The U.S. tax system uses an "Effective Marginal Tax Rate" model. The EMTR is applied on ranges of earned taxable income. Each taxpayer pays roughly the same amount on his or her income within these ranges. According to the IRS, the EMTR schedule for 2011 is:
| Tax Rate | Income Range | Taxed |
|---|---|---|
| 10% | $0 – $8,500 | $8,500 |
| 15% | $8,501 – $34,500 | $25,999 |
| 25% | $34,501 – $83,600 | $49,099 |
| 28% | $83,601 – $174,400 | $90,799 |
| 33% | $174,401 – $379,150 | $204,749 |
| 35% | Over $379,150 | N/A |
Everyone paying income taxes pays the same 10% on his or her first $8,500. So, to calculate a person's "Composite Real Rate" you must average (in a manner of speaking) what he or she pays in overall taxes on earned taxable income. For example, if you earn $80,000 in taxable income in 2011, your taxes are $16,125.10. That's a Real Rate of 20 percent. Yes, the marginal rate is 25%, but the Real Rate of tax is weighted towards the 15% bracket.
An income of $150,000 a year? The Real Rate is 24 percent. And that's not the "real rate" as most of us would think of a "real" tax rate. Why is that? Because taxable income is not even close to what most people actual earn. Earned income and taxable income are two different things in government speak.
So, let's get more complicated. When there was a 94% top rate in 1944-45, there were so many deductions and exclusions that the taxable income was not comparable to someone's entire income. First, the top rate started at $200,000, which today is equal to $2,413,059.90 — so the maximum EMTR would apply only to incomes of $2.5 million. But, that's still taxable income, not earned income.
In 1944, you could deduct business meals, all business travel, all forms of interest payments, and much more. You could even deduct spousal travel expenses on a business trip! (Why travel alone?) Companies could also "loan" or "provide" almost anything to an employee, from an apartment to standard benefits. It was possible to shelter tens of thousands of dollars from taxable income. Three-martini lunches and expense accounts were important realities, skewing tax calculations.
As a result of deductions and exclusions, even the theoretical maximum Real Rate of taxation at 60% in 1944 overstates taxation dramatically. The reality? On earned income, the richest U.S. taxpayers paid close to 40 percent of their earned incomes in taxes in 1944. We simply didn't count much of the compensation as taxable income.
Allow me to introduce you to Hauser's Law. Published in 1993 by William Kurt Hauser, a San Francisco investment economist, Hauser's Law suggests, "No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP." This theory was published in The Wall Street Journal, March 25, 1993. For a variety of reasons, we seem to balance tax collections within a narrow range.
Since 1945, U.S. federal tax receipts have been fairly constant in terms of Gross Domestic Product (GDP), with taxes ranging from 15 to 20 percent of GDP. The graph is as follows:
When people demand higher taxes on the rich, usually phrased as paying a "fair share," they are ignoring how our tax system has functioned historically. We could create more brackets, to tax the top 1% at a higher rate once again, but the net increase in tax revenues wouldn't be dramatic. Why not? Because government spending is near historical highs: we are spending at near-WWII levels. It would be nearly impossible to tax enough to pay the federal bills, and doing so would likely crush the economy.
So, how could we address income inequality if not through increasing taxes? That's really what people are asking when they demand fairness. The real complaint is the gap between rich and poor. I'll address that issue in an upcoming blog entry.
But if we had a tax of 90% on 2.5 million then the people that make that much money will stop making more money and leave some for others to make or invest in hiring more people which is good for every one.. Its like saying theres 100 guys in a room and theres enough food for everyone but one guy says I'm take 60% and theres nothing anyone can do about it cause thats the way the system works..
ReplyDeleteExcept money isn't like food in your example. More money is constantly being printed. Also, your example would more realistically be described as such:
Delete"100 people are in a room. All food comes from outside farms. All people are bringing in enough food to provide basic nutrition and live. One man is bring in much more than he needs. He then uses that extra food to hire other people, giving more people more food, and having services done at the same time (i.e, I fix your sink for food). If this man had 90% of his food taken, he would not be able to hire as many people, and the people who depended on working for him for food would have nothing. Even if this taken food was then redistributed, you would lose the service being provided (the fixing of the sink), and you would end up with less than if you left that man his food."
The economy is not a zero sum game, try again.
DeleteFalse analogy. The room scenario you described is a zero sum game, the economy isn't. Therefore it isn't valid to compare the two.
