The Tax Debate

Right now Republicans and Democrats are both trying to claim their view represents the “common sense” on taxes.  Meanwhile, President Obama and the GOP leadership have hammered out a compromise neither side’s base likes — but that’s always the case for compromises.   But as Renaissance Guy asks over at his blog, what is the right tax rate?

For context, consider this graph:

Tax rates historical

The lighter multicolored lines represent different rates at which Americans were taxed.  Between the 40s and 1980 the highest marginal rate was 90%.   It was a very progressive tax, and most economists agreed the marginal rates were too high.   In 1982 the Reagan reform dropped the highest rates to levels that hadn’t been seen for the wealthy since the 1930s (and they were even lower the the 1920s).    In 2001 the Bush tax reform dropped them even more.   Clearly, in terms of taxes we do not have a very progressive tax structure, and tax rates are historically very low for the wealthiest tax payers.

For one result of this, look at the red line – debt as a percentage of GDP.   Right when tax rates dropped, debt levels started rising.  After dropping a bit just before 2000, they rose again after 2001.  The idea that increased revenues come from tax cuts and thus they pay for themselves is clearly misguided.

For another result, look at this graph:

As our taxes got more progressive in the 40s, the wealthiest 10% went from controlling nearly half the wealth to less than 35%.   The gap between the rich and poor narrowed.   This was also a period of massive economic growth.   As soon as the Reagan cuts were put into effect the gap started to grow again, and by 2007 the wealthiest 10% controlled half the country’s wealth, the most ever.   Clearly the tax cuts were bad for the debt, but good for the very wealthy.

This graph breaks it down:

Arguably, the wealthier you were, the more you benefited from the tax cuts.   As a social scientist I know I’m showing only correlation here, causality would require something far more sophisticated.   But the correlation is strong, especially the timing.   By the way, both of these graphs are from: http://seekingalpha.com/article/157061-gap-between-rich-and-poor-growing-in-u-s

And while the richest in the US earn far above the richest in other states, the poorest don’t fare so well:

Our poorest 10% are behind Greece, but ahead of the Czech Republic and Italy!  (This image was from: http://thesocietypages.org/socimages/2010/01/21/income-inequality-in-international-perspective/)  And yes, they also show where our top 10% are:

Our wealthy are doing superb!   Now, this doesn’t settle the debate about tax rates.  It does prove, though, that those who claim the wealthy are hurt in the US, and that somehow they are victimized while the poor get all the breaks is pure nonsense.  Our wealthy are the wealthiest in the world!

Last bit of evidence: the growth in some incomes since the tax cuts of 1982:

While it is true that income rose for everyone, how much it rose depends on your wealth.   The wealthier you were to start with, the wealthier you got.   And, since 16% of 20,000 is a lot less than 281% of $200,000, it’s clear the balk of the money went to the wealthiest.

Lower marginal rates help the wealthy.  However, it’s not clear they help the economy.   Overall a lot of that wealth went into consumption of foreign produced goods, or financed bubbles as our manufacturing sector declined.   It does not seem to have produced a lot of investment in anything that increased production.   Instead, we had speculative bubbles.

All that said, politically the Obama-GOP compromise was wise, even necessary.  Still, we have to look at the data and ask some hard questions — does this gap between the rich and the poor make the country stronger or weaker?   It’s the largest gap in the world, and our poor don’t have things like guaranteed health care and other protections that other industrialized states provide.   Perhaps that’s a good thing — keep the government small — but as long as taxes are being collected, it does seem to me that in a time of high federal debt, it would not hurt the rich to pay a more progressive tax.

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  1. #1 by renaissanceguy on December 16, 2010 - 07:10

    Regarding the first graph, does it occur to you that debt was even higher when tax rates were at their highest?

    Does it occur to you that debt is a function of government spending, and that spending is not accounted for on the graph? It doesn’t matter if revenues or high or low if the government spends money out or proportion to those revenues.

    In other words, you are looking at correlation and treating it as causation. If anything the graph would have “proven” to people in 1980 that lowering tax rates decreases debt, as it appears to have done from 1960 to 1980.

    Does it occur to you that as the value of the dollar changes, some of those figures would be affected? Unless the graphs use a uniform value for the dollar, it could be misleading. A person earning $250,000 in 2010 is hardly the same as a person who earned $250,000 in 1930.

    You look at the graphs that show wealthy people prospering and think that it is a bad thing. I look at them and think that it is a good thing. One thing we all know from experience is that the “poor” now are better off than they were in the past, even if a larger percentage of people are in the “poor” category.

