Little is ‘fair’ in current income tax code
By Damon Cline
Income taxes are one aspect of federal law every American has dealt with personally.
The topic was no doubt on the minds of voters in November as they chose the candidate who pledged to overhaul the U.S. tax code – which many rightly criticize as being needlessly complex, difficult to administer and unjust in how it rewards and punishes economic behaviors.
“Our No. 1 priority is tax reform,” Treasury secretary nominee Steven Mnuchin told CNBC. “This will be the largest tax change since Reagan.”
President Trump says he wants rate cuts for all taxpayers. Under his plan, the top individual rate would fall from 39.6 percent (technically 43.4 percent with the 3.8 percent Obamacare surtax) to 25 percent, with lower rates graduated down to 10 percent. Corporate taxes would be slashed from 35 percent to 15 percent, and the small business rate would be set at 15 percent.
The cuts would reduce federal revenue, but would pay for themselves over time through economic growth. The exact price tag is open for debate: The Tax Policy Center estimates Trump’s plan would cost $9.5 trillion over a decade; the Tax Foundation says it’s more like $2.6 trillion to $5.9 trillion.
Regardless, analysts expect the political debate and media coverage to focus on the “fairness” of tax cuts for wealthy individuals and big businesses.
“Most Americans are OK with the amount of tax they pay,” notes Pew Research Center senior writer Drew DeSilver. “It’s what other people pay, or don’t pay, that bothers them.”
If a debate is to be had, policymakers and the public should be armed with the facts about who pays taxes and who doesn’t.
The share of Americans who pay no tax at all is rising, from 21 percent in 1990 to 45 percent in 2015. Of those who do pay, the rich pay the most: The much-maligned top 1 percent of wage earners, in fact, pay more than the bottom 90 percent combined.
For example, well-off households making more than $1 million a year account for 13.7 percent of all U.S. income but 21.6 percent of all taxes, according to an analysis by the nonpartisan Tax Foundation.
Middle-class households earning less than $100,000, on the other hand, account for 38.8 percent of American income but only 23.3 percent of the tax burden.
Low-income households have even lower burdens, and may actually have “negative tax rates” – meaning they get more money back from the government than they pay, thanks to refundable credits such as the Earned Income Tax Credit. Factor in federal benefits, such as food stamps and Medicaid, and some receive as much as $8 in federal benefits for every $1 paid in taxes, the Tax Foundation says.
Cato Institute economist and senior fellow Daniel J. Mitchell argues the century-old income tax has evolved from a means of funding essential government operations to a primary tool for wealth redistribution.
“The worst thing is that the income tax enabled the modern welfare state,” he wrote in a 2013 commentary. “Before the income tax, politicians had no way to finance big government. Their only significant pre-1913 sources of revenue were tariffs and excise taxes.”
As for businesses, America’s corporate tax rate already is the highest in the industrialized world, which policy analysts say discourages foreign investment in the U.S., incentivizes American companies to keep foreign profits overseas and encourages business owners to file as individuals.
Corporate income taxes made up 35.8 percent of federal revenue in 1945 but only 10.8 percent today.
The greatest irony of the previous administration was its belief that tax incentives work selectively, U.S. Chamber of Commerce Chief Economist J.D. Foster wrote for The Heritage Foundation in a 2012 commentary. That’s how it could support hiking cigarette taxes to discourage smoking but reject the notion income tax cuts would spur new spending, investment and job creation.
“When it comes to the behaviors that are truly relevant for a strong economy,” he wrote. “President Obama and friends turn a blind eye to incentives.”
The new administration shouldn’t make the same mistake.
Damon Cline is the business editor of ‘The Augusta Chronicle’ in Georgia.
The current tax code started at 400 pages in 1913; today it is over 74,000 pages.
The U.S. tax code is so complex, the Cato Institute noted in 2003, that “there are up to 1.2 million paid tax preparers in the country — six times more than the number of troops in Iraq.”
The tax code picks winners and losers – and nothing breeds special-interest lobbyists more quickly.
“The income tax distorts financial planning and business investment,” says Cato, “and it encourages tax avoidance and evasion. Because the income tax is built on an unworkable base of ‘income,’ the law is continually changing.”
Tax reform and simplification is one of the most important things this Congress and president can do.
Alternatives to the income tax, including the Fair Tax, deserve a look.
“The United States hobbles itself in today’s international economy by continuing to rely so heavily on income taxation,” writes Michael J. Graetz, professor of Law at Columbia University Law School.
Graetz suggests a Fair Tax-style “broad-based tax on sales of goods and services now used by more than 150 countries worldwide.”