Today, we have a two-tier federal tax system: one tax system for the wealthy and powerful corporations and another tax system for everyone else. The tax system for the privileged features loopholes and special provisions that enable wealthy individuals and global corporations to hide taxable income and receive special treatment. The tax system for “regular people” offers few loopholes. Regular people pay the bulk of their taxes automatically, via paycheck deduction.
Billionaire investor Warren Buffett cites himself as one vivid example of this contrast. Buffett actually pays a smaller percentage of his income in total federal taxes than his secretary, who earns around $60,000 a year. Buffett pays only 17.7 percent of his income in taxes because his income comes from investments taxed at the capital gains tax rate, just 15 percent. His secretary’s income comes overwhelmingly from wages, and these wages face both standard income tax, Social Security, and Medicare taxes.
The privileged person’s tax system gives a tax preference to income from wealth. If you make money selling stock, bonds, and other assets, you pay only 15 percent of your earnings in tax. If, on the other hand, you make money from work, you face tax rates that go up to 35 percent, on top of Social Security and Medicare payroll taxes.
The biggest beneficiaries of this special treatment are hedge fund managers. These wheeler-dealers can treat their income as capital gains rather than ordinary income, and pay taxes on their multiple millions at just 15 percent. Closing the “carried interest” loophole — making hedge fund managers pay taxes at a 35 percent rate — would generate an estimated $24 billion over the next decade.
MORE: Coalition Working to Close Carried Interest Loophole
Large corporations also benefit from our two-tier tax system. For instance, they routinely set up subsidiaries in tax havens like the Grand Cayman Islands that have no corporate income tax. They pretend they make their profits in these tax havens, and they register their losses in the United States, a neat maneuver that lets corporations sidestep U.S. taxes.
A small business, anchored in the United States and committed to a local community, doesn’t enjoy the same loopholes, a fact of contemporary corporate life that creates an unlevel playing field between big and small business.
The Great Tax Shift
Has it always been this way?
No. A half-century ago, we taxed ourselves at much more progressive tax rates. Corporations and the wealthy paid their fair share — and revenue from their taxes went into education, housing opportunity, and public infrastructure that built the foundation for a generation of prosperity.
Over time, the rich and powerful lobbied to change to system to their benefit. They argued that reducing taxes on the wealthy would stimulate economic growth that would trickle down more broadly, in the form of productive investment. Congress cut taxes on capital gains, taxes paid primarily by the wealthy. Lawmakers also cut top income tax rates and permitted tax loopholes to open up, moves that have contributed mightily to the extreme levels of inequality we’ve witnessed for the last 30 years.
This “Great Tax Shift” took place under both Democratic and Republican presidents and Congresses. We’ve shifted taxes off of wealth and onto wages, off global corporations and onto small businesses, and off federal taxes and onto state and local budgets. We have also shifted tax responsibilities off of today’s taxpayers onto tomorrow’s taxpayers — by running up massive debt and deficits.
MORE: See our report: “SHIFTING RESPONSIBILITY: How 50 Years of Tax Cuts Benefited the Wealthiest Americans.”
Why is there so much anger on Tax Day?
Most Americans feel they’re paying more than their fair share of taxes. They certainly are, compared to big corporations and the wealthiest Americans. Corporations and wealthy Americans are “gaming the system” to reduce their own taxes. This gaming leaves responsible taxpayers to pick up the bill.
Many taxpayers, not surprisingly, rail at the size of the bill and charge that government is spending too much. That debate — on how much the government should spend — has been going on for as long as we’ve had a United States. But that debate wouldn’t be nearly as angry as it is now if the rich were paying their fair tax share.
What is the purpose of our tax system?
Taxes are the price we pay to live in a civilized society. Societies that do not have functioning and fair tax systems have lower standards of living, poorer public services and less economic mobility and opportunity. Taxes pay for roads, infrastructure, health, education, and other essential services and public institutions that generate economic opportunity.
MORE: How Are My Tax Dollars Spent?
Different Tax Systems
What about abolishing the IRS and replacing it with a “Fair Tax” system with a national sales tax?
We should explore all serious proposals for tax reform. But a national sales tax would further shift tax responsibilities off of the very wealthy and onto low and middle income households.
Advocates for a 23 percent national retail are currently running a well-financed effort to establish what’s branded as a “fair tax.” The key questions to ask when evaluating these tax proposals: Who will pay more? Who will pay less? Are the proposals “revenue neutral”? Will they raise the same amount of money?
MORE: What’s Foul About the “Fair Tax” proposal
Should we replace our progressive federal income tax system with a flat tax?
