Are the rich paying their 'fair' share?

[Al B. Sure!]

Phil Gramm op-ed in the WSJ: The Real Causes of Income Inequality

http://online.wsj.com/article/SB10001424052702303816504577305302658158454.html

It's a long article; he discusses the causes of income inequality but the juicy stuff for debate comes when he uses OECD data to compare the share of the tax burden paid by the richest Americans to the share of the tax burden paid by the richest French and Swedish:

Nowhere is the political debate over income inequality more detached from reality than the call for the top 1% of American income earners to pay their "fair share." The Organization for Economic Cooperation and Development (OECD) data on the ratio of the share of income taxes paid by the richest taxpayers relative to their share of income show that the U.S. has the world's most progressive tax burden.

The top 10% of earners in the U.S. pay 35% more of the income tax burden than in Sweden and 22% more than in France. These figures—from the 2008 OECD publication "Growing Unequal?"—include all household taxes imposed on income at the federal, state and local level, including social insurance taxes.

In an eternal irony unique to large welfare states, it is the expansion of government in the name of the poor and middle class that always costs poor and middle-class families the most. When the U.S. collects 16.1% of GDP in income taxes, the top 10% of taxpayers pay 7.3% and the other 90% pick up 8.9%.

In France, however, they collect 24.3% of GDP in income taxes with the top 10% paying 6.8% and the rest paying a whopping 17.5% of GDP. Sweden collects its 28.5% of GDP through income taxes by tapping the top 10% for 7.6%, but the other 90% get hit for a back-breaking 20.9% of GDP.

If the U.S. spent and taxed like France and Sweden, it would hardly affect the top 10%, who would pay about what they pay now, but the bottom 90% would see their taxes double.

Since OECD members have significantly higher consumption taxes on average than the U.S., the total tax burden of bigger government is even more heavily borne by lower-income citizens in developed nations than these numbers suggest.

The real and alarming message in these OECD numbers is that there appear to be limits in the real world to how much tax blood can be extracted from rich turnips. With much higher marginal income-tax rates, countries that are clearly willing to soak the rich have proven to be incapable of doing so.

Now income inequality may explain some of this. I took the liberty to check the CBO to see what share of national income comes from the richest Americans:

http://www.cbo.gov/publication/42870

Higher-income groups earn a disproportionate share of pretax income and pay a disproportionate share of federal taxes. In 2007, the highest quintile earned 55.9 percent of pretax income and paid 68.9 percent of federal taxes; the top 1 percent of households earned 19.4 percent of income and paid 28.1 percent of taxes. The share of taxes paid by high-income groups exceeded their share of income because average tax rates rise with income. In all other quintiles, the share of federal taxes was less than the income share. The bottom quintile earned 4.0 percent of income and paid 0.8 percent of taxes, and the middle quintile earned 13.1 percent of income and paid 9.2 percent of taxes.

So, Democrats, explain what you mean about 'fair shares'. Looks like the rich aren't paying their fair share... they're paying a lot more.

[Elok]

Fair, in this case, is not being used to mean "equal."

[BlackCat]

Al, you are really easy to be manipulated and fooled by a little statistical manipulation.

[Aeson]

When Buffet eats at an all you can eat buffet, he should have to pay a million times what the average Joe would (I'm not just saying this because my name is Joe, and not just because I'm not average either), because the food that sustains him is a million times more important. We know this because Buffet has a million times more money. Jimmy Buffet on the other hand could eat at the all you can eat buffet for only ten thousand times the regular price.

This is fair. Any other system is in direct contradiction to the laws of thermodynamics.

[giblets]

When people talk about "the rich" not paying "their fair share" they're probably thinking of people like Mitt Romney who only pays 15% of his income in taxes.

[KrazyHorse]

When people talk about "the rich" not paying "their fair share" they're probably thinking of people like Mitt Romney who only pays 15% of his income in taxes.

