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Tax Rates and the Great Fairness Debate

In a year there’s been much jaw-wagging over whether certain people do or don’t pay their “fair share” of taxes, you’d think the CBO’s latest report on the distribution of household income and taxes would garner more prime time.

Yet, barely a peep. Perhaps because the report, based on data through 2009, states the top quintile “received” 50.8% of all income. (Which is a weird way to put that. I think they meant “earned.”) Yet, they paid 67.9% of all federal taxes—which is more. And their average tax rate was 23.2%, compared to the 17.4% average rate for all quintiles—the first quintile paid 1.0%, the second quintile 6.8%, the third 11.1% and the fourth 15.1%. And their shares of federal taxes paid were 0.3%, 3.8%, 9.4% and 18.3% respectively. (For those concerned about “the 1%”, they earned 13.4% of all income, paid 28.3% of all federal taxes, and paid an average 28.9% rate.)

Perhaps when politicians claim the tax system isn’t “fair” they mean it’s “progressive”? (So sayeth the raw data from the IRS.) But I rather doubt it, because those politicians most concerned about “fairness” usually advocate that the system be more progressive. Which is their prerogative, though there’s not much evidence having a more progressive tax code leads to higher tax receipts. In the post-WWII era, the top tax rate has been as high as 94% and as low as 28%, yet tax receipts as a percent of GDP have been roughly 17% to 19% of GDP—sometimes a bit more, sometimes a bit less, but never much more or less.

In 1946, the highest-bracket rate was cut to 86.45% from 94%—and tax receipts were 17.7% of GDP. In 1952, the highest rate was back at 92%, and tax receipts were 19% of GDP. In 1962, the top rate was 91% and receipts were 17.6% of GDP. Two years later, the rate was cut again to 77%—and receipts were 17.6% of GDP. Identical.

In 1982, the top rate was slashed—slashed I tell you—to 50%. And tax receipts were 19.2% of GDP. (Tax receipts were higher at a 50% top rate than any time during the post-WWII era of 80% and 90% tax rates.) The top rate was cut to 38.5% in 1987 then 28% in 1988, and tax receipts were 18.4% and 18.2% of GDP.

Hands down, the highest tax receipts in the post-WWII era were in 1998, 1999 and 2000—at 19.9%, 19.8% and 20.6%—when the top rate was 39.6%. Why were tax receipts higher at 39.6% than at 92%? Easy—would you want to pay a 92% rate? The top earners often have flexibility in when and how they earn income. This is Art Laffer’s famous curve in action. Tax certain kinds of income more, and suddenly, folks earning that income have less incentive to earn it—which isn’t terribly conducive to future economic growth. And they certainly have incentive to alter how that income is reported, using, most often, perfectly legal means.

Now, one may be tempted to say, if the top tax rate has no impact on tax receipts, why not jack it up? Back to 94%! Well, again, that could be be a drag on future growth. Top earners may have incentive to earn less, for one. But also, a lot of wasted productivity goes into (legally) minimizing tax bills. (If it annoys you there are so many ways to skirt tax bills, take it up with your senator. I didn’t write our 73,000+ page tax code and would prefer something more on the order of 2 pages.) Then, too, higher top rates can be a disincentive to small business owners (and would-be small business owners) who may report business income as personal income, and who collectively employ a lot of people and buy lots of goods and services from other small business owners. Also, many people may sell a home (a business, a family heirloom, etc.) and find themselves, suddenly and violently and briefly, in a materially higher earning bracket. And . . . and . . . and . . .

Now, it could be the opinion of some politicians that, even at 67.9% and 28.3%, the top quintile and top 1% aren’t paying enough. That’s fine—they can think that if they like and feel free to campaign as such. But to call that “unfair” you’d have to have a pretty odd definition of “fair.” Or be a politician. Either/or. Or both.



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