The principal federal flat-tax proposal, introduced by Sen. Arlen Specter (D-PA), would reduce taxes on the richest 5 percent and increase taxes on the bottom 95 percent. Specter’s plan, like most flat-tax proposals, would only tax income from wages, not income from wealth and investments.
MORE: Problems with Flat Tax Proposals
Wouldn’t a flat tax be fairer?
Depends what you mean by fair. If we include state, local, and federal taxes, we already have close to a flat-tax system. If we add together income tax, property tax, state sales and excise taxes, and Social Security, people at different income levels already pay about the same percent of their income in taxes — except the very rich, who pay less.
State and local taxes are regressive, meaning the lower your income, the higher percentage of it you pay in taxes. Taxpayers in America’s middle fifth paid 9.4 percent of their 2007 incomes in total state and local taxes. Top 1 percent taxpayers that year saw only 5.2 percent of their incomes go to state and local taxes.
What keeps our overall tax system from becoming regressive is the progressive federal tax system — the higher the income, the higher the tax rate. A fair system should also consider a person’s capacity to pay.
Why not tax consumer products such as soda or cigarettes, or increase the federal gas tax?
Many states raise revenue by just these sorts of taxes, and that’s why state tax systems are more “regressive.” The less money you have in these systems, the higher the percentage of your income you pay.
Taxing products that contribute to health problems may make sense. But taxing consumer products does not affect all Americans in the same way. An extra dollar tax on gasoline places a much greater burden on the typical American family than on a millionaire.
Shouldn’t we simplify the tax system?
Our tax system should be simpler. Ordinary people should be able to do their taxes without having to pay a tax preparer. But the regular person’s tax system already operates pretty simply. The majority of tax filers use the EZ-1040 form and already have their wages withheld. We look up our tax rates on a simple table.
What adds the most complexity to the tax system are the loopholes and special breaks that mostly benefit corporations and wealthy individuals. Special interests lobby for these special loopholes, and that adds layer of complication to tax returns.
Responsibility and Taxes
Is the middle class over-taxed?
Yes, especially if you consider the combined tax bill from federal, state, and local government. Tax policy over the last several decades has been shifting tax obligations off of the wealthy and onto wage earners, off of federal budgets and onto state and local budgets. As a result, the middle class is carrying more than its fair share.
After 50 years of “tax cutting” — from John Kennedy to Ronald Reagan to George W. Bush — middle class families are paying about the same (actually a tad more) percent of their income in federal taxes as they paid in 1960. Meanwhile, the richest 1 percent have seen their effective tax rate go down by half over the same period.
The U.S. annual budget deficit now exceeds $1 trillion and our national debt is over $13 trillion.
Is the National Debt a Problem?
Yes, we should be concerned. There is nothing inherently wrong with government borrowing to make long term investments or stimulate the economy during an economic recession. This strategy is called “borrow and invest,” similar to how individuals buy a house.
The problem is that for the last decade, we’ve borrowed and squandered. Part of our debt is due to the effects of the economic recession. Part is due to the costs of borrowing to pay for two wars in Iraq and Afghanistan. And part is due to tax cuts for the wealthy that were passed in 2001.
There is no overnight solution to the deficit. Rebalancing the tax code is a crucial first step to changing the “borrow and squander” policies of the last decade that got us into this mess. What we are proposing can help get us on the path towards sustainable growth.
The proposal to end the Bush-era tax cuts on high-income households is just one reform. There are many other opportunities to raise revenue through tax reforms — including ending overseas tax havens abuse and instituting a financial transactions tax — that together have the potential to raise over $450 billion a year.
MORE: Robert Greenstein, of the Center on Budget and Policy Priorities, on the Long-Term Budget Problem Facing the United States
The Debate over Expiring 2001 and 2003 Tax Cuts
In 2001 and 2003, Congress passed a number of tax cuts for a wide variety of people. Most of these tax laws are scheduled to expire at the end of 2010. There will be a rigorous debate about which tax cuts we should extend.
What should Congress do about the expiring tax cuts?
They should extend the tax cuts for individuals with incomes under $200,000 and households with incomes under $250,000. But they should allow the tax cuts for incomes over $250,000 to expire.
The tax code is badly out of balance after almost 50 years of tax cuts for the wealthy. For a brief time in the late 1990s, we had a balanced federal budget. Then came the Bush tax cuts for the wealthy in 2001 and 2003 which upset this balance and gave $700 billion in tax breaks to those with incomes over $250,000. As a nation, we had to borrow to pay for these tax cuts. We want to rebalance the tax code, so that all Americans pay their fair share. If we maintain these tax cuts, they will cost an estimated $826 billion over the next decade.
