A third issue that concerns me is the tax structure. Several issues arise under this category—historically low tax rates on high income earners, counterpoised to a growing dependence for tax revenues from the very wealthy, and perhaps the highest corporate tax rates in the world.
First, today individuals—at all levels—are paying the lowest tax rate any of us can remember. Ironically, the top earners are taxed at rates lower than at any time in history, but the revenues collected from this narrow group have soared dramatically.
On the second point, we have seen a growing dependence, especially in states like California, on taxes on the very rich for their revenues. This is ironic since income tax rates, at least at the Federal level, are at their lowest rate in years. Under the current system, however, 50% of all Americans do not pay any federal taxes, while taxes paid by the very wealthy are accounting for an increasingly large percentage of total taxes collected.
Third, the United States may soon wind up with a distinction that makes business leaders cringe – the highest corporate tax rate in the world. America’s rate trails only Japan’s at 39%, but Tokyo says it plans to lower that rate. It is nearly triple Ireland’s, and double that of most European countries and China.
Current tax rates are the lowest in decades
Americans collectively pay less in taxes as a percentage of GNP than virtually any time in history. The top income rate is lower than at any time since the early 1930’s. While the role played by the current tax structure is under intense debate, we do know that high income individuals, major banks and large corporations have experienced a huge surge in earnings and accumulated wealth. On the other end of the spectrum, we also know that the vast majority of U.S. workers have missed out on the “windfalls of this winner-take-all” economy (Chrystia Freeland, “The Rise of the New Global Elite”, The Atlantic, January-February, 2011). Freeland notes that between 2002 and 2007, 65% of all income growth in the United States went to the top 1% of the population.
So what is the tax structure like now? For the top earners, the effective tax rate rose from 25% in 1930 to 94% in 1944, and then dropped slightly to 90% in 1960, 70% in 1980, and 35% in 2010. At the lower end, filers paid 41% in 1944, 26% in 1960, 18% in 1980, and about 12% today (family income of about $60,000).
The Bush tax cuts of 2001 lowered all tax rates, provided a child care credit, and reduced levies on investment income. They were set to expire this year, but have been extended for two years. President Obama wants to take away the new rates for those reporting more than $250,000, which would raise their tax rate from 35% to 39.6% (This is what conservative Republicans/Tea Partiers have been fighting against?).
The crux of the debate today is whether the tax rates are too low, at least on the “super wealthy”, who some feel should be contributing more. Before we try to judge that, let’s look at the revenue derived friom this current tax structure and how much different groups contribute.
Who Pays Taxes Today and How Much?
Despite historically low rates, the very wealthy are paying a much greater share of the total federal income tax collected. Today the top 1% accounts for fully 40% of the collections and the top 5%, 60%. The top 50% contributes over 97% of the total, while the bottom 50% provides less than 3%.
Tax Rates and Share of Tax Revenues from Top 1%
The chart above shows the relationship over time (from 1979 to 2007) between: a) the top marginal income tax rate, and b) the share of total income taxes paid by the top 1%. In 1979 the top marginal income tax rate was 70% and 18.3% of the total taxes paid were collected from the top 1% of taxpayers. By 2007 the top tax rate was 35% (half of the 1979 rate), and the tax share of the top 1% had more than doubled to 39.5% (from 18.3% in 1979).
The historical record shows an inverse relationship between the highest marginal income tax rate and the share of taxes collected from “the wealthy.” Is there a “causality” there? Highly debated, but the data seems to support the thesis that lower marginal taxes result in higher tax collections.
Federal revenues are expected to drop this year to less than 14.8% of GDP. Income taxes produced 41.5% of federal receipts in 2010, down from almost 50% before the “Bush tax cuts” in 2000. There has been only one time since WWII when that figure was lower, that being 1950 (14.4%). It would seem that the lower tax rates for everyone have led to a major decline in federal revenues.
As revenue from income taxes has declined, spending has soared. Government spending has been on a significant rise, particularly in the last two years. This historically high rate of spending and low rates of taxation have combined to produce a string of deficits that are the highest since WWII. As a result the government is borrowing about 36 cents of every dollar it spends.
The graph above diagrams the taxes paid by the super-wealthy, the top 0.1%, and their incomes over time. I’m not sure there is a direct correlation, but many liberal observers feel there is a direct and unfair connection. New York Times writer, Nick Kristoff, for example, cites the “carried interest loophole” in the Bush tax cuts as being particularly helpful to the top earners. He highlights John Paulson, who made $4.9 billion last year (yes, that’s billion!), largely due to the ability to treat his performance bonuses as “carried interest” and therefore as long-term capital gains, not current income. For Kristof and others, closing this loophole and raising taxes on the wealthy would both help fix the budget while “getting us one step closer to justice”.
