Getting the tax debate straight

Geoff Colvin, senior editor-at-large of “Fortune Magazine,” had an interesting article recently concerning the facts surrounding the debate on tax fairness. As a starting point, Colvin notes that one of the major facts missing in much of the partisan tax debate in Washington has to do with the fact that a shrinking number of Americans are bearing an increasing burden from the income tax.

Colvin notes that, in the last year for which pertinent data is available (2005), the bottom 40 percent of Americans had, on average, a negative income tax rate. That means that these individuals actually received more income from the income tax system than they paid. The major factor behind this is the earned income tax credit. The remaining 60 percent of wage earners pay all of the $1 trillion in revenue derived from the income tax.

If the income tax is supposed to be the epitome of a graduated methodology of taxation, it is succeeding.

The top 50 percent of the filers pay 97 percent of the tax. The top 10 percent, according to Colvin, pay 70 percent, and the top 1 percent alone pay 40 percent of the freight (a percentage that has grown exponentially in the last 20 years).

The congressional and presidential campaigns this fall will be filled with rhetoric about tax fairness, some of it crossing the line into class warfare. Beyond the politics, there are facts and obvious policy implications. Did President Bush’s tax cuts provide the “rich” with more tax relief in absolute dollars than was received by the middle class and poor?

Absolutely. Since they pay a disproportionate amount of the taxes, the cuts resulted in more dollars going to those in the higher tax brackets.

Did the poor and the middle class receive unequal treatment in those tax cuts? No. The effective tax rate reduction for the bottom 50 percent of the wage earners was much higher than that for the top 1 percent. In fact, millions of additional workers went off of the income tax rolls completely.

From a policy standpoint, the impending fiery debate about the Bush tax cuts should not overshadow some basic economic facts of life.

The Bush tax cuts did not reduce the net revenue for the federal government, including income tax revenue. There is a limit to how much taxes can be increased on the higher income earners without negatively affecting tax receipts. If individuals see their earnings greatly diminished if they increase their productivity, they are likely to curtail their hours or invest less in money-making activities.

Additionally, when fewer wage earners are not paying the bill for the ever-growing federal wish list of entitlements and spending programs, there is less pressure on our elected officials to spend our tax dollars wisely.

There is no doubt that a smaller number of comparatively wealthy individuals are seeing their incomes rise faster than those at lower levels of income. Improvements in the earning capacity of lower-level wage earners should be a priority for all candidates for office. Using the tax code – instead of better education, training, and productivity – to achieve that end will undoubtedly create negative unintended consequences.

The campaigns this fall should focus on initiatives that will maximize federal government revenues without diminishing economic activity.

Whether that will happen is very much in doubt. Our politicians tend to find it much easier to generate heat than to bring light to a problem.