If we extend the middle class tax cuts and allow the tax cuts on the wealthy to expire, over 97 percent of all taxpayers will see their tax cuts extended. The richest 2.5 percent of taxpayers will pay at the same rate they did in 2000.
MORE: “High Income Tax Cuts Should Expire on Schedule,” Center on Budget and Policy Priorities.
Don’t tax cuts for the wealthy spur investments that create jobs?
Sometimes. Many venture capitalists realize the importance of investing in business. They also acknowledge that the last decade has provided us with plenty of evidence that tax cuts for the wealthy do not necessarily result in productive investment. We need to move from the “borrow and squander” policies of the last period to “tax ourselves fairly and invest” to strengthen our economy.
After three decades of such tax cuts, we have record deficits and long overdue investments needed in education and health care. If we want to remain competitive in the global marketplace, we need to have a first class education system, health care reform that unburdens businesses, and transition of an energy system that moves our country toward energy independence.
Letting tax breaks for the wealthy expire would bring in an additional $45 billion per year. Wouldn’t that $45 billion be better spent if wealthy people were allowed to invest it in businesses that would hire workers and lower the unemployment rate?
Job-creating investment is governed far more by the business cycle than by the tax rate. For example, in the early 1990s, we raised taxes on the wealthy, and yet the economy boomed, 25 million jobs were created, and the budget deficit turned into a surplus. Then, in 2001 and 2003, we cut taxes on the wealthy. We then saw sluggish job growth and enormous budget deficits — and, soon enough, deep economic crisis.
Most economists agree that this is a good time for public spending to “prime the pump” of economic activity.
In the last decade we have seen plenty of evidence that tax cuts for the wealthy didn’t help us move toward productive investment. Instead, trillions of dollars went into speculative investments like derivatives and sub-prime mortgages, which turned out to be terrible investments that didn’t end up creating any jobs at all.
Don’t the wealthy already pay a disproportionate share of taxes? I heard that the top 1 percent pay 39 percent — or some other high-sounding percentage — of federal income taxes.
High income earners do pay a high percentage of total revenue, but only because incomes at the top have gone through the roof over the last thirty years, while middle and low-income Americans have just been treading water. Between 1992 and 2007, the bottom 90 percent of Americans saw their incomes inch up by 13 percent, in 2009 dollars. Incomes for the top 400, over the same years, soared 399 percent.
At the same time, high-income Americans have enjoyed a historically low effective tax rate. Between 1960 to 2004, the top 0.1 percent of U.S. taxpayers — the wealthiest one in one thousand — have seen the share of their income paid in federal taxes drop from 60 percent to 33.6 percent.
I object to some things government does with my money. What should I do?
Almost everyone can identify something they don’t like in government spending (particularly the federal government). Instead of withdrawing, we should be more deeply engaged in the democratic process over the role of government and how our tax dollars are spent.
Over the last 30 years, the wealthy and powerful have used their considerable clout to shift federal tax obligations off of the wealthy and onto wage earners. The wealthiest U.S. households now pay 30-50 percent less in taxes than they paid a generation ago.
Meanwhile, working and non-wealthy people don’t have the option to withdraw from paying taxes. Taxes are taken out of their paychecks. Non-wealthy people and future generations pay a higher percentage of their income for the good and bad things that government does.
MORE: 2010: Where Do My Tax Dollars Go?
What can ordinary citizens do?
We can press Congress to reverse the Great Tax Shift by passing proposals that raise revenue from those who have received the lion’s share of tax breaks.
Let the 2001 and 2003 Bush-era tax cuts expire for households with incomes over $250,000, which would amount to over $45 billion a year.
- Close overseas tax havens that permit global corporations to dodge taxes. Over $100 billion a year.
- Institute a modest financial speculation tax on sales of stocks, derivatives and swaps, hedge fund investments. Over $150 billion a year.
- Restore a robust estate tax or inheritance tax ($30 billion a year).
MORE: See proposals from these organizations: Wealth for the Common Good, and Citizens for Tax Justice’s Legislative Agenda for 2010.
Tax and Budget Research Organizations
Center on Budget and Policy Priorities
Citizens for Tax Justice
National Priorities Project
Tax Policy Center
United for a Fair Economy
Tools and Fact Sheets
Where Our Tax Dollars Go 2010
Policy Basics: Where Do Our Tax Dollars Go?
Tax Facts, from the Tax Policy Center
Tax Brackets Calculator