Who Should Pay More in Taxes?

Perhaps the affluent should pay more income tax, but the middle class will end up footing most of the bill – because that's where the real money is.

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The late Louisiana Senator Russell Long once said that all tax proposals boil down to one principle: “Don’t tax you, don’t tax me, tax that fellow behind the tree.”

Today’s debate, however, is about more than who ends up paying a little extra. There’s a growing concern about fundamental fairness. Taxpayers increasingly question whether some parts of the population are getting away with something, either by not paying their fair share or by receiving government benefits they don’t deserve. And given the troubling long-term economic outlook, there’s also sharp disagreement about whether the root cause of the budget deficit is that taxes are too low in general – or whether the real problem lies elsewhere.

Both political parties have good reason to spin and obfuscate. Central to the Democrats’ policy proposals is the claim that today’s deficits are largely the result of the Bush tax cuts. But even the largest estimates of the cost of those tax cuts over 10 years is a little over $3.5 trillion. By contrast, the U.S. ran a deficit of almost $1.1 trillion in fiscal 2012, the fourth year in a row of deficits above $1 trillion. At that rate, the annual cost of the Bush tax cuts has accounted for less than a third of the deficit.

More important, though, is the fact that while the Democrats regularly talk about the cost of all the Bush tax cuts, they have proposed eliminating the tax cut only for the most affluent, such as couples with taxable incomes above $250,000. Even the most liberal estimates conclude that such a policy would save less than $1 trillion over 10 years – or less than 10% of the deficit at current rates. Raising taxes on “the rich” may be a reasonable policy, but it will not come anywhere near solving the deficit problem.

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Republicans, on the other hand, seem to think that the real problem is that too many people pay no taxes and are bleeding the country. It’s true that 46% of adults pay no federal income tax. But three-fifths of those pay payroll taxes for Social Security and Medicare. That means they are working, just not earning enough to have a Federal tax liability after various deductions and tax credits. Another fifth of the non-payers are retired. The remainder, less than a fifth of the non-payers, earn under $20,000 a year. It may be true that the growing number of people receiving subsidies from the Federal government is a disturbing trend. But the notion that almost half the population consists of moochers, scroungers, and parasites is absurd. We just have a screwy tax code with far too many loopholes, credits, and deductions. Moreover, even if we had a simple, seamless tax system, an estimated 27% would still pay no income tax, chiefly because they are retired or simply poor. About half of those would not pay payroll taxes, either.

These statistics don’t necessarily mean that the affluent and the truly rich are getting away without paying their fair share. Tax rates on earned income are somewhat progressive and will get more so if some or all of the Bush tax cuts expire. Moreover, the top 20% of households account for 51% of all income but pay 68% of all types of Federal taxes (and an even larger share if you consider only income taxes). In fact, the top 10% of households pay a larger share of total taxes in the U.S. than in any major European country. Part of the reason for that is that lots of other countries tax people with incomes low enough to escape income taxes in the U.S.

These facts may all seem to contradict each other. The affluent are paying too little, and yet they are paying more than anyone else. And even if they paid still more, there would still not be enough money to bring down a huge deficit that didn’t exist 12 years ago. Moreover, while a big group of Americans pay no income tax, they aren’t getting away with anything – they’re either retired or relatively poor. How can all these things be true at the same time? Here are five reasons:

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The cause of growing inequality isn’t the tax system – it’s the increasing inequality in how much people earn before taxes. The reasons for that trend are complex, and really another discussion altogether. But changes to tax policy can only address the income gap up to a point. The fundamental solution has to be to come up with policies that enable low-income people to earn more money.

A big part of the deficit results from demographics that we can’t do anything about. The bulge in the population known as the Baby Boom has just started retiring. The strain it puts on the U.S. budget – particularly Social Security and health care — won’t stabilize for another 25 years.

Rich Americans pay a disproportionately large share of taxes, in the aggregate. Those who don’t are benefiting from policies such as low tax rates for capital gains and dividends. Those policies exist for sound economic reasons. Perhaps they should be changed, but there will be costs for doing that, too.

The poor aren’t really the problem, either. Recent growth in the number of people on food stamps or receiving disability doubtless includes people who are taking advantage of the system. But most people receiving help from the government are getting it because they simply don’t have much money. Moreover, they don’t account for most of the budget shortfall.

Spending has had a bigger impact on the deficit than tax cuts have. Relative to GDP, the total tax take in the U.S. – including all Federal, State and local levies – is slightly higher than it was in the early 1980s (although Federal taxes today make up a slightly smaller percentage of the total). Spending at all levels of government as a percent of GDP, by contrast, has soared over the past half century.

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It may make sense to spend more as a society becomes richer, but that ultimately has to be paid for. Raising taxes on the affluent only reduces the deficit by 10%. Letting the Bush tax cuts expire for the middle class slashes the deficit by 35% or more. There isn’t a lot anyone can do about the demographic trends over the next 25 years. Finding a way to boost economic growth would certainly make it less painful to bring the deficit down. But shrinking the budget deficit will mean trimming programs that benefit the middle-class and raising taxes on those same people. Even if the poor get less and the rich pay more, in the final analysis the fellow behind the tree who gets taxed will turn out to be in the middle class, because that’s where the real money is.