No Laffing Matter

by Don Boudreaux on December 7, 2005

Bruce Bartlett offers a very useful analysis is this op-ed appearing in today’s Washington Times. Here are two highlights:

[I]n 1980, when the top statutory income tax rate [in the United States] went up to 70 percent, the share of income taxes paid by the top 1 percent of taxpayers was just 19.3 percent. After Ronald Reagan’s tax cut of 1981, which reduced the top rate to 50 percent — a massive giveaway to the wealthy, according to the political left — the percentage of income taxes paid by the top 1 percent rose steadily.

By 1986, the top 1 percent’s share of all federal income taxes rose to 25.7 percent. That year, the top statutory tax rate was further cut to 28 percent — another huge giveaway, we were told. Yet the share of income taxes paid by the top 1 percent continued rising. By 1992, it was up to 27 percent.

Today, the share of income taxes paid by the top one percent of income earners is 34.3 percent.

A common liberal retort to these data is that they exclude payroll taxes, which are assumed to be largely paid by the poor. However, it turns out that when one includes payroll taxes in the calculations, it has far less effect on the distribution of the tax burden than most people would assume, because the wealthy pay many of those taxes, too.

In a 2004 paper to the American Statistical Association, IRS economists Michael Strudler and Tom Petska calculated percentiles data that included both income taxes and Social Security taxes. In 1999, the top 1 percent paid 23.3 percent of combined payroll and income taxes, the top 10 percent paid 52.2 percent and the top 20 percent paid 68.2 percent.

Bartlett goes on to relate international data showing that as income-tax rates fall, the share of income-tax revenues paid by top income earners rises.

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Randy

Scott,

I agree. And my guess is that the higher one is in the food chain, the higher the percentage of the tax that can be passed on. Bill Gates is probably close to 100%. I, being right at the median income, am probably able to pass on about 50%. The minimum wage worker or unemployed person is at 0%. They take whatever they can get in wages or charity, but pay the full cost of visible and hidden taxes.

Scott

I wouldn't say this is a fatal flaw in your reasoning, but one thing you might be over looking is that even if a producer can pass along tax increases because of the higher prices there may be reduced quantity demanded. For example, if I'm happy selling my output at $10 and can sell 10,000 units at that price, but a tax increase forces my after-tax prices up to $11, if the quantity I sell now is only 9,000 units I'm in essence "paying" for the taxes in the form of my lost profit margin on the 1,000 less units. So, yes while some of the tax increase is just being "collected" by me, I am "paying" some of the tax increase.

Randy

RichardR,

Thanks for the link. I realize I am off topic. I just scanned the study and it appears to measure income in dollars. My concern is not dollar income but process, and at this point its just a thought experiment that goes something like this;

To do a job, or provide a service, I expect a certain standard of living. If the net dollar income after taxes does not provide that standard of living, I will ask for more dollars.

If I have the economic power to get what I ask for, then I'm not actually paying the tax, my customers are. I am collecting the tax, not paying it. If my customers have sufficient economic power, they will pass their cost of taxes on to their customers.

At some point however, we reach a person without sufficient economic power to get the amount requested. That person must accept a lowered standard of living, and is now actually paying at least some of the tax.

Summary; The burden of taxation is not paid in dollars. It is paid in lowered standard of living, and the burden is carried primarily by those with the least economic power.

My belief is that the tax system is considerably more regressive than it is thought to be - and possibly completely regressive. I wish I could measure it. If you know of any studies or books along this lines, I'd be glad to see them. Or, for that matter, if you see some fatal flaw in my reasoning, pass that along too.

RichardR

Randy:

I believe this is the study:

http://www.irs.gov/pub/irs-soi/04asastr.pdf

save_the_rustbelt

"How much did the richest 1%'s share of national income increase between 1980 and 1999?"

We Republicans are opposed to redistribution, excpet when the redistribution is upward. :))

JohnDewey

Spencer,

Correct me if I'm wrong, but increase in savings and investment was only one of several rationales for cutting taxes. I thought that others included economic growth, higher productivity, and increased employment. I think Reaganomics did achieve those objectives.

Clinton does rightfully receive credit for not standing in the way of the Republicans' Contract with America. Wasn't it the Gingrich-Clinton reduction in capital gains taxes that released billions in unrealized capital gains and led to the late 90's increase in investment?

As for the unexpected savings rates during the Reagan era, this CATO explanation makes a lot of sense to me:

"The decline in the personal savings rate in the 1980s was disappointing, but two factors mitigate the implications of these statistics. First, the drop in the savings rate was partly a natural response to demographic changes in America--namely, the baby boomers entering their peak spending years. Second, the savings rate data fail to account for real gains in wealth, which clearly are an important form of savings. The real value of capital assets and property doubled from 1980 to 1990. The Dow Jones Industrial Average nearly tripled from a low of 884 in 1982 to 2,509 in 1989. These increases in the value of stocks, bonds, homes, businesses, and so forth added to Americans' balance sheets hundreds of billions of dollars of wealth that are not accounted for in the savings rate statistics."

spencer

The economic rational for cutting taxes on the higher income group is that this is suppose to lead to higher savings and investment. But since the 1980s lower taxes have been accompanied by lower savings and investments -- nonresidential fixed investment peaked at 14% of gdp under carter. Fell to 10% at the end of the Reagan term before rebounding to 13% under clinton and plunging to 10% and rebounding to 11% under bush. the record on savings was a drop from about 15% of income to negative savings.

