Dispelling the Tax Myth Part II

[rebeccajo 14]

Tuesday, April 17, 2007 at 4:52 pm

Earth to Ari Fleischer: Tax rates on the rich haven't gone up

Noted tax-policy expert Ari Fleischer had a long and deeply bizarro op-ed (subscribers only) in Monday's WSJ. And while I should probably just let the thing go, the piece made me so furious with its misrepresentations and nutso logical leaps that I decided I needed to work through my anger. And what better place to work through one's anger than in a blog post?

Because my mother would have wanted me to, though, I will make two positive comments. First, the factual data in the piece appears to be correct. I know because it almost all comes from the Congressional Budget Office's December report on historical effective federal tax rates, which I've been dredging through lately as well. Second, Fleischer makes one pretty smart comment:

When government revenues derive mostly from the wealthy, the fortunes of a few determine the fate of us all. Surpluses and deficits will be driven less by the economic strength of the country, and more by the gains made by the rich in hedge funds, mutual funds, equities and stock options. Like a spinning top that twirls on a narrow point, the top will stay up so long as it continues to go round. Once it slows down it falls, and the government's main source of tax revenue will plunge with it.

But Fleischer seems to completely misunderstand why our government revenues derive mostly from the wealthy (hint: it's because they're wealthy!), and he has an unhealthy fixation on the 40% of American households who pay no income tax.

To start with the latter: Fleischer portrays the existence of this no-income-tax-paying sector of the American populace as an ominous new phenomenon engineered by soak-the-rich Democrats.

In fact, the federal income tax was originally designed in 1913 to hit just high-income Americans--less than 1% of households had to pay in the early years. It was only decades later that the income tax became a mass tax. This change was the product of a greedier government (run mostly by Democrats), tax brackets that weren't indexed for inflation, and an increasingly equal distribution of income (that is, the bottom 40% of households were gaining on the rest).

Since 1979, though, this trend has turned around. The bottom 40% accounted for 4.1% of income tax revenues then; by 2004, thanks in part to the magic of the Earned Income Tax Credit, they paid negative 3.8%.

Why has this happened? First, because the bottom 40% account for a smaller portion of the nation's taxable income than they did in 1979--that is, the income distribution has become less equal. Second, because of tax law changes, most of them signed into law by Republican presidents, designed to ease the burden on poorer Americans, who pay many taxes (from Social Security to state and local sales taxes) other than the federal income tax. The Earned Income Tax Credit, which seems to especially bother Fleischer, was an adaptation of an idea first proposed by that notorious left-wing zealot Milton Friedman. It's a nice reminder that there's a long, honorable tradition (call it conservative, Republican, or whatever) of looking for ways to help poor people that make economic sense--a tradition that Ari Fleischer appears to be running away from as fast as he can.

Then there's his contention that we have been "piling taxes on the rich." He supports it mainly with this little factoid about those taxpayers in the highest 1% of incomes:

In 1979, the first year of the study, these affluent individuals made 9.3% of the nation's income and they paid 18.3% of the country's income tax. In 2004, these fortunate few made 16.3% of the nation's income but their share of the income tax burden leaped to 36.7%.

The implication here is clearly that taxes have gone up for the rich. But Fleischer can't go beyond that implication because, in fact, the effective federal income tax rate for the top 1% has gone down, from 21.8% in 1979 to 19.6% in 2004.

How can their tax burden have gone down while their tax share has gone up? It's because the top 1% have made much bigger income gains than anybody else over the past quarter century, and their tax rate, while down since 1979, is still higher than the rate paid by those lower on the income scale.

If this is making your brain hurt, think of an economy with one rich guy making $1,000 a year and paying 30% tax on it, and a hundred poor guys making $100 and paying 10% tax on it. The rich guy accounts for 9% of income and 23% of the taxes. Then the rich guy gets a 100% raise, while the poor guys' incomes don't change. Now Mr. Rich accounts for 17% of the income, but 37.5% of taxes. His tax share has gone up by more percentage points than his income share--even though his tax rate hasn't changed at all.

This is an inevitable byproduct of rising income inequality in a progressive tax system. If we had a flat tax across the board it wouldn't happen, but all the flat tax proposals I've ever seen call for exempting the first $9,000 or $20,000 or $40,000 of income from the tax, so the effective tax rate would still be somewhat progressive.

If Fleischer had brought this stuff up simply to make the point that hey, whatever those lefties say, we've still got a pretty progressive tax code, I would have no grounds for complaint. But instead, he was clearly trying to give the Journal's affluent readers the impression that something had changed in the tax code to disadvantage them, when in fact the only significant things that have changed since 1979 are that (a) their tax rates are a bit lower and (B) they're making a lot more money.

Now it's conceivable that Ari Fleischer just didn't understand the math here (in case you hadn't realized, I was kidding when I called him a "noted tax-policy expert"). The only other possible explanation is that he's engaged in a deceptive and, when you think about, truly reprehensible effort to convince the most affluent Americans that they are somehow being snookered by the poor.

Justin Fox is TIME's business and economics columnist.

[one...two...tree 2,762]

A good explanation of our existing progressive tax policy.

I had no idea that Milton Friedman, of all people, would have first proposed the idea of the Earned Income Tax Credit. I've gotten the impression that the EITC is way of throwing a bone to the Working Poor, while vehemently opposing inflationary Minimum Wage hikes, labor unions, the Family Leave Act - other, more tangible ways to help give upward economic mobility to those who need it the most.

[Peikko 1,575]

Very few people understand tax, what it is for, how it works, and the historical context of how it arose. Even less people care except in so far as to get mad because money is withheld from their paycheck - money that is 'rightfully theirs' and of course would be much better spent on purchasing another DVD or video game.

Really, there is little hope to change anything with these levels of ignorance about basic matters.

[mawilson 2,133]

Very few people understand tax, what it is for, how it works, and the historical context of how it arose. Even less people care except in so far as to get mad because money is withheld from their paycheck - money that is 'rightfully theirs' and of course would be much better spent on purchasing another DVD or video game.

But... it would be better spent on DVDs or video games. Video games don't kill people.

As I said in another thread, federal taxes are next to useless. They pay for war and the interest

on government borrowings.

Edited November 8, 2008 by mawilson

[Peikko 1,575]

You have a point at that...