[Dan’s Note: Keep in mind that Progressive means socialistic. Progressive means taking money away from those who earn it and giving it to those who do not earn it.]
The US Tax Code is designed to be progressive, meaning that the more money you make, the higher your tax rate. This is accomplished through tax brackets with increasing marginal tax rates applicable to income within that bracket. Liberals, however, complain that the current Tax Code is not progressive enough and that the wealthy should pay more.
The Tax Foundation recently published tax statistics from 2009 that tend to take the wind out of the sails of the liberals. Here are just a few observations based on the data:
1. The top 1% account for 16.9% of adjusted gross income (AGI), but pay 36.7% of all income taxes;
2. The top 5% account for 31.7% of total AGI but also shoulder over 58% of all income taxes paid; and
3. The average tax rate on the top 1% is higher (24.01%) than any other group, despite lower capital gains and dividend tax rates. The bottom 50% pays an average income tax rate of only 1.85%.
The results are clear “ even with access to lower rates for dividends and long-term capital gains, the top 5% and top 1% pay taxes at a higher rate than any other demographic group. What’s more, the top 50% of households pay almost 98% of all income taxes. That sounds progressive to me. Here’s what the Tax Foundation said about it:
Although the 2001 and 2003 tax cuts were across the board (even though certain provisions within those cuts were targeted at various income ranges), the federal individual income tax remains highly progressive. The average tax rate in 2009 ranged from around 1.9 percent of income for the bottom half of tax returns to 24.0 percent for the top 1 percent. With the possible exception of the estate tax, the federal income tax is the most progressive tax in the United States, and these numbers show why.
More on Capital Gains
As last month’s article notes, it’s very important to consider all of the various changes in tax laws before making any generalized comparisons. Nowhere is this more important than in tax rules governing long-term capital gains. With the revelation that billionaire Warren Buffett pays a lower rate of tax than his secretary, thanks to special rates on dividends and capital gains, these tax breaks have come under much more scrutiny.
Unfortunately, the only consistency of historical long-term capital gains tax rates is that they are inconsistent, changing every few years. Obviously, all of this change makes it very difficult to draw meaningful conclusions when reviewing tax data. Said another way, there’s little wonder that both sides of the capital gains tax debate can claim victory when reviewing the same data. All you have to do is drop a couple of years like the CBO report described in Part I last month, or extend your analysis back into the 1950s when exclusion amounts were common.
The debate is as follows: Democrats say that higher capital gains rates will raise additional tax revenue without harming the economy, while Republicans say that higher rates will not materially affect revenue but could hurt business investment and, in turn, jobs. Who’s right?
When reviewing the tax receipts since the tax law change in 1986, it’s difficult to argue that higher rates produce greater revenues. In fact, capital gains tax revenues tend to be higher when tax rates are lower, as a general rule. It is also significant that realized capital gains as a percentage of GDP generally follow the same pattern “ higher when tax rates are low and vice versa.
So, while Mr. Buffett and his billionaire buddies presently pay a lower rate of tax on this income, they also tend to realize more long-term capital gains when rates are low, producing more revenue. Isn’t that the bottom line we’re looking for? When tax rates move higher, investors tend to hold onto appreciating assets rather than sell them, escaping the higher tax rate. So, based on actual tax receipts, the Republicans appear to be correct.
Those who argue against lower capital gains tax rates obviously can’t dispute the historical tax collections. However, they say that the jumps in tax revenue before a capital gains tax rate increase or after a rate cut are only temporary phenomena. Over the long haul, they argue, the lower rates will produce less revenue.
As proof, they trot out projections by the CBO and others which forecast that tax revenues will suffer over the long term if capital gains tax rates remain low. Yes, the CBO, that bastion of accurate budgetary projections highlighted in last month’s article! We all know the problem with CBO projections is the assumptions used. In the computer world, they have a saying, garbage in “ garbage out. The same goes for the CBO.
Another argument used by those against lower capital gains tax rates is that most middle-income households do not benefit from tax breaks related to capital gains and dividends. According to an article from the Center on Budget and Policy Priorities, the Tax Policy Center has estimated that the top 5% of households by income receive 83% of total capital gains income.
We’re now back full-circle to the liberals’ desire to wage class warfare. Can you truthfully say that just because a tax break isn’t available to most middle-class taxpayers that it shouldn’t exist? The special tax rates for dividends and capital gains are there for a purpose (see below). If the purpose of the tax break is still valid, then that should dictate its value, not the demographic group that uses it the most.
