Wednesday, June 22, 2011

Robert Reich Prefer To Tax Income Of The Rich

The 'Real' Tax Rates on Top Earners

Jon N. Hall

The top rate for the federal Individual Income Tax was 91 percent in 1963. In 1965 Congress lowered the top rate to 70 percent, in memory of JFK who had floated the idea. Then Ronaldus Magnus charmed Congress into lowering the top rate to 50 percent in 1982. Reagan again scored in 1988, when the top rate went to 28 percent.
Through the good graces of two or our more popular presidents, the top rate on personal income taxes fell by 63 percent in 23 years (source).
But the top rate soon began creeping up. In 1991 Bush the elder broke his "read my lips" pledge and the top rate went to 31 percent, and in 1993 under Clinton the rate went to 39.6 percent, retroactively as it were. Then along came W., who ratcheted the top rate back down to 35 percent in 2003, where it has since remained.
So there you have it, a condensed history of the top rate on personal income taxes going back to the 1950s. Actually, the story on tax rates is a little more complicated than this. You see we've only been talking about statutory rates, not the real rates of what folks actually pay the I.R.S., which the feds call the "effective rate."
2004 paper from the Congressional Budget Office details the effective rates from 1979 through 2001. In the second section (Effective Individual Income Tax Rate) of Table 1A, we see that the effective rate for the "Top 5%" of taxpayers was 19.0 percent in 1979 and 20.8 percent in 2001, a difference of just 1.8 percent.
For this "Top 5%", the lowest effective rate was 16.6 percent (1986) and the highest effective rate was 21.6 percent (2000) -- a range of just 5 percent -- and the average effective rate was 18.9 percent.
However, the effective rate for the "Top 5%" was lower when the top statutory rate was higher: In 1979, the top statutory rate was 3.68 times higher than the effective rate, but in 2001 it was 1.9 times higher. And in 1990, when the statutory rate was at its lowest, it was only 1.6 times higher than the effective rate, the smallest separation for the period.
Of course, not every taxpayer in the "Top 5%" may have been hit by the top rate. But if we look at the effective rates for the  "Top 1%," we also see similar low rates. Indeed, the top effective rate for the "Top 1%" was 24.2 percent (1996 and 2000).
The 23-year span from 1979 through 2001 encompasses recessions, stagflation and the booms of the eighties and nineties. Yet, the effective tax rates for the top taxpayers were fairly steady while their top statutory rate fluctuated within a 42 percent range.
In an interesting article in The Wall Street Journal on June 16, "Why 70% Tax Rates Won't Work," Alan Reynolds of the Cato Institute takes Robert Reich to task:
The intelligentsia of the Democratic Party is growing increasingly enthusiastic about raising the highest federal income tax rates to 70% or more. Former Labor Secretary Robert Reich took the lead in February, proposing on his blog "a 70 percent marginal tax rate on the rich." After all, he noted, "between the late 1940s and 1980 America's highest marginal rate averaged above 70 percent."
Reynolds quotes from Reich's February 15 blog, wherein Reich proposes his "truly progressivetax":
Regardless of where the highest marginal tax rate is set, the rich will always manage to reduce what they owe. During the 1950s, when it was 91 percent, they exploited loopholes and deductions that as a practical matter reduced the effective top rate 50 to 60 percent. Yet that's still substantial by today's standards. The lesson is government should aim high, expecting that well-paid accountants will reduce whatever the rich owe.
At what effective rate would Mr. Reich prefer to tax the income of the "rich"? High effective tax rates leave not only less for the taxpayer, they leave less for state and local governments, too. Regardless of how high your income is, when government takes 50 percent of it, you're halfway to slavery. A rational people wouldn't allow government (at all levels combined) to take more than 50 percent of a citizen's income.
Unlike the 1950s, Europe and Japan aren't still in a recovery mode from the ravages of WW II.  Also, new competitors have emerged, like the BRIC economies. And capital can now be shipped around the world at the speed of light with just a few keystrokes. So dollars might well leave America under Reich's rate regime.  Not to worry, Reich advises: "Those who take their money abroad in an effort to avoid paying American taxes should lose their American citizenship." (If Reich is not cracking a joke, then should those who "take their money abroad" to buy foreign automobiles because they don't like what the feds did to the GM and Chrysler bondholders also lose their citizenship?)
Any serious discussion of income taxes must address effective rates. And effective rates necessitate addressing the "exemptions" in the tax code -- the write-offs, loopholes, deductions, "tax expenditures" and such that the feds use to get tax rates down to acceptable levels. Exemptions in the tax code are what accounts for the differences between statutory and effective rates.
Exemptions also account for the complexity of the tax code. Simplification of the code would entail the stripping out of exemptions. But if it is not to whack the taxpayer with a tax hike, simplification must be paired with rate reductions, which take the statutory rate closer to the effective rate. For example, the 1986 tax bill cut exemptions from the code in exchange for lower statutory rates, which resulted in a top statutory rate that was only 3.8 percent higher than the top effective rate for the 1979-2001 period. Reagan was zeroing in on the real rate. Nevertheless, exemptions soon snuck back into the code, and along with them, complexity.
Calls for simplification of the code are old news. The most recent cries for simplification came from the president's deficit commission, the Bowles-Simpson commission. Former Senator Judd Gregg made a good case for simplification in The Hill in March. (A few years ago I wrote up my own ideas about simplification here.)
If "rich" folks actually had to pay their federal income taxes at the top statutory rate -- it was 94 percent in 1945 -- they'd have long ago left these shores.
We don't want to lose our rich folks, do we? So we shouldn't be clamoring for higher statutory tax rates on them, thinking (as Robert Reich does) that exemptions will lower their rates. Rather, we should be demanding simplification of the tax code.
Simplification of the tax code is really rather simple -- merely eliminate exemptions and set the statutory rates to their effective rates.
But simplification of the tax code would mean a huge change for American politics. You see, Congress doesn't want simplification; Congress created the complex maze of the tax code for its own purposes. But if your behavior is acceptable to Congress, then you get to pay your taxes at a lower rate.

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