Income Inequality: Can We Tax Our Way Out of Trouble?

Emmanuel Saez just published his study on income inequality, and people are going ballistic about it.

Incomes may not be equal, but neither is the tax burden. Consider this: In 2007, the last year for which IRS data is available, the top 1% of incomes in the country, with a minimum of $400,000 in AGI, paid 40% of all personal income tax. And the top 5% paid more than the other 95%.

You might think this is fair, and maybe it is. However, if higher taxes on the top income earners are enacted, it will spawn a different problem.

The fact is the majority of Americans currently barely feel the burden of income tax, as 40% of Americans pay no income tax at all. Having a populace that thinks everything Congress spends money on is not their problem is damaging to democracy. People are likely to support any new expenditure, knowing it won't burden them. That support feeds even more spending from caviling politicians looking for popular measures.

And maybe this is the reason why people are so callously loutish and indifferent about the federal debt, even as it is now at levels unprecedented since World War II, at about 80% of GDP, or over $11 trillion. They think they have no skin in this game.

But they do. Our fiscally reckless policies have major adverse consequences. They will inevitably cause the dollar to devalue, interest rates to rise, and inflation to increase.

This already spooks investors. International investors are so worried that Secretary Geithner had to publicly state the administration is committed to shrinking the deficit back to sustainable levels. His words may not be relevant because it is Congress that holds the purse strings, but the concern is there nonetheless.

Buyers of U.S. Treasuries are also showing their discomfort. Recently, rumors spread that a Capitol Hill vote on a health care deal is further delayed. Interest rates immediately declined and the dollar strengthened. This is no coincidence. Regardless of your personal opinion on health care reform, the fact is that health care could add another trillion dollars to the deficit over the next ten years. By pushing the health care debate back, that danger is alleviated.

The national deficit problem is exacerbated by substantial household debt. There are approximately 110 million households in the U.S. Of those, about 75 million are homeowners. Of those 75 million homeowners, approximately 68%, or 51 million, have mortgages. As of the end of the first quarter of 2009, about 14 million U.S. homeowners, or approximately 27% of all homeowners with mortgages, had negative equity.

That is a staggering number. And it is getting worse by the day. Before home prices stabilize, perhaps 25 million homeowners will have negative equity, or close to half of all mortgagors.

Borrowers with negative equity may be forced to default if they lose their job (unemployment is at 9.5% and trending higher) but they also may be "strategically" defaulting even if they still have a job, as they lose hope of recouping the purchase price of their home and can now rent a similar house at a price lower than their mortgage payment. So our runaway spending has real life consequences for everyday Americans.

I would argue that when people want to keep what they earn, they are not being greedy or unenlightened. And wanting to take what you earn is not progressive. But we digress. The point is, you can't raise taxes on the rich without negatively impacting their productivity and enervating their will to work. And without the most financially productive members of society, the poor will simply be left with more of the burden.

Federal outlay as a percentage of GDP is going to be 27% in 2010. Higher taxes are not a sustainable policy. Instead, there is simply no alternative other than aggressively cutting back spending.


Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at [e-mail].

Comments

[Konnie]

nice try, as you can see by the comments no one is buying your bs....

[dadw5boys]

The true bottom line is that few people ever pay enough taxes in their life time to even pave the roads they drive to get grocerys.

No business has built a highway ~ a bridge~ or a tunnel ~ we the American People have used our combined effort to pay for these things.

So when a Business or some Billionaire builds a highway or bridge on their own I will listen to self centers published articles . Call me when that happens, ok.

[-brandon-CAL]

So we should keep raising taxes on the rich when, like you said, few will ever pay enough in taxes to pave the roads they drive on? When 40% of Americans don't contribute to the tax base at all I believe based on principle that they should contribute. It may not be "progressive" but in my view fair. If you live here and reap the benefits you should contribute (of course not a crippling amount). I completely agree with the author that raising taxes on the rich is only a temporary solution that could produce no long term positive effect. They are the ones who spend money and stimulate the economy. I really wonder how much the "progressives" think that they should pay. 60%? 70%? What is the acceptable number for you people? How would you feel if half of the paycheck you earned or maybe even more went to the government? Is that really fair?

[GrainOSand]

Taxation should be fair. Loopholes should be closed. Those who make more should pay more. It is simple. As for all of this 40% nonsense, all I know is in my career I worked the first three months of the year free...bas­ed on taxes. I did not complain because I was still making mint (for me). Greed will have you thinking that no amount is ever enough to be satisfied. So much clinging in this society, guns, religion, money...do you people know that death is imminent for us all? You ain't taking a dime with you, why all the hording and clinging in fear (as if life is forever) especially when I hear all the boo-hooing about the babies, and the future generations vis-à-vis the deficit? If there were real concern for the future, greed would not be so damned rampant. We had the Regan cuts and the Bush cuts and the income gap grew wider, and now you are implying more of the same -- I don’t think so; I hope not; that would truly be insane.

