Poor in NYC

In case you had to see the graphic mentioned in my comment on Traub's essay, here it is. Given that New York City residents pay some of the highest taxes in the country, it's interesting that only 3 percent list "taxes" as a reason for feeling poor.

Perhaps if they knew of the tax-avoidance schemes being employed by the city's super rich and its army of trusts and estates attorneys, the very act of paying taxes, independent of the marginal rate, might begin to feel more impoverishing. As David Cay Johnston says: "Taxes, They're not for Everyone."

More on Leonhardt

Beyond the two points in my last post, two of Leonhardt's tax facts deserve brief comment.

First, Leonhardt notes that despite the corporate income tax rate remaining unchanged at 35 percent since 1993, corporations have continually found ways to lower the portion of their profits going to federal income taxes (down to 22 cents of every dollar by 1998). Johnston (Perfectly Legal 14) notes that for almost three decades corporate profits have been growing faster than corporate income taxes.

A major cause of this tax avoidance is American-owned multinational corporations shifting profits to lower tax jurisdictions (e.g. Ireland or Bermuda). America's complicated approach to taxing income from multinationals enables such profit-shifting schemes. For a better approach to multinationals' profits, see discussion paper from my Reed Professor Kim Clausing (with Reuven Avi-Yonah). Clausing and Avi-Yonah contend that their reforms would increase corporate income tax revenue enough to make reductions in the corporate income tax rate revenue-neutral. Someone ought to mention these ideas to Charlie Rangel.

Second, consider this summary of Leonhardt's first two facts:

As a group, the rich pay a greater share of taxes than in the past.

The top 1 percent of taxpayers — those with adjustable gross income of at least $267,000 in 2004 — paid more than 25 percent of all federal taxes that year, according to the Congressional Budget Office. That was up from 15 percent in 1979.

The affluent are paying more of the taxes because they’re making so much more money.

A family in that top 1 percent of earners paid a total federal tax rate — including everything from payroll taxes to income taxes to capital gains taxes — of 30 percent in 2004. That was down from 41 percent a decade before. Since the 1950s, tax rates on high-income families have generally been falling.

The top earners pay a bigger share of the government tab than in the past because their incomes have risen so sharply — even more sharply than their tax bills.

The affluent, in short, are paying less in taxes on every dollar they earn but earning many more dollars.

While noting that the incomes of the richest 1 percent have grown more quickly than their tax bills, Leonhardt neglects to numerically compare the richest 1 percent's slice of the tax pie with its slice of the income pie. In 2004, when the richest 1 percent payed 25 percent of all federal taxes, they earned 19 percent of national income. In 2005 the richest 1 percent's take of national income rose to 21.2 percent, the highest share recorded since the IRS began tallying the figure in 1986. Thus, not only is a rising share of national income the cause of the richest 1 percent's rising share of the national tax bill, the two percentages are fairly close.

Leonhardt on Taxes

David Leonhardt sensibly highlights five facts crucial to the tax debate. While acknowledging that facts alone cannot dictate what constitutes "fair" tax policy, Leonhardt at least sets the table for fair argument. Valuable as Leonhardt's list is, however, any discussion of the American tax system must also include these two points.

The Entire U.S. Tax Code - Federal, State, Local - Resembles a Flat Tax System

Warren Buffett caused a splash recently by arguing that his federal taxes equaled a smaller percentage of his taxable income than did his receptionist's of her income (17.7 percent versus 30 percent). Greg Mankiw criticized Buffett's calculation as inaccurate, and Mankiw's corrections indeed show the federal tax system to be progressive.

The spirit of Buffett's objection, however, is valid even if his focus on federal taxes alone is misplaced. Since America has enacted a federalist system - allowing taxation powers to devolve to states and localities - the President and Congress have an obligation to consider how federal tax laws interact with state and local ones. It makes no sense to consider a federal tax burdens in a vacuum. And since states and localities rely heavily on sales taxes whose burden falls as income rises, the overall American tax system is far less progressive than the federal system alone. David Cay Johnston states the case (Perfectly Legal 96):

The federal Bureau of Labor Statistics, in its annual consumer expenditure survey, looked at the burden of local and state taxes as well as federal levies... For 2001 the government found that all taxes at all levels of government consumed 19 percent of the incomes of the best-off fifth of Americans, those individuals and families whose average income was $116,666 that year. Down at the bottom of the poorest fifth, whose average income was $7,946, paid 18 percent.

What this means is that the entire tax system at all levels amounts to a crushing flat tax, one that is crushing the poor and one that does not extract the harsh levies so often cited by politicians who owe their allegiance to the political donor class. This leveling of tax burdens between those most able to pay and those least able to pay reflects the regressive nature of sales taxes on merchandise, excise taxes on various consumer goods, and the high rate of property taxes in poor communities. The burdens of these taxes diminish as incomes rise.

Though Johnson's figures are slightly dated, I doubt the situation has changed much since 2001, especially given the dire fiscal condition of many states in the intervening years. Leonhardt's discussion ignores state and local taxes, and this is standard in debates over federal tax policy. I believe this is unwise. If the federal government permits states and localities to adopt regressive taxes, one might argue that the federal tax code should be all the more progressive to compensate.