DeleteHey Andy,
DeleteWhen the rich dude has '90% of his food taken', it doesn't disappear. It gets spent by the gov instead of him. So instead of viewing him as a 'job creator', he's just another consumer. He may consume other peoples' labor (time/skill/effort) in creating a corporation to earn him profits, but he's not a job creator. The market demand creates jobs. Not entrepreneurs. Entrepreneurs just chase demand and buy labor in order to earn even more revenue and make profit. Entrepreneurs do not create jobs unless the demand permits them to profit. They are not responsible for job creation. It's a side effect of profit-seeking.
You and all libertarians confuse that taxes are not just 'taken'. They are not burned under the Capitol in a Pagan Orgy. They are just respent by the gov't, which again, creates jobs, and multiplies as the dollar flies around the economy. If the government destroyed each dollar it taxed, your viewpoint (shared by millions of misguided Americans) might be valid (even then, it would deflate the currency still around, so it probably wouldn't be valid). But it's not. The government spending money is a much more effective job creator and employer than rich entrepreneurs spending the same money. The question is, how can you spend a dollar that it will fly around the economy the most times. If you leave it with a rich man, he won't spend it unless there's already a good economy in which he can get a great return. But the government isn't interested in ROI for themselves, they're looking for biggest multiplier effect they can find. The latter is much more likely to move economies toward fuller deployment of capital so supply can meet demand, and fuller utilization (higher employment) can be realized.
http://en.wikipedia.org/wiki/Fiscal_multiplier
One thing that liberals and conservatives will disagree on, is whether the government spending creates demand. I think it depends on how they spend it, but I can prove to you it creates demand.
Indulge in the following thought experiment: imagine the US gov't printed money, took in war bonds, and spent all the money exactly how it did to build tanks, planes, ammunition, etc during WWII. Now imagine that instead of fighting a war, we just sent thousands of men, planes, bombs, tanks, etc to the bottom of the ocean, or out into space on a one-way trip to the sun.
Now, realize the economic effect is 100% exactly the same whether those planes/tanks/bombs/men fought a war or were sunk or fired into the sun.
T.M. -
DeleteI've written several times on this blog about the "Broken Windows Fallacy" — which economists generally agree is just that: a fallacy. Regions destroyed by natural disaster would, under this theory, experience not only a short-term boon, but an overall improvement. They don't. Instead, the capital (human/material) that could be spent on advancement is lost to rebuilding what already existed. In other words, progress is suspended to repair and rebuild. That's not a net positive, unless you are against advancement.
Your example of WWII is mistaken on several fronts because the factories and knowledge from WWII was not all destroyed or without purpose. Also, while much was destroyed, a significant amount of the items built and people trained were not destroyed.
The factories were quickly "repurposed" because the economies of the time were steel and rubber. Making a car is similar to making a Jeep. Making a battleship and making a cargo ship, also similar. Retooling after the war was relatively easy for the United States, while European industry was destroyed. The U.S. quickly became the leading exporter to nations that had no serious manufacturing ability.
Spending without purpose is not productive. The immediate effect on GDP is positive, but only because we measure GDP as short-term spending. Long-term, waste is lost opportunity, misdirecting human and material capital away from projects that might lead to innovation and discovery.
Our recovery after the war was in large part because we were relatively unscathed — running directly counter to the Broken Windows Fallacy. We benefited while Europe had to borrow and spend to buy goods from the United States. Even better, they borrowed and shifted funds from the United States, along with grant monies that circled back to the U.S.
As for spending, Japan is evidence that spending on hundreds of projects for the last decade haven't helped their economy. Plenty of articles also exist on Japanese stimulus spending and its stunning failure to stimulate, much less multiply, growth.
Government doesn't spend well, for any number of reasons. We know schools have a multiplier effect and prisons do not. (Prisons, like natural disasters or wars, have an "opportunity cost" that outlasts any initial and limited boon to a small region.) But, even knowing schools are a positive and prisons a negative, many states spend more on prisons. One only needs to look to California to see odd spending priorities and their economic effects.
Again, I've written on this blog on the various studies demonstrating problems with the Broken Windows Fallacy, the WWII myths of growth, and spending as a multiplier. The San Francisco Federal Reserve has published some of the best studies on problems of the multiplier effect: it never seems to match the predictions, and sometimes is negative.
Money, unlike food or natural resources, is not a "fixed" quantity -- even on a standard, such as gold, the value of money does shift and change.
ReplyDeleteStudies in econometrics, both historical analyses and experiments, have shown that if you take money from the top performers within a relatively short time they rise to the top again. That's one explanation for why many entrepreneurs have one or more bankruptcies / disasters / business failings and still rise back to the top. This is also true of people moving from one system to another -- the people at the top remain at the top following transitions of government or business.