    One thing about seeing wealthy people getting wealthier is that it gives ambitious people encouragement to produce and invest their money so that they too can achieve that level of financial success. In a society in which the wealthy are punished, what incentive is there to expand production or to invent new goods and services. The productivity of the wealthy is what allows “poor” families to be able to afford to buy cellular phones and home computers, by the way.

  2. #2 by Scott Erb on December 16, 2010 - 12:35

    Debt rates were highest during WWII — for obvious reasons. After that we steadily paid done the debt until 1982 when the country took a very wrong turn, starting to go deep into debt, both public and private. In the 80s we increased debt during a boom, something very dangerous, and we did that again in the 00’s. And no matter what the dollar’s value, clearly any claim that we soak the rich or the rich have at all been victims is false; they have made out like bandits. They control the show, and strongly influence both political parties. They run America, their influence in the government is immense.

    The first graph is a % of GDP, so dollar value is irrelevant. The idea that the wealthy are prospering because they somehow work harder or are more innovative is naive. They’re structurally advantaged, and often work less hard, or can use their wealth in speculation games (dot com bubble, housing bubble, etc.) while the poor and middle class struggle. To quote Don Henley again, from the song “Inside Job” (title track of that 2000 album):

    “It was an inside job
    Like it always is
    Just chalk it up
    To business as usual

    You think that you’re so smart
    But you don’t have a fucking clue
    What those men up in the towers
    Are doing to me and you
    And they’ll keep doin’ it and doin’ it
    And doin’ it and doin’ it
    And doin’ it and doin’ it
    And doin’ it and doin’ it
    Until we all wake up
    Wake up, wake up, wake up, wake up!”

  3. #3 by Scott Erb on December 16, 2010 - 14:00

    By the way, I don’t mean Henley’s “you think that you’re so smart…” to be directed at you, RG! I just had his lyrics on my mind as I listened them today while doing the step machine.

  4. #4 by Black Flag on December 16, 2010 - 18:50

    Scott,

    However, it’s not clear they help the economy.

    You stop your analysis short.

    People do not invest (a phenomena of “future thinking”) based on a temporary benefit. Investments tend to go toward consistency, and temporary and consistency are rarely bed mates.

    It is no surprise that people see temporary tax relief as a “windfall”, and not an investment opportunity.

    Further, the net gain of income from tax increases will make not a dime difference to the financial mess of the government.

    However, it will create massive economic turmoil as the people work to once again avoid the perversion of government into the economy. People will defer certain investments, purchases etc. that would normally meet economic outcomes, and will purchase, spend or pervert their choices to avoid the loss of wealth due to tax seizure that will result in no material return.

    As in UK during the top of their socialist years, the rich bought a record number of Rolls. Better spend the money then let it fall into the unproductive hands of government.

    The best solutions:
    (1) Cut the government budget, however, this is politically impossible, and therefore will not be done
    (2) Cut taxes permanently. This will spur investments.
    (3) Cut taxes in any manner or form. Best keep money in the hands of the People.

  5. #5 by renaissanceguy on December 18, 2010 - 13:00

    “. . .when the country took a very wrong turn, starting to go deep into debt, both public and private.”

    Absolutely no argument from me there. We are in complete agreement.

    However, income seems to have little direct affect on debt, public or private. Private individuals who are in debt generally seem to see an increase in income as an excuse to go deeper into debt. At least that is what I have observed. So does the government.

    I think it would be flat out wrong for the government to insist on taking more tax money, if all that they will do is go exponentially deeper into debt. Therefore, if there is some show of good faith that they are cutting spending, I could accept an increase in tax rates in order to help pay off the debt.

    “And no matter what the dollar’s value, clearly any claim that we soak the rich or the rich have at all been victims is false; they have made out like bandits.”

    I do not claim that we soak the rich or that they are victims. I claim that it is inherently wrong to tax people beyond what the government needs to fulfill its minimally necessary duties. I claim that it is wrong to confiscate money from some people and give it to other people, whether it significantly hurts the former group or not.

    Bandits is an interesting word. It implies that everyone who is considered wealthy stole their money. That is rude and unfair for you to imply. Certainly some people have made their money dishonestly, and they should be punihsed. However, most wealthy people made their money the old fashioned way, as they say.

    “They run America, their influence in the government is immense.”

    Get over it. That’s the way it has always been and the way it always will be. The best solution is to create an economic climate in which more people can gain wealth instead of stirring up class envy. Any dream of a revoluton by the proletariat ends with the nightmare of “some pigs being more equal than others.”

