March 21, 2010

A Perfect Storm: Deficit Soaring…Debt Soaring…Number Who Pay No Taxes…Soaring

by Hal Gershowitz

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The “Perfect Storm,” described by author Sebastian Junger in his 1997 best-selling novel by the same name, referred to a confluence of weather conditions that produced a monster hurricane off the coast of New England. Today the term is commonly used to describe any combination of circumstances that drastically aggravate any given situation. For example, an exponential increase in the number of retired elderly Americans who require more health care being supported by a declining number of young Americans who provide the funds to cover those health care costs. With over 70 million baby boomers about to retire we, indeed, have the conditions for a perfect storm

The President and Congress seem to have no trouble grasping the logic that the more people who share the cost of health care the less the cost per capita will be. In fact, the very cornerstone of their health care program is that everyone be required to pay into the system with which we manage the nation’s health care. That same logic, however, seems to elude them when it comes to sharing the growing cost of government. They consistently propose that we compensate for the ever-diminishing number of American taxpayers by simply increasing the taxes on those who already pay the most. Their mantra for every expansion of government programs is that the wealthy should pay their fair share. How can you argue with that? Shouldn’t everyone pay his or her fair share, whatever that is?

Unfortunately, the path we have traveled in the past half century in relentlessly increasing so-called “entitlement” expenditures has put us on the horns of a dilemma in which the number of Americans who pay absolutely no taxes is soaring at the very time government spending is producing a voracious federal appetite for tax revenue. The good news is that 142 million tax returns were filed in 2008 (the last year for which data are available). The bad news is that nearly 52 million of those returns, utilizing a potpourri of deductions, exemptions and tax credits, reported zero taxes due. What is even worse is that, in just the last ten years, the number of tax filers reporting zero taxes due has increased by 60 percent. So just how did such a bizarre reality come to be? The answer is simple: politics.

We doubt that anyone would argue with the notion that those who earn more should pay more in taxes. We certainly wouldn’t. But America has been sold on the idea that the rich should not only pay more in taxes (which is only fair) and that they should also be taxed at higher rates than anyone else, but also that they should pay their “fair share” of the taxes from which many of their fellow citizens have been excused.

Who is rich, of course, is in the eye of the beholder. How much of the bill (one’s fair share) for providing government services should be sent to those who are perceived to be rich depends largely on the motivation of those who write our nation’s tax legislation. On one end of the spectrum we have those who are motivated by the politics of envy. On the other end of the spectrum we have those who appreciate the economic need to maintain an environment encouraging risk taking and entrepreneurship. Another motivating factor is, of course, the extent to which our citizens believe that government, in order to maintain a just and orderly society, must supply certain needs and desires that require income to be transferred from one set of citizens to support another set of citizens.

Government has grown tremendously over the last eighty years as politicians have embraced the idea that Washington should be a proxy for family…that we should look to government to provide more and more of what people need or desire rather than depend on our personal and family support systems and our own labor and intelligence. Thus, more and more of what we need or, perhaps, desire are not viewed as goals or objectives to be attained, but more as rights that are conferred upon us by the moral obligation one citizen owes to his or her neighbor …which morphs eventually, but assuredly, into a governmental obligation.
Before the New Deal, the role of government was more limited to services usually provided by states and cities such as police protection, firefighting, emergency ambulance services and public elementary and high schools. The federal government provided for such services as the national defense, foreign relations between nation states, regulation of interstate commerce, national banks and postal service. Basic day-to-day care, feeding and nurturing were individual and family responsibilities with strong support, when needed, from charitable organizations.

At the national level, ever since 1913 when the 16th Amendment to the Constitution was ratified, federal expenditures have been funded largely by income and excise taxes. From its inception our federal income tax system has called for a graduated rate of tax, which means that at each increase in certain stated marginal income levels, the next amount of income is taxed at a higher rate. Although many believe the tax system would work better and fairer if all deductions and exemptions from tax were eliminated and only one rate were applied, there has been widespread support for the notion that those who make more money should pay tax at increasingly higher graduated rates.

At what level of income should the highest rate apply and what should that rate be? President Obama campaigned on the promise that any tax increases proposed by his Administration would be imposed only on the highest five percent of the population and that taxes for the rest of the people would not go up by a dime. His cutoff point is often said to be $250,000 per annum.

Given our annual deficit, now running close to $2 trillion, it is clear that annual income tax collections are not sufficient to support the level of government we have, nor the debt service on the accumulated debt, which we have already incurred. Nor, even with confiscatory tax rates can we plug the gap. (More on that later.)

As we have previously written, we can service our debt and provide government services either by rolling over and expanding the nation’s debt, printing money, thereby cheapening our currency and risking massive inflation, finding more and more sources to tax, thereby taking more money from the private sector, or cutting spending. Sadly, so far the current Administration and Congress, not to mention the Bush Administration and the prior GOP congresses have shown no signs of having any spending discipline. Congress recently passed a program into law, which requires that each new expenditure be accompanied by a corresponding expenditure cut or a new source of revenue. A step in the right direction, you might say. Not more than three weeks later, however, they passed an $80 billion spending bill and waived the pay-as-you-go requirement.

Because the debt problems of the nation have reached such a critical stage, major new programs have become far more contentious. Health care reform, a cap-and-trade environmental law, expansion of college scholarship programs, even if they all were to work as envisioned, will add to the deficit and all Americans know it. The health care bill, which the president says is revenue and expense neutral, will cause a major increase in our deficit. It is neutral only because it includes ten years of taxes and contains only six years of benefits…among other accounting tricks, such as burying the “doc fix” in separate legislation — an action that will add approximately $250 billion over the next ten years.

