent).

So here's the sad, twisted result: we've spent money we don't have, causing us to take more money from the poor so we can give it to the government. The best way to help the poor is to take some short-term suffering--like cutting government programs, foreign spending (e.g., Iraq war), and general benefits (e.g. government employee pensions), so we actually have money in the bank to help the poor in the future. We had a surplus only a few years ago. See chart, below.


For the Republicans gloating right now, our surplus occurred under Democratic President Bill Clinton, a fact that helps Sen. Obama, not Sen. McCain. For the Democrats gloating now, the surplus occurred under a Republican Congress. As we can see, the issue of out-of-control deficit spending is non-partisan. We need to go back to having a surplus before we think about helping others. Anyone who talks about maintaining spending programs or worse, increasing entitlement programs, is doing our country a disservice.

Patriotic Americans must take away Uncle Sam's credit card, cut it up, and not return it until he reforms his profligate spending. That means cutting programs that help senior citizens, the poor, teachers, the military, and other government employees. There's no way around this harsh scenario--being on a budget isn't easy for anyone. But unless you want Uncle Sam to default on his debt, rampant inflation, or 50% taxes on your children, you will support a balanced budget. If you're still not convinced we have to cut spending, all you have to do is go out there and find that money-growing tree. It's out there somewhere, probably nearby the Tree of Wishful Thinking. Hopefully you'll find it before we all go off a cliff.

http://www.youtube.com/watch?v=VYnZL0BOXDc

Signed,

Not the King of Wishful Thinking

Top 25% of Earners Paid 85% of All Taxes in 2006

The numbers the IRS released regarding tax burdens in 2006 is stunning. Basically, the top 10% pay 68% of all income taxes. That means if you're making less than $108,904, your contribution to the pool is fairly small in comparison, and if you're making more, well, thank you.

BREAKDOWN OF INCOME AND TAXES PAID BY CATEGORY
Income Category	2006 AGI			Percent of All Income			Percent of Income Taxes Paid
Top 1%	Over $388,806			22%			37%
Top 5%	Over $153,542			37%			57%
Top 10%	Over $108,904			47%			68%
Top 25%	Over $64,702			66%			85%
Top 50%	Over $31,987			87%			97%
Bottom 50%	Under $31,988			13%			3%

The above chart is from Kiplinger's:

http://finance.yahoo.com/taxes/article/105468/What%27s-Your-Share-of-the-Nation%27s-Tax-Bill?

This reminds me of a joke I read on Greg Mankiw's (http://gregmankiw.blogspot.com) blog. He told a story about a group of four friends who went out drinking. At first, they divided the bill equally, each paying 10 dollars for a pitcher of beer. Then, the four friends realized that one only made $10/hr, while another made $90/hr. They agreed the higher-earning friend should pay 20 dollars as a "fair" share. The friend agreed, everyone else paid about 7 dollars each, and everyone was happy. Everything was going well, until the other three friends demanded that the higher earner pay 30 dollars as his "fair" share. The friend got ticked off and moved out of the city. The next time the three friends went out for beers, they all paid about 14 dollars each, more than if they had been nicer to the higher wage earner.

The lesson? People will move or take other measures to avoid taxes if they are too high or unreasonable, leaving everyone else with a higher bill.

Update on April 13, 2009: more on income taxes here and here.

Update on August 10, 2012: more on overall tax burdens here: http://online.wsj.com/article/SB10000872396390444246904577571042249868040.html?mod=e2fb  (David Wessel, August 6, 2012, The Numbers Inside a Hot-Button Issue)

"In the 1980s, the top 5% averaged 22.6% of income and paid 28.5% of taxes.

In the 1990s, the top 5% averaged 25.3% of income and paid 34.3% of taxes.

In the 2000s, the top 5% averaged 28.4% of the income and paid 40.3% of the taxes."

"Average tax rates have come down for everyone. On average, the tax bite on the rich is bigger--except for those whose income mainly comes from capital gains and dividends."

"The share of taxes paid by the bottom 40% of the population has been shrinking along with their share of income." 

July 25, 2008: WSJ Letters to the Editor

I've been reading the Wall Street Journal for years, and I've never seen better letters published on the issue of income taxes. From July 25, 2008 newspaper:

By Sim Pace, from Arlington, VA--the spirit of Jefferson shines bright:

"[T]he top 50% of taxpayers paid 97.1% of income taxes in 2006...Isn't that the well-known definition of democracy, the poorest 51% of the population tyrannizing the richest 49%? I suspect Sen. Obama would like to see the pendulum swing even further and have the top third of taxpayers pay all the income taxes, then the other well-known definition of democracy will have been validated: two wolves and a lamb voting on what to have for dinner.

By Bruce Kebbekus from Hotchkiss, CO:

It should be mentioned that letting about half the citizens escape and pay no income taxes will lead, and probably has already led, to voter disinterest and bad government. Too many have no stake in the game.

By Harold Arkoff from Calabasas, CA:

California...receives back from Washington a smaller percentage of income taxes than it pays. A greater burden is placed on the local population to pay for state services which must be paid for by other sources of revenue..."Their fair share" can have more than one meaning. Is California getting a fair share?

What do D.C. and Delaware produce? They are usually in the highest brackets in terms of per capita GDP by state. See

http://www.bea.gov/newsreleases/regional/gdp_state/gsp_newsrelease.htm

Delaware has attracted almost all the major banks to its state by having a pro-business platform. Also, most of us didn't elect the Delaware Chancery Court to decide economic legal issues, but its opinions make waves nationally in business matters. This small state and D.C. have made themselves epicenters of influence despite their unimpressive physical statures (D.C. is a swamp after all).I t's commendable to see a small state and a district attract so much business and influence. At the same time, one wonders why California and Texas citizens don't project themselves as well as these smaller entities. Is this a case of Lennie and George, as Mr. Arkoff implies in his letter?

Scott Burns and Taxes

Financial journalist Scott Burns used to work for the Dallas Morning News, and now he has his own website. His most recent column explored taxes and had some interesting facts:

http://assetbuilder.com/blogs/scott_burns/archive/2008/05/02/the-truth-about-income-taxes.aspx

Here is an excerpt (published under fair use guidelines in good faith under 17 USC 504(c)(2)--these excerpts also incorporate facts publicly available)

Only 953,000 taxpayers--- about 1 percent of the total who paid taxes--- paid at the top 35 percent tax rate in 2005. They paid $315.4 billion in taxes on their $1,094 billion in income.

The most common marginal tax rate is 15 percent. That’s the rate paid by 54.4 million taxpayers...The second most common marginal tax rate is 10 percent. About 25.5 million taxpayers pay taxes at that rate...So of the two-thirds of all households that pay anything in income taxes, about three-quarters pay at 15 percent or less.

Another 22 million, 3.7 million and 1.5 million households pay income taxes at marginal rates of 25, 28 and 33 percent, respectively. In the year 2000 this top 25 percent of all taxpaying filers paid a whopping 83.6 percent of all income taxes. By 2005 they paid 85.6 percent of all taxes...

You were in the top 25 percent of taxpayers in 2005 if your taxable income exceeded $61,055.

Millions of Americans have no idea what fat cats they are.

Copyright: Scott Burns, "The Truth about Income Taxes" (2008), www.assetbuilder.com blog