On the other end of the political spectrum, Robert Barro writes in the Wall Street Journal (“Robin Hood Can’t Lead us Out of the Debt Hole”, July 27, 2011), that trying to solve the growing budget deficit by higher taxes “will only lead to additional decreases in future economic growth”. Barro advocates, in fact, dropping corporate tax rates (see below) and estate taxes to zero, but implementing a broad-based flat-rate consumption tax (VAT) at around 10% (with very few exceptions).
Raising taxes, especially on the super-wealthy, is the subject of an intense debate ongoing in Washington, and you have heard enough of the claims and counter-claims to come to your own conclusion on that. For me, however, achieving $4 trillion in spending reductions over the next few years in return for shifting the tax rate on the very highest incomes to 39.6% from 35% would have been a worthy compromise. Alas!
As we have seen, federal coffers from income taxes are increasingly being filled from the top tiers of taxpayers, even as tax rates have declined. Much the same thing has happened at the state level.
In California, nearly half of the income taxes before the recession came from the top 1% of earners. While that dependence proved volatile over the past few years, the Golden State continues to increase its dependence on income taxes, which now account for more than half its general revenue, up from a third in 1981. And like at the federal level, these collections are increasingly from the very wealthy. This means that California’s future is no longer tied to the broader economy, but to a small group of ultra-earners.
California’s “progressive” tax system has provided a temporary band aid, but it won’t be able to raise enough funds from a small minority to offset soaring employee costs. In the future the state must address changes in public employee benefits, which are one of the state’s biggest cost drivers. Republicans have proposed instituting an optional hybrid 401-K plan for new employees and $106,000 cap on pensions, but that’s taboo for Democrats. The Democratic plan is to ride the recovery to next year’s elections, when they hope that a new redistricting plan will give them a super majority. However, they will have to contend with pension reform initiatives from independent tax payer groups.
Reforming the Corporate Tax Structure
The United States will soon have the “distinction” of imposing the highest corporate tax rates in the world. Topping out at 35%, only Japan has a higher rate (39.5%), but it plans to lower that. Our tax rate is about 10 points higher than that in Denmark, China or Austria, and nearly triple Ireland’s.
Some economists feel that as a result of this high tariff, U.S.-based firms are placed at a comparative disadvantage against their foreign counterparts in trying to sell their goods and services in the global marketplace. In addition, the U.S. taxes its companies on foreign income when that income is brought back to the U.S. This discourages American companies from bringing profits back to the United States.
But before anyone sheds a tear on behalf of these corporations, the fact is that by taking of advantage of numerous breaks and loopholes that other countries do not offer, U.S. corporations pay only slightly more on average than their counterparts in other industrial countries. American corporations use aggressive strategies to pay less. Indeed, a recent GAO study found that 55% of U.S. companies paid no federal income taxes during one year in the last seven.
Many companies now use accounting maneuvers to shift profits to low tax countries. A good example of this tactic is that employed by General Electric, which established its global headquarters for financial transactions in an obscure town in Switzerland. Thus GE was able to escape paying ANY federal income taxes last year! Ironically this information was highlighted just as President Obama named GE’s CEO, Jeffrey Immelt, to head up his new advisory council on economic growth.
Other major corporations have “off-shored” much of their earnings, to obscure tax havens in the Caribbean as well as Europe. The earnings are then taxed only when they are “repatriated”.
A key question for debate is this. Would lowering the corporate tax rate encourage these companies to shift their earnings back to the U.S. as the differential disappears? This seems to have happened with the lowering of individual tax rates, as the super-wealthy are less interested in tax shelters or hiding income through myriad loopholes and just pay their assessments. And would lowering the corporate tax rate make these companies more competitive in the global market? Most argue strongly, “yes”.
Still, it is hard to get too worked up over corporate taxes. Like the super wealthy, major American corporations have done very well recently, despite the recession. Corporate profits over the last three years are at record levels, even as the country wallows in a recession and the fortunes of the average American flounders. Corporate profits now account for the largest share of GDP since 1955 (12.6%), while wages and salaries account for the smallest share of GDP (55%).
So Where Should the Individual and Corporate Tax Structure go from here?
Having studied these issues fairly intently over the past several months, I am struck by the fact that I have come to very few conclusions. The further I delved into the data and the analyses, the more complex and multi-sided they appeared.
It does seem to me that raising all of our tax rates slightly is necessary, and I do believe that we could raise the top rate to 39.6% without causing the super-wealthy to lose much sleep. And if that were coupled with the $4 trillion in spending cuts that were discussed during the debt ceiling debate, I think that would have been an excellent trade-off.
Following a suggestion from Prof Elliott Parker, I would also propose that there be both a minimum and maximum rate for all taxpayers, so that everyone would at least pay some taxes. For the lowest bracket the rates could range from 1% to 10%.
With respect to corporate taxes, I do believe they should be lowered, say to 20%. I believe that this would actually encourage more collections.
In sum, no great ideas here. Perhaps you have some? If so, and you have really thought it through, then please send them on!
– Tyrus W. Cobb
– NSF Minister of Enlightenment
– 8/5/2011