In the case of romney, who may or may not have paid earned income taxes on his current "income", this is a fair criticism. In the case of somebody who has earned income, paid taxes on it, then paid additional taxes on the time and risk values accruing to his investments, it is stupidity generated by the idiotic and financially nonsensical definition of "income" currently in use

[KrazyHorse]

Dp

[Jaguar]

When people talk about "the rich" not paying "their fair share" they're probably thinking of people like Mitt Romney who only pays 15% of his income in taxes.

Mitt Romney pays a low tax rate on his "income" by design, because some people designing the tax code (thankfully) have a much better understanding of financial math than voters do. Mitt Romney's purchasing power has been reduced far beyond the "15%" rate that people calculate using amateur financial math. Fortunately, the actual algebra on this isn't too hard to understand.

I. Simple Model: Wage income and investment income

Your consumption, without tax, on wages (W, invested at interest rate r from time t0 to time t is this:

W*e^(r(t-t0))

Your wage income is W and your investment income is, naturally, (e^(r(t-t0)) - 1)W. This is just the total consumption with the wages subtracted.

II. Adding Wage Taxation

Now let's add a simple tax on wage income only. A tax at rate T paid at t0. Your consumption after-tax is this:

(1-T)W*e^(r(t-t0))

In this case, your wage income is (1-T)W and your investment income is (e^(r(t-t0)) - 1)W(1-T). Note that the term (1-T) has distributed to both types of income. That is because by reducing the principle, you also reduce future investment income by precisely the same amount.

III. Capital Gains Taxes

Finally, we add a capital gains tax rate, C.

Your consumption after taxes is now this:

(1-T)W*(1+(e^(r(t-t0))-1)*(1-C))

Wage income is again (1-T)W, and investment income is now (e^(r(t-t0)) - 1)W(1-T)(1-C). The investment income has been reduced by both tax rates, while the original wage income has been reduced only by the wage income tax rate.

IV. Conclusion
Calculating people's tax burdens in a serious, rigorous manner doesn't actually involve dividing one number by another. Ironically, the closer a rich person's "effective tax rate" is to 15%, the more their ability to purchase goods and services has been reduced by taxation.

[Jaguar]

Addendum for KH: I fully agree with your criticism of "income", in the way politicians typically use it, as an incoherent economic concept. If I were discussing this with you alone, I would have written my post much differently, or just assumed we agreed and moved on. I chose to write a post using the popular definition of "income" for the benefit of other posters, not for you.

[SlowwHand]

When Buffet eats at an all you can eat buffet, he should have to pay a million times what the average Joe would (I'm not just saying this because my name is Joe, and not just because I'm not average either), because the food that sustains him is a million times more important. We know this because Buffet has a million times more money. Jimmy Buffet on the other hand could eat at the all you can eat buffet for only ten thousand times the regular price.

This is fair. Any other system is in direct contradiction to the laws of thermodynamics.

His buffet is a lot different than ours.

[Al B. Sure!]

In the case of somebody who has earned income, paid taxes on it, then paid additional taxes on the time and risk values accruing to his investments, it is stupidity generated by the idiotic and financially nonsensical definition of "income" currently in use

I'm actually making this argument on facebook right now. Among my friends, I feel like you on Apolyton

This is what I wrote in response to 'the rich avoiding tax on certain incomes'. For you/Jaguar, it'll sound sophomoric but I have to approach this slowly like a teacher, not confound people with algebra/terms they wouldn't understand Kindly correct any mistakes I made so I can keep looking smart to my peers.


Well yes but we already have a progressive income tax system. The effective tax rate for the richest is higher than the ETR for poorer portions of the population. What complicates it is when a rich person has a large share of their income coming from capital gains which is taxed at a lower rate; that is how Romney pays a lower tax rate than some other millionaires. Here's the problem. Capital gains lower the tax rate some rich people pay but bumping up the capital gains rate is problematic for a few reasons: 1) Capital gains in the US are double taxed in two ways: Corporations are taxed (with Japan's recent cutting of their corporate tax rate, the US now has the highest corporate tax rate in the world) and because the money used to purchase an asset was income at some point and was taxed BEFORE the investment was made; 2) Capital gains, especially with long-term assets like land, are largely due to price inflation and may actually represent no gain in value; 3) Taxing capital gains at a rate equal to or higher than income tax would dis-incentivize investment in favor of consumption; consider, making an investment and achieving a return means you borne risk and put off current consumption. Increasing the capital gains tax rate would discourage such behavior. What these problems mean is that increasing the capital gains tax to 'correct' ETR's would be foolish.