Behavior, human nature, is not dictated by political or economic systems. What is dictated is how some personalities find ways to "win" within whatever systems they find themselves.
When the top "stops making more" there simply is no evidence someone else enters the void. The top 1% of U.S. incomes starts at $350,000. That's no where near the "millionaires and billionaires" some decry. If you're an entrepreneur in California, $350,000 in S.F. or L.A. doesn't go very far. Plus, parts of both areas have "living wage" laws, which have increased the numbers and actually widened the earnings gap.
You could tax me more, but I'll just work harder and pay myself more to make up the difference. That risks moving more money out of the lower and middle classes, at least as income. Sure, the government might redistribute that money, but my drive and my desire to be the best of the best isn't going to vanish. My bitterness and cynicism will increase, though.
There is a reason the "wealthy" don't take much "income" each year. The super-wealthy will always find ways to compensate themselves circumventing income taxes. The income tax will, by its nature, only penalize the moderately "wealthy" and the middle class. (The poor are already exempted -- 47% or more pay no income tax.)
"But if we had a tax of 90% on 2.5 million then the people that make that much money will stop making more money and leave some for others to make or invest in hiring more people which is good for every one"
ReplyDeleteThis illustrates one of the main fallacy with leftist thinking about wealth. They assume it is something in a big pile to be distributed so if some have more they must've gotten to the pile first and taken more than their fair share. This may have had some kernel of truth in feudal and pre-industrial times when wealth was concentrated in land ownership. But even then and especially now, wealth is created by improving land, creating new inventions and processes, doing things more efficiently.
Bill Gates is not rich because he got to some mythical pile of wealth too early, but because he created a product which millions of people found useful. His wealth is just a measure of how much gross utility he provided for someone else. All non-coerced trade is by definition good for both parties or they wouldn't engage in it.
Limiting peoples income to $X either by fiat or by setting marginal tax rates so high that it is no longer worthwhile to make more than $X leaves no more wealth for others to claim. In fact, it reduces overall wealth by restricting the main creators of wealth. If such limits were imposed, there would likely be no PCs, no IPads, no cars, no trains, no planes, no washing machines, ad infinitum...
Envy is one of the most destructive of emotions, it has no positive aspects and in the end destroys what is sought. Yet it is the barely hidden support beam of almost all leftist economic thought which can be reduced to "I want what he has and if I use the government to give it to me it's not theft," except academics with good word skills make it sound more noble.
Van Gogh didn't sell a single painting in his life thus your premisse that "If such limits were imposed, there would likely be no PCs, no IPads, no cars, no trains, no planes, no washing machines, ad infinitum..." is proven wrong. Human curiosity, inventiveness, genius does not need profit to flourish and this is proven times and again in history. The greed and lust for money, on other hand, has nothing to do with progress ....
Delete90% taxation ushered in the largest economic growth for America because that $$$ that was made from taxation, was spent on American goods and services! .... in business, only profit is taxed, so if you didn't want to pay all 90%, you can just spend more expenses with your company! hiring more workers, or buying more goods.. what we need here in the USA now, is to close the foreign loopholes and force companies to be more local.
ReplyDeleteDon't forget John that: Bill Gates makes multiple billions in Government funding buying his computer OS and high-end services.
ReplyDeleteThe "90%" marginal rate only applied to a handful of people, nowhere near the numbers affected by the AMT and top rates today. You can have a "90% rate" that applies to nobody — I suppose having the rate made someone feel better, but it was meaningless.
ReplyDeleteFrom CBS Marketwatch: "The AMT was designed in 1969 to ensure that wealthy taxpayers didn't use loopholes to escape paying their fair share of taxes. The original target was 155 filers with the then-exorbitant income of $200,000 who avoided paying any federal taxes."
Imagine that: 155 filers earned $200,000 at that time. Today, the AMT affects millions of tax filers, because the floor is $75,000 in taxable income. Yet, we don't seem to be any better off because there are still plenty of loopholes and exemptions for those with less "earned" income.
Bill Gates doesn't "make multiple billions" in taxable income — I guarantee he keeps most earnings as capital gains, unredeemed stock, and bonuses of various kinds (which are taxed differently). Having an income tax allowed Steve Jobs to have an income of $1/year. Technically, he wasn't in any tax bracket.
Having 155 families in the top bracket? That was the top in 1969. As rates were lowered, the brackets were also expanded. That's a very reasonable approach if we insist on an income tax instead of a consumption tax.
The *effective rate* is what will always matter. And the effective rate seems to be very constant. Therefore, the better solution is closing loopholes, making the tax code simpler and more difficult to abuse.