    Our current welfare system actually ensures that the rich will keep on getting richer, since it keeps a large segment of society continuously dependent and unable to gain wealth for themselves.

    “The idea that the wealthy are prospering because they somehow work harder or are more innovative is naive.”

    In the rare cases in which somebody inherits money and lives off ot it, you are right. In such a case it is usually gone within two or three generations, if not in the first generation. However, in most cases people did not acquire wealth by sitting around and doing nothing. If they did make it by investing in the stock market or by buying real estate, they obviously had a bit of ingenuity in doing so and the courage to take a big risk. Oprah Winfrey certainly worked for her billions. So did Bill Gates. Isn’t that so?

    By the way, I have a family of five, and I make about $40,000 per year. That is our sole family income. How about you? From what I know about you and your wife, I think you probably are “rich” relative to me.

  6. #6 by Scott Erb on December 18, 2010 - 13:37

    The government should increase revenues to decrease the deficit. They should not increase debt. In my own life when I’ve had debt an increase in income has helped may pay down the debt. Government has done that in the past to. To claim that an increase in income must necessitate increased debt is an untenable claim.

    The rich have benefited from the legal protections and social stability provided by the state. That means they have to pay a higher share of the cost of maintaining this stability and legal protections. Right now we have wealthy who live lives of absolute luxury and oppulence, while poor families struggle to get by. To claim this is just, or that their efforts or innovation makes this a good outcome does not make sense. In most European countries you don’t have the immense gap between the very rich and the very poor, yet the quality of life is just as good, or even better.

    Don’t get me wrong — I’m not calling for communism or total equality. But the gap need not be as large as it is. It is growing, the middle class is declining, and we’re becoming a society where you have some very rich, and a lot of working poor. We are becoming more like a third world state. It is part of our steep decline as a country and an economy. There is no way to justify the immense gains of the wealthy compared to the meager gains (or loses, when inflation isconsidered) for the poor. How can you justify that?

  7. #7 by Black Flag on December 18, 2010 - 22:45

    Scott

    The government should increase revenues to decrease the deficit.

    How much damage to the economy do you suggest should be dealt in the form of increase in taxes for how much decrease in deficit?

    Total Income Tax: $1,366 billion

    So a 10% across the board would create a paltry $136 billion more revenue.
    So how about 50% across the board – move the rate up to a staggering 80% (assuming of course that there is no avoidance) – only gains $700 billion.

    So you tank the economy, and STILL have to borrow $800 billion annually if you increase it by 50%.

    Even if it increased all its taxes, just not income @50% would just cover the deficit (Total $2,691,538,000,000 over all taxes – 50% $1.35 trillion extra)

    But I will tell you, the increase in taxes – even a 10% increase will devastate the economy. So government increasing taxes is a foolish idea. It crushes the economy and doesn’t do squat for the deficit.

    They should not increase debt.

    So what are you going to cut?
    Defense?
    SS?
    Medicare?
    Education?
    Energy?
    …..

    So easy to say “no more debt” – and drop it there….

    In my own life when I’ve had debt an increase in income has helped may pay down the debt.

    And here is the problem common in this discussions:
    You mix “pay down debt” to “lower deficit”.

    They are not the same thing.

    Your first point was using revenue to slow down the increase in debt. @50% across the board-all-taxes increase would merely stop going into debt – but wouldn’t even begin to start paying down the roughly $70 trillion (some say more) that is owed!

    Here, you suddenly shift gears and infer you are paying down the debt with your plan – when you haven’t even stopped the debt from growing!

    Government has done that in the past to.

    Really? When?

    The last (and only) time the US has been debt free was on January 8, 1835 under President Andrew Jackson.

    To claim that an increase in income must necessitate increased debt is an untenable claim.

    “must” is probably a poor choice of words by RG.

    How about “has traditionally always caused a debt increase” as governments nearly always spend more than it receives.

    The rich have benefited from the legal protections and social stability provided by the state.

    False dichotomy.

    People benefit from social stability.

    To claim government creates social stability is a contradiction to the evidence of government action, which always creates instability.

    When one uses violence to solve non-violent problems, one destroys reason in favor of a gun.

    To claim that irrational applications of solutions improves stability is a terrible brain-tornado.

    That means they have to pay a higher share of the cost of maintaining this stability and legal protections.

    By a irrational premise, you forward more irrational nonsense.

