Tuesday, February 21, 2012
It is clear that the rising inequality of wealth and income and how the wealthy should be taxed will be major issues in the political campaign. ... One problem that undoubtedly will arise is how to generalize about any particular income class’s tax burden. ...
[A] tax system that lightly taxes capital and heavily taxes labor is necessarily going to benefit the wealthy. As this chart illustrates, federal tax rates on the wealthy have been falling since 1978, when Congress cut the maximum capital gains rate to 28% from 35%.We rationalize this mainly on the grounds that increasing the stock of capital is good for everyone. For example, it will raise productivity, which in the long run will raise wages for all workers.
The empirical question of whether sharply lower taxes on capital, and hence the wealthy, has actually raised saving, investment and productivity is one I will revisit. Suffice it to say that since 2003, when the current tax rates on capital gains and dividends were instituted, the economy offers little, if any, evidence on this score. (Before 2003, capital gains were taxed at a maximum rate of 20% and dividends were taxed like wages and salaries.)
The point I want to make here is that differential tax rates on different forms of income mean that tax burdens will vary not only between income classes but within them as well. The latest Economic Report of the President has an interesting table that illustrates this point.
For the wealthy, we can see effective tax rates vary between 12% for those at the lower end of the top quintile and 29% for those at the upper end. Among the top 1%, effective rates vary between 9% and 35%. Those paying the highest effective rates are, no doubt, those such as doctors and lawyers with large incomes consisting mostly of salaries.
Thus we see that the bottom tenth of those in the top 1% pay well less in federal taxes as a share of their income than at least 25% of those in the bottom income quintile. And 25% of those in the top 1% pay less than substantial numbers of households in the upper three quintiles. ...
We can see, then, that the tax system in the United States violates the fundamental principles of income taxation. Those are “vertical equity,” which says that those with upper incomes should pay a higher effective tax rate than those with modest incomes — as far back as Adam Smith, ability to pay has always been a core principle of taxation — and “horizontal equity,” which says that those with roughly the same income ought to pay roughly the same taxes.