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U.S. Income Tax: Who Paid What in 2009 and the Flat Tax Scam

December 22, 2010

Americans have witnessed a rare phenomenon over the last two months, a conversation regarding income inequality and taxation actually entered the mainstream consciousness. This conversation culminated last Friday when President Barrack Obama passed legislation to extend the Bush Tax Cuts.

Because Americans tend to shy away from talking directly about income inequality; and because no one wants to think, let alone talk, about something as boring and generally awful as taxation, when the conversation did come to the forefront you got a lot of weird, incorrect, and bizarre polemics about it.

Among the bizarre arguments I’ve heard are: The rich make up such a small percentage of the population, and that they should pay an equally small amount of taxes. Redistributive Taxes are Socialist/Communist, but a flat-tax is not. Tax cuts are better than/different from government spending when it comes to deficits.

While everyone knows taxes are bad, because the government uses them to pay for things we don’t want, we tend to forget those services and public goods that we enjoy or are essential to the free-market (but that is another post entirely). People just don’t have a great grasp of what to think or how to talk about the subject.

So I decided to take a look at the actual income-tax numbers from 2009, and write a brief post on who pays what and the theories about taxation.

The first point I wish to make is that the rich pay a lot, when it comes to income taxes:


If you look at this chart, you’ll notice that the lower half of the country (median household income is $50,000) accounts for a small amount of total income tax (7.6% of the total), and those making above $500,000 pay roughly 1/3rd of all income taxes.

Clearly the income tax is in some way redistributive, with those at the top paying more relative to those at the bottom. However, the flat tax is similarly redistributive as the reason the rich pay more in taxes is not only because they have a higher tax rate (The rich pay at a 35% rate while the middle-income households pay 25%), but also because they simply have more money.

As you can see, the income distribution is clearly concentrated in a small percentage of the population, while the bulk of U.S. households account for a small share of total U.S. income (the bottom 65% of U.S. households receive 23% of the annual income generated).

We can compare the redistributive nature of a flat tax by comparing the U.S. population’s current income-tax payments to how the percentage of total income is distributed in the United States (as total income would be taxed at a flat rate).

What we see is the flat tax is still a redistributive tax, the rich are paying more in taxes, however the tax rates on the lower half of the population rise significantly while the tax rates on the rich fall significantly. The rich pay more because wealth and income in the country is highly concentrated in the upper-class. With the top 1% of the country accounting for 17.8% of the nation’s household income (note: this does not include assets, just yearly income). Thus, if we maintain the current tax revenue the government receives from income taxes, a flat tax means a tax increase for everyone making less than $200,000 a year and a tax decrease for everyone making more than $200,000 a year. Now that is a scam!

Analysis

Now that we have seen who is paying how much and why in the U.S. we should ask what is the appropriate tax policy? Clearly when income (which makes up much of the tax base) is so concentrated in the hands of a small group of individuals, that small group will end up paying more in taxes then their share of the population. This cannot be amalgamated by taxing assets, because asset ownership is even more concentrated in the U.S.’s upper-class. So if you are basing your tax policy on any sort of economic phenomena the rich will end up paying more in taxes (probably on the basis of how much “richer” they are then everyone else). And we know that you need to tax something.

Taxes are necessary to fund government services and ensure the foundations of the free market, and even the most ardent libertarian will likely agree that national sovereignty needs to be defended by a tax-funded army (or else Cuba may invade “Libertarian U.S.A.” and institute Socialism). Furthermore, the U.S. government should not aimlessly print money unless it wants its currency to become debased; as a result cutting taxes works just like increasing government spending in terms of driving the deficit.

What this shows is that you can not have a conversation about cutting taxes across the board without a conversation regarding government spending as well. To argue that taxes are too high, without looking at where the money is going is foolish and childish. You cannot have your ice-cream and eat it too. If you are serious about cutting taxes, you have to argue for concurrent specific cuts in government services (and even Reagan officials who invented the policy admit “starving the beast” does not work).  Thus what a serious-minded person knows, is that if taxes are too high in generally then what that really means is there is a disagreement about how the U.S. government is allocating and spending tax-revenues. If a person says taxes are too high on a specific income group, they are arguing to raise it on another group (or cut government services and infrastructure), and are likely from that income group or paid by them (because why else would you want to raise taxes on someone else?).