To clarify, it was 155 families that avoided paying income taxes, despite income of $200,000. The total filers in the top bracket was slightly more than 1000 filers. But, their effective rates were about 40% according to the data.
ReplyDeleteEffective rates still show that people top-out near the 40% range. Maybe there's a psychological threshold, because I've seen studies showing the wealthy manage a 40% rate in most of Europe — despite much higher marginal rates.
Behavioral economics do come into play. We'd have to study at which point the behaviors of the wealthy change. It seems to be 40%, but why? Is that the point at which they perceive no more return from government services?
Personally, I believe 40% is too high. But, I also don't like relying on an income tax. You can't shelter consumption as easily as income. A consumption tax is unlikely, though, and I fear if we did add one, it wouldn't be accompanied by lower income tax rates. I'd demand lower income tax rates in return for a consumption tax.
Thank-you! I heard that 90% tax rate figure, and I just couldn't believe it! It made no sense. All the rich people would move out of the U.S. if that had actually been true. Common sense just doesn't allow for it.
ReplyDeleteI don't understand why you continue to fight for this heavy progressive tax program. Just look at history it's been tried and it doesn't work. If your not familiar with the term war communism regaurding the Russian regim of Vladimir Lenin then get familiar. This progressive ideological thinking is straight out of the book of Marx.
ReplyDeleteI've posted recently on the 16th Amendment and the limits it places on taxation. Sadly, after 1916 we saw both the states and federal governments rush to tax income. The system is broken -- and penalizes behaviors we want while rewarding passive earnings that are not considered regular income.
ReplyDeleteAt most, I've suggest a three-tier, no-deduction, semi-flat rate approach applied to all income (wages and other income).
Right now, a farmer with a single great year (which does happen) is "wealthy" for that one tax return. We should encourage such an example farmer to save and prepare for the next bad year. Instead. Washington is considering changing investment and savings policies. I don't get it. You work hard, have a good year, and get punished for it.
Dividend and carried interest income is a different matter, but still absurd to have so many rates and gamed deductions. Three rates, almost no deductions. Right now, taxes are a jobs program for tax law specialists.
Even if they were paying *merely* 40%... that's still much higher than the 0%-13% that Mitt Romney and his buddies pay today, and it would be much better for the country.
ReplyDeleteAlso, raising the rates to 95% again would be a great thing, even if we brought back all the deductions. It incentivizes companies to put money into their businesses and employees. Either do something with your money (preferably not martini lunches, but.. housing for your employees? That's a great idea. Larger salaries, bigger benefits, more hiring in the United States, investment in infrastructure to grow the business! Finally they might live up to the hilarious "job creator" misnomer the GOP has given them)... or if you can't find something productive to do with your money.. give it to the government and they will.
Romney and Ryan wanted a 0% tax rate on the wealthy. They just want rich people to sit on their mountains of cash and not do anything with it... which is what most of them are doing today. This is the worst thing for the economy.
The highest *income earners* do pay more, both as a percentage of earnings and as a percentage of revenues, than other groups. The problem is a legal one I've written about before: the Sixteenth Amendment is clear on the nature of income taxes. We don't have "wealth taxes" at the federal level in the U.S.
DeleteFurther, higher taxes in 1940 or 1950 were never going to cause anyone to leave. Today, more than 1780 Americans renounced citizenship in 2011 alone — it is easy to move. We don't live with the same types of real or political borders as in the past.
Raise taxes on "income" and suddenly you have people with company cars, company dinning halls (the executive dining room returns?) and so forth. You can easily get the benefits of wealth without having any income at all. That's why Steve Jobs was quite happy "earning" $1/year at Apple — compensation can take many forms, many of them outside the limits of the tax structure set by the Constitution and federal code.
From an earlier post:
ReplyDeleteWith a $3.5 trillion annual budget, all the wealth of Bill Gates ($45B) would fund 1.3% (4.7 days) of the U.S. government. That's it. Not even one week. The 400 richest Americans, all their wealth, would fund the system for 100 days. There are 403 billionaires in the U.S., with a total net worth of $1.28 trillion.
http://almostclassical.blogspot.com/2010_11_01_archive.html
The numbers haven't changed much. You might get 180 days by taking (not even taxing) all the money of the One Percent. Better to grow the economy for everyone than to merely seek some sort of "fairness" through taxes. Then what? The rich would be poor… and the nation, still broke.
let's do that first and then we will grow the economy together. It is not fair to ask the poor to grow the economy while the rich enjoy good life. We don't buy this argument
DeleteWe will be in the 28% 2013 tax brackets. I'm happy because we are skating close to the edge and the 2014 changes will keep us in the same tax bracket.
ReplyDelete