The Increasingly Risky Federal Income Tax Portfolio
By Randall Holcombe • Friday August 13, 2010 1:45 PM PDT • 8 Comments
Many people are aware that over the years upper-income people have been paying an increasingly large share of federal income taxes. One consideration is determining someone’s “fair share” of the tax burden. For example, (all data taken from this web site), in 1980 the top 1% of income earners paid 19% of all income taxes. By 2007 the top 1% paid more than 40% of all income taxes.
Similarly, the top 5% of income earners paid 37% of all income taxes in 1980, and 61% in 2007. The top 25% paid 73% of all income tax payments in 1980 and 87% in 2007.
I will leave it to others to decide if these tax shares are fair. Another concern, which I will set aside for the moment, is that if a minority of taxpayers are paying virtually all taxes (the bottom 50% paid less than 3% of all federal income tax payments), it’s easy for the majority at the bottom end of the income distribution to want more federal spending, because other people will be paying for it.
Something I haven’t seen discussed is that incomes at the upper end of the income distribution tend to be more volatile. Wages don’t fluctuate as much as investment returns, bonuses, commissions, and so forth that make up a larger share of the incomes of upper-income people. So, as we increasingly move toward taxing the rich, the tax portfolio of Uncle Sam becomes increasingly volatile.
While the Obama administration is interested in taxing high-income people more, such a move will make the tax system increasingly dependent on the condition of the economy. When high-income people are taxed more, tax revenues will go up more in a boom than they would with a tax system that spread the burden out more, and will decline more when the economy is sluggish, as it is now.
Many of President Obama’s policy proposals would have negative impacts on economic growth, ranging from his health care initiatives (partially passed this year), his energy policies (which face an uphill battle at the moment), his redistributional policies (including the extension of unemployment benefits), and his regulatory initiatives (such as the recently-passed financial regulations). Setting aside whether they are in any larger sense desirable policies, one thing they will do is reduce tax revenues by more than if the tax burden were more evenly shared.
As the president proposes placing an even larger share of the income tax burden on upper-income Americans, this, in concert with his other policies, will have a negative impact on aggregate revenues collected. The president claims to be concerned about the looming future deficits, but his policy proposals suggest otherwise.
Back in 1980, when the top 1% of income earners paid 19% of total income taxes, the highest marginal income tax rate was 70%. Now, the highest rate is 35%, and the share of taxes paid by the top 1% is more than double what it was in 1980. Higher tax rates on upper-income taxpayers don’t necessarily bring in more revenue.
Tax volatility like this has been referred to as an “automatic stabilizer,” designed to slow the economy down as it grows, and stimulate it during downturns (with “automatic” tax reductions). If the economy starts to recover, do we really want to slow that recovery down? And on the other side, it should be obvious that increasing tax rates won’t “stabilize” a sluggish economy.
There are many reasons I have seen mentioned to oppose the tax increases President Obama proposes as the Bush tax cuts expire at the end of 2010. One I haven’t seen mentioned is the increased volatility this would induce in aggregate income tax revenues.
Tags: Budget and Tax Policy, Economics, Taxation 
Those poor rich folks. Let’s all shed a tear for them. However, I’ve also noticed that the sales tax on a pound of filet mignon is much higher than the sales tax on a pound of hot dogs – how unfair!
The percentage share of federal income taxes of the top 1% would seem to be consistent with their share of aggregate wealth and total annual income. I would also point out the the top 1% are in fact the elite of our society and are the very people who bankroll politicians and are among the most politically connected in America. I can’t help but wonder why they continue to support politicians that cause them so much suffering, the poor things.
Perhaps the elite prefer the system that exists over a free-market economic system that has no income tax. While we are talking about fairness in taxation, let’s consider that a minimum wage earner pays a much higher percentage of income in FICA taxes than top wage earners.