The rich avoiding taxes on investment income isn't a valid criticism. Let me expand on the idea of double taxation; not just from the fact that corporations are taxed first, then dividends are taxed on individuals (remember also that the price of a share is the present value of all future dividends, even if a company doesn't currently offer dividends), but also because the money used to make an investment was taxed as income of some sort before the investment. Let's say I earn $100,000 as ordinary income (for simplicity's sake, let's suppose I have no expenses). That's taxed at a 25% rate. I put my remaining $75K in stock and sell later for $85K (13.3% return). I've realized a capital gain of $10K. This $10K is taxed at 15% so I make $8500. In net, I earned $110K, paid $26.5K in taxes, and made $83.5K in profit for an ETR of 24%, slightly lower than my nominal tax on ordinary income. I look like I'm UNDERpaying my taxes but what is forgotten is that I IMPLICITLY paid a 25% tax on my capital gains income because I could not invest $25K that was paid in ordinary income tax. To illustrate, suppose there was no capital gains tax and instead, I am taxed on total end of year income at a nominal rate of 25%. I'm now able to invest my full $100K at 13.3% return so now I earn $113.3K, paid 25% of it in taxes ($28.3K in taxes), and made $85K in profit. Note now that my ETR is 25% but I actually made more money; I paid a higher tax rate but I'm now richer because I was NOT implicitly taxed on my foregone investment income. This disparity is the effect of double taxation.

[giblets]

Mitt Romney pays a low tax rate on his "income" by design, because some people designing the tax code (thankfully) have a much better understanding of financial math than voters do. Mitt Romney's purchasing power has been reduced far beyond the "15%" rate that people calculate using amateur financial math. Fortunately, the actual algebra on this isn't too hard to understand.

I. Simple Model: Wage income and investment income

Your consumption, without tax, on wages (W, invested at interest rate r from time t0 to time t is this:

W*e^(r(t-t0))

Your wage income is W and your investment income is, naturally, (e^(r(t-t0)) - 1)W. This is just the total consumption with the wages subtracted.

II. Adding Wage Taxation

Now let's add a simple tax on wage income only. A tax at rate T paid at t0. Your consumption after-tax is this:

(1-T)W*e^(r(t-t0))

In this case, your wage income is (1-T)W and your investment income is (e^(r(t-t0)) - 1)W(1-T). Note that the term (1-T) has distributed to both types of income. That is because by reducing the principle, you also reduce future investment income by precisely the same amount.

III. Capital Gains Taxes

Finally, we add a capital gains tax rate, C.

Your consumption after taxes is now this:

(1-T)W*(1+(e^(r(t-t0))-1)*(1-C))

Wage income is again (1-T)W, and investment income is now (e^(r(t-t0)) - 1)W(1-T)(1-C). The investment income has been reduced by both tax rates, while the original wage income has been reduced only by the wage income tax rate.

IV. Conclusion
Calculating people's tax burdens in a serious, rigorous manner doesn't actually involve dividing one number by another. Ironically, the closer a rich person's "effective tax rate" is to 15%, the more their ability to purchase goods and services has been reduced by taxation.

You sure enjoy wasting time don't you? Or maybe you're trying to insult me by giving me a detailed explanation of a simple argument.

[Jaguar]

If you could have understood that in fewer words, great for you. Other people might benefit from the airtight algebra. Most of the formulae are just copy and paste from the initial version, with the new taxes added in. I don't feel bad about spending seven or eight minutes on a post that explains a simple concept that many leftists, including and especially President Obama, are unable to understand.

[giblets]

Obama realizes the Buffet rule polls well among voters and may hurt the Republicans.

[Hauldren Collider]

I don't know if Obama is unable so much as unwilling to understand.