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Sunday, February 19, 2012

Taxing the rich

A 2/17/12 New York Times article on tax rates of the rich and not so rich, includes data from the IRS. The NYT summarizes that data as follows:

"The 400 highest earners in the country, by adjusted gross income, earned an average of $271 million each in 2008 (the most recent data available). Most of them paid a federal tax rate of 10 to 20 percent, and by far the largest portion of their income derived from capital gains, dividends and interest."

The data also shows that 56.8% of the AGI of these 400 individuals was derived from capital gains, which in 2008 were taxed at 15% rather than the usual 20% (18% for assets held over five years). That is quite a tax reduction for 400 individuals. Consider that if average AGI was $271 million, then for the group, aggregate AGI was $108,400,000,000.  Capital gains represented 56.8% of this amount or $61,571,200,000. Assuming a normal rate of 19% (on average (I'm guessing)), the 4% rate savings resulted in reduced revenues for the fisc of $2,462,848,000 for 2008.  Yes, I realize that these are averages and perhaps some sales would not have occurred without the reduced rate.

President Obama's FY 2013 budget or ("Greenbook") includes a proposal to have these 400 and others with income above $200,000 ($250,000 if married) have a 20% capital gains rate. That is projected to generate $36 trillion over ten years.

Additional revenue would be generated from the "upper-income" taxpayers (beyond the 400; roughly 2% of taxpayers) by:
  • Restoring the 35% and 39.6% brackets and letting the 2001/2003/2010 tax cuts expire
  • Reinstating the limitations on itemized deductions and personal exemptions
  • Taxing qualified dividends as ordinary income
  • Taxing net long-term capital gains at 20%
President Obama projects that these changes will generate $1,422,059,000,000 (that is $1.4 trillion) over 10 years!  He also proposes to tax carried interests as ordinary income to generate $13.5 billion over 10 years.

The New York Times has an article with a good discussion of tax rates and some issues involved - "Working All Day for the I.R.S." by James B. Stewart (2/17/12). (It really should be "Working all day for the fisc" not the IRS.)

Some thoughts:
  • A good discussion on how progressive the federal income tax should be and how to get there would be great. It should include discussion of the 130+ tax breaks for individuals and how that lowers the tax liabilities of many individuals.  This discussion should also consider which tax expenditures to remove or reduce, how a lower corporate tax rate interacts with the individual rate structure (such as due to dividend and passthrough entitites), and what happens to AMT.  
  • Why the focus on people making over $200,000 if single and $250,000 if married. Indeed, these are high income individuals representing about 2% of individuals, but these income levels pale in comparison to the average AGI of the 400 top income individuals who had average AGI in 2008 of $271 million!  Perhaps there should be more brackets (such as for income over $500,000, over $1 million and over $2 million).
  • Complexity - the provisions for upper-income taxpayers have a lot of pieces to fit together. For example, reducing itemized deductions and then being sure they don't also provide a benefit greater than a 28% savings.  Can't there just be one cut-back?
  • I think most people think the cut back of tax benefits for upper-income individuals is just for itemized deductions. It is not. It would also include exclusions, such as for tax-exempt bonds and employer-provided health insurance, and more. I think this also might cause some complexity and certainly some uncertainty as to exactly what one's average and marginal tax rates are. (See pages 73 - 74 of the FY2013 Greenbook.)  
  • Given the point in the prior bullet, we should change tax forms to require people to list all of their income and then back out excluded income such as for employer-provided health insurance. This would give a more accurate (and lower) effective tax rate that truly reflects the number of tax expenditures (tax breaks) that all individuals are entitled to claim.  It would also be a reminder of all of the various subsidies, tax breaks, pork, or whatever people want to call the $1 trillion dollars of tax expenditures in the federal income tax system.
What do you think?


david k waltz said...

Professor Nellen,

Given that filling out tax forms is a multi weekend process for most individuals using a 1040 (and much longer for companies), headlines that compare a couple of numbers in a tax form are certainly simplifying a complex reality.

One of the economic stimulus measures enacted was to provide "bonus depreciation" to companies that made investments into the economy.

Yet now, when the effects of that bonus depreciation come into play, the headlines malign these same companies for earning income without paying much tax (since depreciation offsets the earnings).

Is this a case of unintended consequences? Or a press in search of a headline?

While we might all envy those who make a lot, until we walk a mile in someone elses mocassins we might be missing an important part of the picture.

estate taxes nj said...

Great pointers but it would be hard to get the rich, most of them with ties to the government to approve such things.

Jiung Jeong said...

Restoring the 35% and 39.6% brackets doesn’t seem like the best way to make the current complex tax system more efficient, as it would only raise small amount of GDP. But the limitations on itemized deductions and personal exemptions that mostly bring advantages to top income earners seem like a sound policy. Because those deductions and exemptions often encourage people to act in certain ways such as taking out big mortgages, the limitations on certain deductions and exemptions would hinder a change of behavior, meeting the goal of neutrality tax policy to focus on raising revenues.

There should be a simplification of tax code to bring simplicity and certainty as to exactly what one’s average and marginal tax rate would be. It seems as if any top income earner who is advised on how to create tax avoidance could easily avoid paying tax on 35% and 39.6% brackets, given that many exemptions are currently used in the tax code. Simplifying the tax code would not only repeal many exemptions that benefit the rich and reduce tax rates, but it would let people to know how much each taxpayer contributes in a transparent tax system.

Vertical equity is best achieved when tax burdens are base on the taxpayer’s ability to pay. Merely raising tax rates would make high taxpayers to move to a different tax jurisdiction where state tax rates are small. Simple tax code with the limitations on some deductions and exemptions would prevent loopholes and cause better economic efficiency and economy in collection to help the economy.