As for what is fair, that is arguable: should we have a flat tax or a graduated income tax? But you cannot cut taxes for some without raising them for others. Generally, there are two approaches to thinking about fair taxation. The Ability-to-Pay principle, put forth by Rousseau and John Stuart Mill, states that tax rates should be based on the ability to pay. The Benefit Approach principle, put forth by Hobbes and Locke, states that people should pay based on the benefits that they receive from the state.

My general opinion on the issue is that a redistributive tax is fair on both counts. Not only are the rich excellent at hiding wealth through their tax attorneys and empirical evidence shows taxing them at a higher rate doesn’t change their incentives to work, but they generally own or work in industries which benefit from government subsidies and protections, operate businesses which benefit from imperfect competition (oligopolies and barriers to entry such as government regulation), and also must have benefited the most (gained the greatest utility) from living in this great country which afforded them such wonderful infrastructure and protections so that they could amass such wealth. Thus it makes sense that they pay more, simply because they’ve received the most from the civilized society that our government allows.

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4 Comments leave one →
  1. March 7, 2011 3:31 pm

    See the following link for further discussion on the redistributive implications of a flat tax and questions of fairness:
    http://www.ppionline.org/ppi_ci.cfm?contentid=1398&knlgAreaID=125&subsecid=163

  2. Jaysom permalink
    April 18, 2011 1:23 pm

    I don’t see how a flat tax is a scam. The scam is that about half of all outlays of the federal and state governments are entitlement payments for which most of the high income taxpayers are not entitled. The scam is that about half the population does not have any skin in the game of taxes because they do not pay income tax.

    A flat tax is the only fair tax. Make it one rate. No deductions. No exemptions. No double and triple taxation. Marital status would be irrelevant. Begin taxing at $1 earnings.

    • April 21, 2011 1:11 pm

      Hey Jaysom,

      I’m glad you posted this comment because I felt as though one of the points of this article (the flat tax scam) got lost in the rest of the information.

      Now, to address your first paragraph, I’ll restate my point. Government provides public services, which are in effect public goods (i.e. the market cannot efficiently provide them because you cannot commoditize the goods in way in which everyone who benefits from them pays). Now, we have to figure out a way to pay for them. We cannot pay based on usage for many of these goods… note the fact that temporarily unemployed people are not starving and running riot in the streets benefits whole spectrums of our society… not just the unemployed.

      Okay, so how should we pay? Well every man woman and child could contribute $6,980 per person. But a flat rate wouldn’t be feasible for many income brackets… So what do you do? You tax income. That is what we currently do.

      Now you get into what is a fair rate. Your answer to this question is, its unfair if rich people pay more in taxes (oblivious to the fact they are benefiting from a higher standard of living, secured in part by the government/society). Well, news flash for you, the rich will pay more in taxes, flat tax or not… wait for it, because they have more money and therefore compose a larger share of the tax base. So your “equity” issue for those poor people making more than $100k issue isn’t solved. But you argue this point anyway because you’ve been told its “just” and what “smart” people who think they know more than policy makers say… In fact, you’ve been scammed. It isn’t “just” (the rich will always pay a higher share relative to their share of population), and it isn’t that “smart” unless you’re making more than 100k. This is because, what you arguing for is to raise the rates on everyone making less than 100k in order to lower them for everyone making above that bracket. If that’s what you want… then say it, stop acting like a flat tax is anything other than that.

      As for your second paragraph, maybe you have some good points there… but then again you’re assuming you know more about taxation than government peons who have worked in the field and have advanced degrees in the subject. Could be true, but its a hard claim to make based on nothing more than vague talking points.

      • New2Taxation permalink
        June 4, 2011 1:41 pm

        floodingupeconomics,
        Thank you for your insight into taxing.

        Jaysom thanks for the comment I agreed, but when I heard floodingupeconomics response I realized that my understanding of a flat tax rate was flawed (incorrect). I always thought I wanted flat tax, but after learning that it is a flat dollar amount, it’s not what I had in mind.

        What would be problematic or beneficial to having a flat tax percentage, so instead of everyone paying $6,980 (amount from floodingupeconomics), everyone pays 15%* on total earning. Now add in Jaysom’s caveat.
        *No deductions. No exemptions. No double and triple taxation. Marital status would be irrelevant.

        Begin taxing at $1,000

        How would this affect the national tax income? We also need to make drastic changes to reduce governments spending, but first taxes.

        Thanks in advance for you responses

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