As I have said before, the capital gains tax rates are designed to provide an incentive for investors to take risks necessary to invest in new and existing businesses. The chief risk is that they may lose all of their investment, something not considered by the tax-the-rich crowd.
Given the long-term history of capital gains tax rates, perhaps the best way to say it is that realized capital gains tend to seek the lowest level of taxation. Investors know that capital gains rates change with almost every administration, so they are likely going to be content to just hold onto their appreciated property during higher rates, awaiting lower rates that are sure to follow.
Tax Breaks for Everyone!
In all of the hoopla surrounding the tax-the-rich rhetoric, we sometimes forget that there are tax loopholes written into the law that benefit middle-class and even lower income taxpayers. A recent Washington Post Special Report notes that there are 172 total tax breaks written into the tax code. 116 of these are reserved for individual taxpayers. Here are a dozen of the more common tax breaks available to virtually anyone, along with their projected cost in terms of lost revenue for 2011:
1. Employer-provided health insurance & cafeteria plan exclusions: $146.6 billion
2. Employer retirement plan contributions and earnings exclusion: $105.8 billion
3. Home mortgage interest deduction: $93.8 billion
4. Medicare benefit exclusion: $63.6 billion
5. Earned Income Tax Credit: $52.4 billion
6. Charitable contribution deduction (including education and health): $43.5 billion
7. Annuity and life insurance gains grow tax-deferred: $25.7 billion
8. Real property tax deduction: $22.8 billion
9. Educational tax breaks (various): $17.5 billion
10. Individual Retirement Accounts: $17.3 billion
11. Gain from sale of principal residence (within limits): $16.5 billion
12. Medical expense deductions: $13.5 billion
(Source: Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2010 “ 2014)
These 12 tax breaks were expected to cost the federal government a total of $619 billion in 2011, or roughly half of the estimated deficit of $1.3 trillion. Now compare some of the individual totals above to the cost of capital gains and dividend taxation, which was projected to be $84.2 billion in 2011 in the Joint Committee’s estimate. Even if you did away with all favorable tax treatment of long-term capital gains and dividends, it would amount to only a drop in the bucket when compared to the deficit and accumulated national debt.
That’s no-doubt why President Obama and others have already recommended chipping away at some of the tax breaks above for those with higher incomes. However, it won’t be long until the government’s insatiable need for money will begin to push down the threshold of who is rich, until we see the burden hit the middle class. Count on it! [Dan’s Note: If we allow these progressive (i.e. socialistic) ideas to continue, all apartment owners will eventually be treated as if you are also part of that so-called 1%!! Be careful about what ideals you endorse “ it will eventually apply to you. Example: If you supply housing for two families and 90% of the population struggle to supply only housing for themselves, what does that make you? Answer: Rich! And, they will come after you next!!!! You are already wealthy and part of that 1%.
In this article, I have tried to make the point that, while the tax-the-rich mantra has a populist political appeal, it doesn’t always result in additional tax revenue. Thus, if the Democrats are successful in raising tax rates on the wealthy, they could end-up winning the battle but losing the overall war of reducing budget deficits and federal debt.
Yet recent polls show that Americans now generally favor taxing the rich. When you really get down to it, however, the issue isn’t necessarily taxing the rich, but rather tax someone else other than me. Most people are not in the top 1% and do not make a million dollars per year and may not know anyone who does, so they think those paying higher taxes are others who can obviously afford it.
The problem is that due to the flexibility many wealthy individuals (especially the top 1%) have in regard to how and when they realize income, the actual tax revenue generated may fall far short of what is needed to significantly reduce deficits. Where do you think they’ll look then?
One thing is for sure in this age of record large budget deficits: politicians will be looking for ways to raise taxes. The Democrats are already targeting beneficial tax breaks like home mortgage interest, employer-provided health and retirement benefits, charitable giving, etc., etc. [Dan’s Note: Prop 13 as it applies to apartment buildings.]
Once they figure out that the reduction or elimination of these tax breaks don’t create enough revenue to make a significant dent in the deficits, where do you think they’ll look then? Can you say, tax increase on the middle class? Case closed!
Gary D. Halbert is the president and chairman of Profutures, Inc. Subscription rates for Forecasts & Trends is $197 for 12 issues and may be obtained by visiting his website at www.profutures.com.