Tax Day – Renewing The Case For Fairness

The New York Times, in an article April 13 by David Leonhardt, reports that 47% of households owe no Federal income tax for 2009 but concludes that figure is highly misleading because it does not tell the whole story. The usual suspects on cable television and talk radio are using that number ahead of the Tax Day Tea Party protests coming up on April 15 to suggest that “the wealthy face a much higher tax burden than they once did while growing numbers of Americans are effectively on the dole.”

Leonhardt makes three important observations on why that conclusion is misleading:

[a] Over the last 30 years, rates have fallen more for the wealthy, and especially for the very wealthy, than for any other group. At the same time, their incomes have soared, and the incomes of most workers have grown only moderately faster than inflation. So a much greater share of income is now concentrated at the top of distribution, while each dollar there is taxed less than it once was. [emphasis mine]

[b] Taking into account both taxes and tax credits, the average household in this group paid a total income tax rate of just 3 percent…. But the picture starts to change when you look not just at income taxes but at all taxes. This average household would have paid 0.8 percent of its income in corporate taxes (through the stocks it owned), 0.9 percent in gas and other federal excise taxes, and 9.5 percent in payroll taxes. Add these up, and the family’s total federal tax rate was 14.2 percent.

[c] State and local taxes … may actually be regressive. That is, middle-class and poor families may face higher tax rates than the wealthy. As Kim Rueben of the Tax Policy Center notes, state and local income taxes and property taxes are less progressive than federal taxes, while sales taxes end up being regressive. The typical family pays a lot of state and local taxes, too — almost half as much as in federal taxes.

A week ago I wrote an article entitled Paying Taxes is a Privilege in which I noted that the stated objective of the tax cutting movement is to lower the “marginal” Federal income tax rates to benefit the wealthiest Americans. The essence of the argument is “fairness” and the tactic is a proposal to eliminate differential income tax rates in favor of a “flat tax” that everyone would pay at the same rate. The question of tax “fairness” is a complicated one that could be answered in different ways depending on what values and assumptions are considered in the discussion but, regardless, the practical effect of lowering taxes on the wealthy inevitably involves shifting more of the burden onto the middle class and the poor. That is not an opinion—it is just a mathematical fact.

It is reasonable to argue that “fairness” of the tax burden means fairness in terms of ability to pay and that those who are wealthy have profited more from society and should pay more for its support. It is also obvious that requiring a wage earner with a middle class income to pay 10% of his income as tax, which cuts into the amounts required for food, clothing and shelter, creates a much greater burden on the middle class than a 10% tax on the income of a millionaire creates on the lifestyle of the wealthy. Does anyone seriously doubt that is true?

Remember, as pointed out above, the current real Federal tax rate paid by most of that 47% taxpayer group is 14.2% which includes payroll taxes of 7.65% for Social Security and Medicare taxes, so it is important that the implications of the Flat Tax proposal be compared on an “apples to apples” basis. In other words, does the Flat Tax proposal include all Federal taxes, or does it intend to exclude the 7.65% FICA tax paid now by all wage earners, because if the FICA tax is in addition to the flat tax rate, then to get the actual rate paid by lower and middle income taxpayers you need to add the two rates together for a real Federal tax rate of 17.65%.

To clarify the fuzzy math of the flat tax advocates, as I argued in more detail in an earlier essay, [It’s Time To End Entitlements For The Wealthy] here is a fact, from the IRS, about the super wealthy–they paid an effective tax rate of 16.6% on their average income of $344.8 MILLION, a tax rate slightly lower than my tax rate, because of loopholes, capital gains and other tax gimmicks that favor the wealthy.

Here’s another fun fact about how the tax system transfers wealth from lower income people to the wealthy—Social Security tax is paid on wage income up to $106,000 at a rate of 7.65%. An individual making $50,000 per year has $3825 taken out of his wages. An individual making $2.5 million has $8109 taken out of his wages, for a net FICA tax rate of 0.324%. The lower paid person pays a rate 23.54 times HIGHER than the millionaire.

For the doubters out there, here are the actual calculations:

$50,000 x 7.65% = $3825 total social security tax on the individual.

$2,500,000 income is taxed only on the first $106,000. $106,000 x 7.65% = $8109 total tax on the individual.

$8109 divided by $2,500,000 is a rate of 0.32436%.

The person making $50,000 pays 7.65% of their income ($3825) to social security.

The person making $2,500,000 pays 0.32436% ($8109) of their income to social security.

7.65% (the rate paid by the lower income) divided by 0.32436% (the rate paid by high income) is 23.58 times higher.

As David Leonhardt states in the article referenced at the beginning of this essay, the amount of tax money that goes into the Treasury accounts as Social Security and Medicare funds and the tax money that goes into the Treasury as Federal Income Tax funds are just bookkeeping entries. The fact is that they are all Federal tax funds. This is important in looking at the implications for the Flat Tax concept. Here’s why. If the Flat Tax applies only to the portion of Federal taxes designated as income tax and all taxpayers continue to pay the FICA tax as now structured, the inequity of the present system is compounded because a person making $50,000 would be taxed on his earned income at 17.65% and a person making $2.5 million would be taxed on his income at 10.3%. The absurdity of this should be obvious. That is neither reasonable nor fair.

Contrary to the argument made by the wealthy, lowering taxes on the wealthy and shifting the burden onto the middle class involves a wealth transfer (redistribution of wealth, anathema to the right) from the lower and middle class to the wealthy, and that cannot be fair in any reasonable sense of what “fairness” means. This is a message that needs to be constantly repeated to the Flat Tax advocates. It sounds on the surface like a good idea, but the Flat Tax approach will not pay the bills without transferring the burden away from the wealthy to the middle class, and that is clearly the primary objective of the flat taxers despite their denials.