The Very Rich Have Gotten Fabulously Richer (to quote chapter three title of David Cay Johnston's Perfectly Legal)

Leonhardt discusses the extraordinary income gains of the richest 1 percent of Americans over the past thirty years, and rightly diagnoses this as the main reason the richest 1 percent is paying a larger portion of federal taxes (in 2004 paid 25 percent of federal taxes and earned 19 percent of national income). To treat the richest 1 percent as homogeneous, however, is to ignore the astounding income gains among the top rung of this class, those 13,400 households in the top 1/100th of one percent who in 2000 had an average income of $24 million (560 times the average U.S. household income of $42,700). I would contend that we cannot discuss tax fairness until everyone truly appreciates the extent of wealth concentration in America.

Between 1970 and 2000 this elite group's share of national income grew from 1 percent to 5 percent. This enormous income growth for the top 1/100th of one percent (henceforth "the Fortunate Few") vastly exceeded even the income gains of other households in the richest one percent; the incomes of the Fortunate Few grew almost 1,000 times faster than those in the bottom half of the richest one percent (meaning that in 2000 the bottom half had an average income of f $777,450 while the Fortunate Few had an average income of $24 million).

When compared to the income gains of the bottom 99 percent, the strides of the Fortunate Few become truly spectacular. Johnston reports that from 1970-2000 "For each dollar of additional income going to each of those in the bottom 99 percent of Americans the richest each averaged an astonishing $7,500" (Perfectly Legal 41). This disparity in income growth has produced a sea-change in the distribution of wealth. Whereas in 1970 the poorest third of Americans had more than ten times the income of the Fortunate Few, by 2000 the Fortunate Few (a mere 13,400 households) had slightly more income than the 96 million poorest Americans (e.g. roughly the poorest third). Johnston puts it well (Perfectly Legal 41):

Here is the most important news in these pages - just 28,000 men, women, and children had as much income in 2000 as the poorest 96 million Americans. Each group had about 5 percent of all reported income that year. To visualize the enormity of this chasm imagine these two groups in geographic terms. The super rich would occupy just one third of the seats at Yankee stadium, while those at the bottom are the equivalent of every Americans who lives west of Iowa - plus everyone in Iowa.

Given this almost comic disparity, discussions of U.S. tax equity ought to focus on the position of the Fortunate Few in particular as opposed to the top one percent in general. In 2000 the Fortunate Few earned 5 percent of national income; what share of federal taxes did they pay? This information is difficult to come by because the IRS data does not disaggregate among the top 1 percent, even though there is an obvious difference between a family earning $700,000 and a family earning $24 million.

Without even discussing raising statutory rates on the Fortunate Few above those currently imposed on the top 1 percent (something I would support), Johnston's Perfectly Legal explains the many tax and accounting schemes employed by this elite to artificially reduce their taxable income. Taxing the super-rich is indeed difficult, because they can hire an army of lawyers and accountants to outsmart the IRS (assuming they have not already persuaded Congress to pass ill-conceived laws, such as the preferential treatment of income accruing to hedge funds and private equity firms). Nonetheless, before getting swept up in debates over what share of a person's income the government can legitimately take, we should be studying ways to ensure that the Fortunate Few among us pay the taxes they owe.

(For a history of U.S. income inequality and taxes see Pikkety and Saez)

Stay Positive - The Externalities of Smoking

With Democrats' S-Chip legislation proposing to fund increased child health insurance subsidies with higher tobacco taxes, now is an opportune time to discuss the externalities from smoking.

Traditionally we think of smoking as imposing costs on third-parties not fully borne by the smoker - health care costs of nonsmokers associated with secondhand smoke, medical costs paid by the government to care for ill smokers, and fires caused by cigarettes. These third party costs are the negative externalities; to the extent that they reduce tobacco consumption, we generally applaud policies that raise the price of tobacco (e.g. taxes) for forcing smokers to take these third-party costs into account.

Yet here come Stock and Watson relaying a fascinating observation about positive externalities from smoking (p. 446):

The biggest economic benefit of smoking is that smokers tend to pay much more in Social Security (public pension) taxes than they ever get back. There are also large savings in nursing home expenditures on the very old - smokers tend not to live that long... All the studies agree that, by tending to die in late middle age, smokers pay far more in taxes than they ever back in their brief retirement.

Here that, Platzer? With every puff you're subsidizing my twilight year leisure!

Seriously though, Stock and Watson note that the beneficial impact of smokers' early death on public finances could significantly reduce cigarette's per pack external cost (hence appropriate level of tax). Maybe. Without getting into this technically and morally thorny issue too deeply, I simply interpret this research as a reminder that to the extent our public programs succeed in reducing smoking - and the propriety of such programs is to me beyond question - they may increase public health expenditures later on. Rather than treating cigarette taxes as solely win-win (either people smoke less, or they smoke the same amount and government raises needed revenue), we should recognize that such taxes could be both a boon to public finances in the short-term and a drain in the long-term. Ideal would be a way to protect a portion of cigarette tax revenue to cover future increases in health expenditures; given our government's difficulties respecting such "lock-boxes", however, maybe we had better not go there.