Let me be the first to stand up for America’s elite and call for the abolition of all federal taxes and the federal government for the sake of fairness for all. Meanwhile, we could take up a collection to help out the top 1%.
Tom Blanton | Aug 13, 2010 | Reply
Those poor FICA payers — what you don’t say is that the formula for PAYOUT is incredibly slanted in their favor. Has been for 50 years and the histories of Social Security show this redistribution was intentional. SSA was/is a great cover for redistribution — AND left-liberals can complain that the poor are “taxed too much!” Beautiful.
As for the generalization about the top 1% being “connected,” you are talking about millions of people. All can’t be so connected, and moreover the “connected” are often at odds–even businesses.
I would be much of the volatility comes from self-employment income. My years of self-employment income are WAY up, down, then nothing, then WAY up again. And that is my SECOND job (how do you think people get in the top 1%? It is documented that they work longer, more jobs, stay married, multiple earners, etc., etc.).
But screw me. If I have a good year, my self-employment tax rate (total) is over 50% in a low tax state. I deserve it. Beat me, beat me. I won’t wok a 2d or 3d job again.
Jonathan Bean | Aug 14, 2010 | Reply
Of all the human emotions, envy is surely among the ugliest. Thou shalt not covet, and all that... I’m referring to you, Tom Blanton. Your little missive positively oozes with envy for what others have.
Instead of whining about your neighbor’s good fortune, why not question why your predicament is less than you’d like it to be, then take positive steps to improve matters? It sure beats having politians steal his stuff and hand you the loot.
After all, whose property is it, Tom?
Steve Hogan | Aug 14, 2010 | Reply
Just as a matter of fact (from the first link in my post), the top 1% of income earners earned 22.83% of total adjusted gross income, and paid 40.42% of total income taxes. The top 5% of income earners earned 37.44% of adjusted gross income and paid 60.63% of total income taxes. So upper income people pay income taxes more than in proportion to their incomes.
Randall Holcombe | Aug 14, 2010 | Reply
Steve, perhaps you should take a second look at the ooze on your computer – it might be the ooze of the undeserved pity for the poor top 1% who are paying more than their “fair share” in taxes to a statist system that is obviously serving them rather well.
I guess you all must have thought I was joking when I said taxes should be abolished in fairness to all. While you guys shed tears for the top 1% and accuse me of envy, I’ll reserve my pity for those who are truly going through some hard times in this economy as a result of matters beyond their control. Our children and grandchildren deserve a little pity as the burden of this leviathan’s debt will fall on their shoulders.
And Steve, watch those knee jerk responses – you might hurt yourself. If you re-read what I wrote above, there is nothing there about me not being satisfied with my earnings and nothing remotely suggesting that I want government to take someone’s property and give it to me.
I’ll also stand by my belief that if you are in the top 1%, you are among the elite. They are in a good position to influence politics – certainly better than the average person.
Tom Blanton | Aug 14, 2010 | Reply
By the way, if my math is correct, there is no way possible for more than 1 out of every one hundred people to be in the top 1% – no matter how much they earn or how hard they work.
Tom Blanton | Aug 14, 2010 | Reply
Tom,
I’m not questioning your math skills. One percent does indeed represent 1 out of 100.
If your position is that taxation is theft, then we’re in agreement. The impression I get from your writing is that people in the top 1% have somehow achieved their success through something other than merit.
While there are certainly a few crooks in the bunch, we are talking about tens of thousands of people here. Most of them are the people that actually create jobs for the poor you’re worried about. The elite can live comfortably in retirement, while the masses will suffer. The current torrent of federal and state policies practically guarantee it. Is that what you want? I don’t think so.
The alternative is to allow the profit motive to re-emerge. You know, something resembling a free market. To increase employment, you need employers. The idiots in Washington haven’t quite figured that out, though they are quite adept at demonizing the “rich” (defined as anyone making more than they do). It’s great politics, but sucks morally and economically.
Steve Hogan | Aug 14, 2010 | Reply