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April 18, 2005

Max Sawicky Cheers for the Income Tax!

He writes:

TomPaine.com - The Late, Great Income TaxMax B. Sawicky. April 15, 2005:Let us count our blessings. The cornerstone of the U.S. system is the taxation of income and estates. Income is the broadest conceivable base for taxation, permitting the lowest possible rate for a given amount of revenue. (Estate taxation is an indirect means of taxing income that has never been taxed.) The high point of income tax reform was the base-broadening achieved under the Tax Reform Act of 1986. Since then, of course we have seen backsliding, in the form of a blizzard of new deductions, credits and exclusions. As we speak, the Estate and Gift Tax is under assault in Congress. The most infamous of the post-'86 reforms is the increasing favor afforded to income received by the wealthiest Americans—capital gains and dividends. Legislation to this effect was signed by Bill Clinton in 1997, and later by George W. Bush, seemingly once a month. This trend marks the evolution of the income tax into a wage tax, shifting, as John Edwards says, the federal tax burden from wealth to work.

Even so, the income tax is still progressive, just not as much as it used to be. The average effective rate of the tax is 8.6 percent, according to the Brookings/Urban Institute Tax Policy Center but the rates vary enormously by income class.... For the bottom 40 percent of the population, the average rate of the individual income tax is negative—taxpayers get more back from refundable credits than they pay in. For the middle 20 percent, the rate is just 3.3 percent, and for the fourth quintile it's 6.3 percent.... It's the top quintile that pays 86 percent of the income tax (at an average rate of 12.2 percent of income).

Insofar as there is genuine popular animus towards the income tax, surely it has as much to do with where Americans would like to be, rather than where they are now economically. The tax that tolls for most people is not the income tax, but the payroll tax. Should this upset us? I would say no. The payroll tax finances our vital Social Security and Medicare programs. Gene Steuerle and Adam Carasso have estimated that the lifetime benefits of these programs are huge. Converting the projected streams of benefits into lump sums, they find that for a married couple with average wages and life expectancy reaching age 65 in 2030, Social Security's value will be the $470,000, and Medicare's $490,000. What a country.... [P]resent-day workers are not contributing for the sake of receiving benefits at current levels. They can look forward to higher real benefits commensurate with their wages at retirement time, as long as privatizers don't succeed in carving up the program....

One common notion is to transition towards a consumption tax. The hope is that savings and economic growth would get a boost. The fact is that for many people, the income tax is already a consumption tax. Anyone who has unused opportunities to contribute to a deductible pension or IRA—and there are many such people—does not face income taxation on the margin. If they put a dollar in a tax-preferred savings vehicle, the returns to their saving would go untaxed. If they instead spend that dollar on consumption, it is subject to tax. So the existing income tax—really a hybrid income-consumption tax—already provides savings subsidies. These could be extended for lower-income persons, but that is a reform that is completely feasible under the current tax system. Since we are talking about low-income people, however, it would not promise much for national saving.

Greater savings subsidies aimed at the higher-income end of the population run the risk of simply offering new channels for savings already in the pipeline, not net increases. If you are really determined to do something about national saving, the logical place to begin is the Federal budget deficit.

Isn't the income tax too complicated? Sure. How to simplify it? One way is to tax all income under the same rates, rather than favoring wealth over work, as above. Another is to consolidate deductions and credits... my pet project is to merge the Earned Income Tax credit, the Child Tax Credit and the dependent exemption into a Simplified Family Credit....

So weep not for the income tax. Rather, be wary of those who have been fixing it. If they keep on, we will end up with a tax system focused like a laser beam on moderate and low-income working families, providing grossly inadequate revenues.

As Justice Holmes said, with taxes we buy civilization. Let's avoid the bargain-basement version.

Posted by DeLong at April 18, 2005 01:51 PM