Democrats Want a Tax Cut. Take It!
July 14, 2011
(This item originally appeared at Forbes.com on July 14, 2011.)
Democrats want a tax cut–specifically, a reduction in payroll taxes. Republicans should take it, and maybe even make it permanent.
In 1950 the top income tax rate in the U.S. was 91%. Today, it is well below that, a development that is generally considered a positive one. While I agree with the idea of a progressive income tax system–higher rates on higher incomes–the notion of a punitive tax system, with rates above 40%, is one that has been properly assigned to the trash bin of history.
However, something else has happened since 1950. Tax rates on lower incomes have gone up by huge amounts.
In 1950 a married couple was exempt on its first $1,200 of income. These seem like low numbers, but they were meaningful in 1950 dollars, when $35 was equivalent to an ounce of gold. In 1950, per capita income was about $1,510, so a large chunk of income was tax-free.
In 2010 per-capita income was $40,584. However, the standard deduction for a married couple was $11,400. You can see that a much greater percentage of the typical family’s income is now subject to tax. If you were to use the same per-capita income/deduction ratio as 1950, the standard deduction for a married couple would be $32,260 today.
In 1950 the FICA tax was 1.5% for both individuals and employers, rising from its original 1% in 1937-1949. In 1954 it rose to 2%. In 1960 it was 3%; 5.1% in 1978; 5.7% in 1985.
Today it is 6.2% for both employee and employer, over four times higher than it was in 1950. We then add Medicare, which makes the total FICA take 15.3%, including both employee and employer portions. This is a meaningful amount, especially since it applies to the first dollar earned, and income taxes (with the low standard deduction mentioned) are piled on top of that.
With whatever is left over, people then pay sales taxes. The data is murkier, but in aggregate, it appears that the total income from state sales taxes more than doubled from 1956 to 2000, as a percentage of personal income, suggesting a similar rise in tax rates. In more recent years, the aggregate sales tax rate has risen from an average of 7% in 1983, to 8.2% in 2000, to 9.6% in 2010, according to Vertex Inc.
To the degree that a nation allows itself to be overtaken by oligarchic interests, we tend to find that the wealthiest have ways of avoiding taxes altogether, while the poor and middle classes pay very high taxes. Often in these situations, a large part of that tax revenue actually ends up in the pockets of the oligarchic interests themselves, in the form of interest payments on debt, overpriced public spending contracts, and so forth.
Today, a large part of federal tax revenue (and deficit-financing revenue) ends up in the pockets of the medical-industrial complex (Medicare), military-industrial complex, financial-industrial complex, the government employee mafia, and so forth. In centuries past, the religion-industrial complex was also a major player, as the Church was the wealthiest entity and largest property owner, and free of taxes.
You could see it as a means of taking from the poor and delivering to the rich. Which, you could say, was exactly what it was intended to do. This was a dominant characteristic of Spain during its imperial decline in the 17th century, and also France before the revolution in 1789.
Some recent studies have found that, taking all taxes into consideration, the percentage of income paid as taxes is roughly the same at the lowest income levels and the highest. For example, 33.9% of the Federal government’s revenue in 2007 came from FICA taxes, while 45.3% came from personal income taxes. Adding sales and property taxes at the state and local level (residential property taxes are effectively paid by tenants) further skews the tax burden onto the lower incomes.
Oddly enough, this huge increase in taxes on lower incomes has not had any effect on federal tax revenue. It tends to hover around 18% of GDP today, around where it was in the early 1950s. Along the way, however, we have acquired huge new expenses, in the form of health care obligations and a Social Security system that is struggling with demographic changes.
The division between wealth and poverty has been a problem of every capitalist economy–perhaps of every society beyond the tribal level. Attempts to rectify this with government social programs have had some success, but tend to be problematic at best. However, even the most libertarian observer can agree that, if we cannot think of something better to do about the less-well-off, then at the very least: don’t take their money!
One reason that Republicans have focused on top marginal income tax rates is because the payroll taxes have been considered untouchable. They supposedly fund Social Security and Medicare directly, although this was always something of an accounting fiction. Thus, a reduction in payroll taxes could be construed as a direct defunding of the large entitlement programs, which has been politically difficult.
The other taxes which affect lower incomes directly, namely the sales taxes and property taxes, have been a matter of state and local tax policy. To be fair, Republicans at the state level have made a great effort to at least keep these taxes from rising.
However, now Democrats have opened the door to discussing the payroll tax. This is a good start for a much broader discussion on taxes: What would our ideal system look like, taking into account sales taxes, property taxes, payroll taxes and income taxes, both corporate and individual?
Payroll taxes are just another form of income tax, and it makes sense to integrate income taxes into a single system. I suggest that, while tax rates on the highest incomes should be below 25%, including all state taxes, we should also endeavor to make the first $30,000 of income for a family tax-free.
The remainder of revenue could be raised by sales taxes and possibly resource-related taxes such as a carbon tax. The nice thing about these, for lower incomes, is that they are avoidable, either by spending less (saving more) or by using fewer resources.
This structure is very much like Singapore, which has a top tax rate of 20% on income of $262,000, and the first $16,000 of income for an individual is tax-free. The 11.5% tax bracket doesn’t apply until income of $65,500 for an individual. There is a goods-and-services tax of 7%. There is no payroll tax, capital gains tax or inheritance tax.
It seems clear that Republicans’ efforts to reduce destructively high marginal tax rates in the U.S. are being undermined by their increasingly obvious disregard for steadily rising taxes on lower incomes. Democrats are setting the pace here. Why not join them?