Since the left sees 2010 as a chance to transform America into a nation almost totally dependent on government, with more and more decision making and personal responsibility taken away from private citizens and managed by Washington, let us see if, as the Pelosi/Reid/Obama axis claims, new programs can be paid for if only the wealthy would pay their fair share.

The National Center for Policy Analysis reports as follows:
• According to data from the IRS, the bottom 50 percent of income earners pay approximately 4 percent of income taxes.
• The top 25 percent of income earners pay nearly 83 percent of the income tax burden, and the top 10 percent pay 65 percent.
• The top 1 percent of income earners pays almost 35 percent of all income taxes.
• The top 400 richest Americans [out of 320 million of us] paid 1.58 percent of total income taxes in 2000.

Empirical evidence also shows that the wealthiest citizens are also paying an ever-increasing proportion of all taxes collected by the federal government. Data from the Congressional Budget Office show not only that taxes on the wealthy have risen over time, but also that the 2001 Bush tax cut barely kept their share of the tax burden from rising further.

• In 1984, after the Reagan tax cut had been fully phased in, the bottom 20 percent of income earners paid an average federal tax rate (individual, payroll, corporate and excise) of 10.2 percent.
• The top 20 percent of earners paid 24.5 percent and the top 1 percent paid 28.2 percent.
• In 2001, after the first Bush tax cut had taken effect, those in the bottom quintile paid average federal income taxes of 5.4 percent, about half of what they did 20 years ago.
• Those in the top five percent saw a slight decline in their federal tax rate (28.6 percent, down from 29.7 percent).
• The top 1 percent, however, saw their overall federal tax burden increase slightly, from 33 to 33.2 percent.
Despite the accusation that it was the very wealthiest who benefited the most from the 2001 tax cut, their federal tax burden stayed level at best and increased at worst.

Catherine Reynolds in the July 20, 2008 online edition of Economix updates those figures further reporting that in 2007 the top one percent of taxpayers paid 40-42 percent of total federal income taxes representing the second year in a row that the wealthiest one percent paid more income taxes than the bottom 95 percent.

What if we were to raise tax rates further? Again there is interesting historical evidence reported by the National Center for Policy Analysis. In the 1920s the top rate fell from 73 to 25 percent but the wealthy went from paying 44 percent of the tax burden to 78 percent during the decade. A similar result occurred when President Kennedy cut the tax rate during his administration. And in the 1980s after the Reagan tax cuts the top one percent saw their share of the income tax burden increase from 17.6 percent to 27.5 percent. Clearly, time and again, raising the marginal tax rate cuts rather than increases the federal “take.”

Conversely, tax increases reduce incentives, drive business to cut costs (read “jobs”), move outside the United States and reduce research and development expenses and innovative risk taking. This country evolved from a standing start in the 18th century with a puny population, to an international economic engine, which lifted millions of people worldwide out of poverty as a result of private effort, private capital and private risk taking. We created industry after industry and millions of jobs, yet the left focuses on anecdotes of the profligate life style of a relatively few wealthy people who publicly flaunt their opulent life style. But truthfully, do we really care if in the course of creating jobs and economic security for the “many” there are a “few” who become very rich?

There is another disincentive, which every now and then gets the public’s attention: the estate tax (or as conservatives call it “the death tax”). Prior to the Bush tax cuts the government taxed (confiscated some might say) 55 percent of a decedent’s taxable estate over $1 million. Under the Bush program the estate tax was to be phased out until there was no such tax in 2010 … only to spring back to life, just like the Bush income tax cuts, in 2011 at the 2001 rate. Everyone believed at the time that over the following ten years a compromise would be reached by Congress, not only to prevent the expiration of the tax in 2010, but also to have a lower rate and a higher exemption amount thereafter. Since Congress rarely misses an opportunity to be irresponsible, that hasn’t happened. This clumsy handling of tax policy regarding residual wealth, net of all taxes paid during someone’s working life, has cost the public billions of dollars in legal fees trying to adjust wills, trusts and marital deductions to this unresolved matter.

But let us return to the disincentive of the death tax. After having one’s income taxed at rates up to 39.6 percent, paying Social Security tax of 6.2% if you are an employee (or 12.4% if you are self employed) on the first $106,800 of earnings, state income taxes of up to 12 percent in some states, Medicare tax of 1.45 percent on total taxable income (2.9% if you are self employed going up to 3.8% on ALL income, including interest, dividends and capital gains, which the left refers to as “unearned income,” under Obamacare), sales taxes up to ten percent in some cities and states, the government under this most hideous of taxes would take 55% of anything you might have left over for the children or grandchildren.

Essentially the United States is heading toward what might be called a tipping point. Increased government takeover of historically private personal obligations initiates a vicious cycle. The more we have a society where substantial numbers of people pay no taxes (now close to 40%), the more we create a voting bloc of citizens who will inevitably support new programs for which they don’t have to pay. Business people have a term for this. They dislike investing money with partners who do not invest even a minimal amount with them. It is called having “skin in the game” another way of saying that we all need to have common incentives.

We have now gone full circle in this essay. Who is wealthy? Is it someone who has any disposable money? How much should they pay? If you are a married couple raising children in Washington, D.C., New York, Los Angeles, Boston or San Francisco, to mention a few costly places, does earning $300,000 make you wealthy so that close to 40% (more if taxes are raised by the Congressional leadership) of every additional dollar earned should go to Uncle Sam? Are you a morally bad person if you do not want to shoulder an ever-increasing government appetite to provide more and more benefits to a segment of the population who view these benefits as if they are birthrights?
In our view the questions answer themselves, but as we said earlier in this essay it is all in the mind of the beholder.

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