I am for the rich being rich. I will never back unfair policy that penalizes individuals for individual accomplishment. It is not unfair to ask the rich to pay their fair share. Follow Mr. Gates and Mr. Buffets example, they are giving it away to worthy causes. What is more worthy than one's own country?

[Hank007]

Now be a good writer. and run along and look up in actual dollars what the giant corporations pay in federal tax. (hint: Microsoft $0). They are allowed to use the 'market' i.e. consumers however they want, get laws made to accpomodate them, and pay nothing for the priviledge. On paper, we have the 3 rd lowest corp tax rates in the world, in practice, the lowest.

[dadw5boys]

Nice try to Baffle us with BS wasn't it.

Funny how all that falls apart when the wealthy get to write off meals, trips, all personal taxes, incestments overseas, while the take salarys from non profits they setup to aviod taxes.

Really funny.

[ThePeacemakers]

Once again...bu­ll crap article.

Anyone who works and gets taxes taken out of their paychecks is a TAXPAYER.

"40% of Americans don't pay any personal income tax at all" is a bunch of bull. Are you saying 40% of Americans, of age to pay taxes, don't work?

[yappnmutt]

the problem with your analysis is two fold. the easiest one first. the only time .gov considers lowering expenses is during economic collapse. taxation retes will take a back seat to other more pressing issues during that time.

taxes should be based upon wealth percentages and not income. that's the only way for the tax structure can reflect the responsibility of those that benefit most from the usa economy to pay the most in taxes. that won't happen either.

the only viable, possible change is for those that pay ss taxes to be exempt from income taxes and the rest should have to pay a flat tax based upon gross income and not adjusted gross income above the amount that is taxed by ss and medicare.

[FoonTheElder]

What a load. Whenever the right wingers and corporatists talk about taxes, it's always only personal income taxes, as if that is the only tax out there.

The biggest reason for this continuing inequality is that the TOTAL percentage of taxes that the top earners pay on their income isn't much different than anyone else. The top 1% pay at a rate (30.9%) that is less than the next 19% (31.5% to 32.2%), and not much of a larger percentage than anyone else except those in the bottom 20%.

Top 1% pay 30.9% of income in taxes-avg income $1,445,000
Next 4% pay 32.1% of income in taxes-avg income $253,000
Next 5% pay 32.2% of income in taxes-avg income $144,000
Next 10% pay 31.5% of income in taxes-avg income $101,000
Fourth 20% pay 30.0% of income in taxes-avg income $66,100
Middle 20% pay 27.0% of income in taxes-avg income $40,000
Second 20% pay 22.3% of income in taxes-avg income $24,500
Lowest 20% pay 18.7% of income in taxes-avg income $12,000

There's no question who has already won the class war. The top 1% are actually undertaxed.
http://www.ctj.org/pdf/taxday2009.pdf

[sonofsamphm1c]

Interesting statistics.

[joebaggadonuts]

Yes, and it would look a lot better for the progressives if you noted that Foon is talking about AGI rather than pure income (if that's true) and that it ignores all the off-shored and deferred income and black market and bribes which somehow don't get taxed at all. And do you think your congress people pay taxes on the re-election slush funds they use for their own travel and expenses?

But I think that long term the solution is to move away from income taxes and toward VAT, excluding food and clothing.

[General Washington]

The problem with these wealth taxation - and effect thereof - arguments against increasing the marginal rates on both income and capital gains is so bloody simple it defies logic.

The goal of wealth is to accumulate more wealth. Period, full stop.

It is not to spread that wealth around in the form of jobs. That would be contrary to the goal of increasing your wealth.

Evidence to these facts are amply demonstrated by the ever increasing productivity rate and the ever decreasing hourly wage rate.

Increasing both income and investment taxes on the wealthy furthermore prevents the temptation to invest in dangerous instruments such as CDS's and high-interest loan bonds, or those very same "investments" that have just screwed everyone in this country EXCLUDING THE WEALTHY!

[MMartha]

Once again Mr. Schram, isn't it interesting that you want to live in a country where there is no equity in pay but there is equity in cost!

[AnotherMcIntosh]

The idle rich pay 40% of the taxes?

Is this what you want us to believe?

The idle rich regularly increase their wealth by means other than receiving money which is reported as income.

Last year, for example, one particular individual made news in financial centers by increasing his wealth by over a billion dollars. At the start of the year, he began with almost a half-billion dollars. Some months later, he tripled it. This was celebrated by some of the greedy rich because it set another example for them to follow.

Did he pay a 40% tax rate on the increase in his wealth? No. The rate of tax that he paid was much lower. This increase in wealth was taxed at the capital gains rate.