    People pay the costs of their own protection as they see fit, not as you see fit for them.

    Your conceit that you know the “proper” amount of protection for all people, and thus, self-rationalize the use of your guns to force others to accept your level of protection is the height of evil.

    Right now we have wealthy who live lives of absolute luxury and oppulence, while poor families struggle to get by.

    So what?

    Because one person may have acquireda substantial amount of goods does not justify your theft of those goods because you believe you, in your conceit, believe you can use those goods that you did not earn better than those whose goods they are

    To claim this is just, or that their efforts or innovation makes this a good outcome does not make sense.

    It makes no sense because your measure of justice is wholly subjective. However, this does not stop you. You hold that you are the master in deciding what is “fair” and what is a “good outcome” and willing to use violence on non-violent men to enforce your perverse measures.

    Thus, you guarantee human evil.

    In most European countries you don’t have the immense gap between the very rich and the very poor, yet the quality of life is just as good, or even better.

    Total mush.

    You continue to use your weak subjective as “quality of life” = without any objective measure = to justify your support of violence on non-violent men.

    Don’t get me wrong — I’m not calling for communism or total equality.

    Yes you are – you believe you know “just enough whipping” is necessary to create “just the right society” for you. You have no constraint on how much violence you will inflict, because you are perverted in the means you wish to obtain your goals.

    As long as your goal is unmet, you will use as much evil as necessary to achieve it.

    But the gap need not be as large as it is. It is growing, the middle class is declining, and we’re becoming a society where you have some very rich, and a lot of working poor. We are becoming more like a third world state.

    Remove government from the economy and let free men choose their own paths to wealth.

    It is part of our steep decline as a country and an economy. There is no way to justify the immense gains of the wealthy compared to the meager gains (or loses, when inflation isconsidered) for the poor. How can you justify that?

    No man needs to justify his rights to those whose only answer to problems is the use of evil.

  8. #8 by Scott Erb on December 18, 2010 - 23:04

    I think a mix of spending cuts and revenue increases could slowly pay down the debt to sustainable levels, I’d recommend a target of 30% of GDP.

    Many countries have much higher tax rates than ours, and well functioning economies. I’m not sure why you think increasing taxes will devastate the economy. Our taxes are very low in comparison to those of other advanced industrialized states. Germany’s economy is performing better than ours at the moment.

    Places with no governments or ineffective governments tend to be instable and poor; places with the most prosperity and stability have large, effective governments. A claim that governments create instability does not seem borne out by the evidence. It does matter what kind of government exists — democratic governments embracing market economics due well. Totalitarian governments trying to control the economy do poorly. But there are no examples of wealthy, stable societies with no government. There are many examples of weak governments with unstable and poor societies.

    In a democracy I don’t decide the proper level of protection, the public votes for representatives who decide and debate that. There is always spirited debate. Yet I think in principle my claim is valid; the rich benefit greatly from government.

    Quality of life is measured by subjective appreciation of life, as well as standard of living, things like public safety, general liberty, and opportunity. There are many measures, and scales being used to do so. I could cite a few if you wish.

    I see no empirical evidence that removing government would do any good — the real world evidence I see is quite the opposite. That’s the weakness of your argument; it’s theoretical and based on assertions of principle, rather than evidence and a developed argument.

  9. #9 by Vern R. Kaine on April 11, 2011 - 06:12

    Very interesting discussion and I appreciate the viewpoints from both sides.

    I think there are many other factors to consider with these graphs over the time period. For one, we shifted from a manufacturing economy into an information/knowledge/Internet economy which, among other things, raised the bar on what was required of the “average worker” education-wise.

    To that end, of all the people I know whose wage was more/less stagnant these past 10 years, they all “settled” for mostly cost-of-living wage increases. Most are older. None took on major education upgrades, none of them ventured out to start their own business (or invest in one), and none of them made career changes into more “in demand” or higher-paying industries. Some believed naively that real-estate never depreciates in value, and to this day most of those people still don’t care to know what makes one mutual fund different from another other than it’s prior rates of return.

    This sounds harsh, but in my opinion the world changed and they were either too slow, too unwilling, or too afraid to change with it. Furthermore, the speed of this change is so fast that now fortunes can be made or lost overnight. The rich stay on top of these things, the poor and many in the middle class do not. Should the rich be blamed and also punished for this? Some deserve it, but to me not the bulk of them. We’d be better off fixing the education system of our young so that it teaches them exactly what a mutual fund is, the merits of starting your own business, and the value of a debt-free life.

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