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Tim Taylor has yet another fine post today, this time summarizing the incidence of taxes when marginal income tax rates were high in 1958 versus today when they are, across the board, lower. Here are some highlights:

At the bottom, across this time period, roughly 20% of all tax returns owed no tax, and so faced a marginal tax rate of zero percent. Back in 1958, the most common marginal tax brackets faced by taxpayers were in the 16-28% category; since the mid-1980s, the most common marginal tax rate faced by taxpayers has been the 1-16% category.

Virtually half of income tax filers today have NO income tax liability. Remember this when you see a politician propose a tax cut and folks run to the microphones to say that they “are tax cuts for the rich” … well, who else is left to cut taxes for? Here’s more:

…the share of income tax revenue collected by those in the top brackets for 2009–that is, the 29-35% category, is larger than the rate collected by all marginal tax brackets above 29% back in the 1960s

Note that this came at a time when the top rates approached 90%, and some people want to go back to that time, not for any fundamental economic reason, but simply for the symbolism of it all (it says a lot about what “we” think about inequality, even if it has no impact on it whatsoever).¬†And some more:

Raising tax rates on those with the highest incomes would raise significant funds, but nowhere near enough to solve America’s fiscal woes. Baneman and Nunns offer this rough illustrative estimate: “If taxable income in the top bracket in 2007 had been taxed at an average rate of 49 percent, income tax liabilities (before credits) would have been $78 billion (6.7 percent of total pre-credit liabilities) higher, taking into account likely taxpayer behavioral responses to the rate increase.” The behavioral response they assume is that every 10% rise in tax rates causes taxable income to fall by 2.5%

In other words, ignoring any longer-term responses to these higher rates, they’d have the possibility of cutting the $1.3 trillion deficit by … six percent. ¬†Taylor ends the post with some thoughts, to which I would add:

  1. These sorts of analysis are certainly illustrative, but completely misleading because for many people the taxes that hit hardest are not income taxes, but rather are property taxes, embedded sales and excise taxes and most surely payroll taxes. My payroll tax liability this year (if you consider that most of the incidence is borne by workers) is approximately $15,000. My property taxes are $6,000. The sales taxes I end up paying get close to $4,500. So, while I would probably support an income tax policy that expands the tax base I really would only do so if we saw across the board spending cuts at all levels of government – an event as unlikely to occur as my campus turning into a cabal of conservatives.
  2. Taylor hints at a good policy compromise, which will never see the light of day — ending the tax preference for municipal bonds. The interest received by holders of municipal bonds is “triple-tax-exempt” to holders of those bonds from those municipalities. Thus, if the city of Rochester borrows money to renovate a bridge, and it pays interest on those bonds, the interest income to me is exempt from any local taxes, any state taxes and any federal income taxes so long as I am a resident of Rochester. In other words, it is cheaper for the city of Rochester, ceteris paribus, to borrow funds than it is for corporations and even the federal government (remember, that is a ceteris paribus observation). Thus, municipal bond tax policy is regressive for TWO reasons: at the individual level and at the state level. At the individual level, the typical holders of municipal bonds are high net worth individuals who like the secure stream of tax free income (of course there are institutional investors who hold them on behalf of less wealthy clients). This income is not taxable to these high net worth individuals. Since the muni market is pretty illiquid, and typically requires large blocks of funds to engage in, the little guys are largely excluded from taking part in that market. Plus, the tax free income is “worth more” to someone in a higher marginal tax bracket than in a lower one.

    Muni bonds are regressive in a less obvious way too. How? Well, since the interest is exempt from federal income taxes, in effect when states and cities borrow money they are receiving subsidies from the federal government to do it. The states that are on net the largest borrowers tend to be the richer states and “spendier” states. Therefore, taxpayers in Kentucky, Alabama, West Virginia, Mississippi, and other lower income states are subsidizing spending on (sometimes questionable) projects in wealthier states. Now, in the US, the “South” is not very important, so I suppose this sort of a thing is celebrated in a weird kind of Neitzschean sort of a way.

    Put these together and if you eliminated the tax preference for municipal borrowing you would probably generate more federal tax revenues, make the federal tax system more progressive and encourage municipalities to be more prudent in terms of what they borrow money for: when they have to pay 7% interest on debt and not 5%, for example, my sense is that they are going to work harder to get their public pension and health benefit plans under control. Of course, if it ever came to that, I am almost sure that we’d see an increase in these sorts of activities: but that is a post for another day.

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