His salary of a few million dollars was taxed at the rate applicable to the ultra rich, but that was only a few million.

The ultra rich also know how to offset reported income with paper losses.

Warren Buffet says that it is wrong from him and others in the ultra rich class to pay a lower effective tax rate than his secretary. He would never be taken in by any statistics which fail to account for capital gains and paper losses.

[Steven Duke]

I'll make $100 a day, you can make $10 a day and we can each pay $5 a day in taxes and call that equal. You are a fraud, your ideology is a fraud and your economic ideas are a fraud. The rich in this nation did not "create" anything, they stole it from those who created it. Extortion, black mail, shell games and lies. And as long as the degenerates who sit around the pool at their country clubs collecting dividend checks on someones else's work are paying less of their money in taxes than the pool boys bringing them their drinks you can stop selling your free market fallacies on the huffpo because we are not the deluded sycophants that believe you are entitled deserving truthful or necessary.

[-brandon-CAL]

What about the people who worked hard through college, moved up in the world because they were a good employee and had something to offer their company, and then happened to become wealthy because of it? That doesn't sound like extortion, blackmail, shell games and lies to me. And btw I'm speaking of the majority of the wealthy. The majority are human beings with compassion just like you. Not everyone is this greedy pig who will step all over other people to get ahead.

[sonofsamphm1c]

If you add up the AGI for top 1% of all taxpayers, you get 2 trillion dollars. So if they were taxed 100%, which I am not suggesting, it would do extreme damage to the current deficit.

[pfrogger]

thanks for the rich man perspective. I'm so sorry that you're hurting and won't be able to buy that 5th vacation home. it must be tough.

why not start paying YOUR fair share. why do hedge fund managers only have to pay 15 %? are you guys special? I don't think so.
http://www.huffingtonpost.com/2009/02/26/will-the-taxman-cometh_n_170082.html
"hedge fund and private equity managers pay a 15-percent capital-gains rate on the multimillion-dollar fees they collect -- substantially less than the top income tax rates paid by their secretaries, chauffeurs, and the pilots of their private jets."

Buffett blasts system that lets him pay less tax than secretary - http://www.timesonline.co.uk/tol/money/tax/article1996735.ece
even buffett sees the problem. he makes millions but pays less taxes in percentage. and he knows it's wrong!

[KDog76A]

and then there is the payroll tax (social security, medicare etc) thats another 7.5%...

[joebaggadonuts]

Actually it's more like another 15%. Your employer would otherwise have an additional 6.2% plus 1.45% to pay you with if s/he did not have to fork it over for SS and Medicare on your behalf.

http://law.freeadvice.com/government_law/social_security_law/social_security_tax.htm

I'm not sure whether Alan ignores this purposely or accidentally, but he certainly does not mention it.

[Aaror]

Oh, one question we should all ask anyone who thinks we can cut spending to get out of the hole we are in, "Where?"
They will sputter about waste, but press them, if they can't give you a choice, present them with this one:
Social Security-cut benefits 40%
Medicare/Medicaid, end the program.
Unemployment Insurance, end the program.
All of the above choices present an interesting question, as each is funded by taxes specifically to pay for the program. If you ended these programs to eliminate the deficit, people would be paying the tax without getting the benefit.
The remaining two choices (the only two choices left):
Eliminate the military-ALL OF IT.
Eliminate all of the government but the military-eliminate the department of homeland security, the FBI, the CIA, FEMA, the court system, the FDA, the national parks, close every federal building, fire every federal worker.
Yes, it is that bad. Depending on how you want to look at it, we have either been borrowing the budget for the entire military, or for everything else!

[Aaror]

I think you missed a step in your argument.
By pointing out the danger of huge deficits, you convinced me to raise taxes on the rich to pay them down. Then you warned me of the recession, and I realized that we will have to increase government spending. Then you pointed out that millions of americans are so broke they don't make enough to owe taxes, and it reinforced my desire to tax the rich. Then you pointed out that homeowners equity is drying up, and I realized that inflation would be great for those people (as opposed to our current deflation).
Then you say we need to fight inflation, fight taxes, and reduce spending..­.
I'm confused.

[KDog76A]

"By pointing out the danger of huge deficits, you convinced me to raise taxes on the rich to pay them down."

You could raise taxes to 100% of the income on the top 5% of the population and it would not reduce deficit spending.

"Then you warned me of the recession, and I realized that we will have to increase government spending." Who told you this is how its supposed to work? Cutting taxes fights the recession.

Equity is only being dried up on people who overbought and overborrowed. This is a result of government interference through things like Fannie Mae Freddie Make and FHA.

[sabredance]

What is the source of most subprime loans? FNMA? Freddie? FHA? Nope, independent mortgage lenders: ~80%.

What is the default rate on those loans? ~60%