If this is an example of a successful policy I would sure hate to see a failed policy.

Paul McMahon

Hmmm. Anyone bother to check with the authors of the underlying paper, Tom Petska and Mike Strudler? Google should get the paper for you, as it is on at least two websites: the American Statistical Association's and TaxStats. One might wonder if they agree with the Wash. Time's re-interpertation.

Based on conversations, I'd say NO.

Randy

Ivan,

Re; "Wouldn't that mean that you shouldn't push the rich to avoid taxes as much?"

Short answer - yes.

Longer answer - the problem is the myth that the rich can be taxed. Everyone believes in it. Lower income folks think their problems can be solved by taxing the rich, while the rich grumble about being over taxed. Neither is correct. Nearly all taxes are eventually paid in the form of a hidden sales tax. Another way to think of it; if 25% of GDP is transferred from private to public spending, then roughly 25% of every dollar spent is a hidden sales tax. Repeat, every sale - including food, clothing, medicine, etc.

So, step one is to destroy the myth. As long as people believe in a free lunch, they will vote for legislation authorizing free lunches. Step 2 would be to replace the federal income tax with a federal sales tax - on everything. Step 3 would be to halt government spending on anything that doesn't add value.

But failing in step one (which is likely because destroying a myth is nearly impossible), the current system works pretty well. The current system doesn't hurt the rich nearly as much as they think it does - so we can all live with the grumbling. And as long as most people think the other guy is paying the taxes, they will be willing to pay taxes.

John P.

Two quick points:

1. If you read the linked article, you'll see that Bartlett brings in similar data from several other Western countries to make his point.

2. As a transactional lawyer, I've observed that tax avoidance involves significant transaction costs (unless you want to cross the line from avoidance (legal) to evasion (illegal), which is something most rich people understandably don't want to do). This is one of the reasons, I believe, why lower marginal rates result in more income. The costs of avoidance don't scale down as one's marginal tax rate scales down.

Timothy

It's Gini while we're going about correcting spellings of esoteric economic terms.

Drtaxsacto

The term is Ceteris paribus. But the real point is that as rates dropped the percentage of income taxes paid by the very top of the Genie coefficient increased.

Ivan Kirigin

"P.S. I think the justification for progressive taxation is not, as usually stated, the ability to pay, but rather that the greater the individual's economic power, the greater the ability to pass on the tax burden."

Wouldn't that mean that you shouldn't push the rich to avoid taxes as much?

Isn't that the whole point of the Laffer curve: making it worth it to avoid taxes with ridiculously high rates means you collect less taxes from those people.

A flat tax, low enough to not be avoided, and simple enough to expose loop-holes, is a good goal.

Add an earned income tax credit, perhaps with allocations explicitly for catastrophic health insurance and HAS for non-catastrophic health care costs, and you have a complete tax system that will fit on a single page, or even a single graph!

Patrick R. Sullivan

'How much did the richest 1%'s share of national income increase between 1980 and 1999?'

Quite a bit. Wouldn't you expect it to?

Randy

My interest is in what percentage of taxes the top tiers pay after subtracting out the amount passed on in the form of higher prices and reduced wages. That is, what percentage is actually paid compared to the percentage that is simply collected? For example, my guess would be that in 1999 the top 1% actually paid about 3% of total taxes and simply collected and turned in the other 20%.

My belief is that the form of taxation (and therefore the form of tax cuts) is irrelevant because all taxes are ultimately regressive. What matters is the percentage of GDP transferred from private to public use, and the purposes to which it is applied.

P.S. I think the justification for progressive taxation is not, as usually stated, the ability to pay, but rather that the greater the individual's economic power, the greater the ability to pass on the tax burden.

spencer

From 1980 to 2004 the share of national income going to the top quintile increase from 44% to 50%.

The share going to the top 5% increased from 16.5% to 22.5%.

Sorry, I do not have the top 1% handy.

But this has been the an era of extremely rapid income inequality growth that played a major role in the tax burden data you are quoting.

David Yaseen

It's extremely relevant, doinkicarus, as I suspect you are aware. As you point out, we can expect the proportion of taxes paid to track with income earned. However, Bartlett's point (I believe) is to at least insinuate some direct causal link between lower top marginal rates and higher proportions of taxes paid by top income earners. My comment above was merely meant to suggest that other factors could have caused the observed change, as I believe Bartlett to have been engaging in a bit of post hoc, ergo propter hoc.

doinkicarus

David: is that question relevant? It strikes me as the tip of a very implicit iceberg - why don't you come out and say what you're hiding with rhetoric?

If that segment of society has increased its "share of the national income" then it follows they are currently paying more taxes than they would have in the past, ceterus parabus.