The trouble with historical tax bracket comparisons

It seems like an absurdly small amount of people understand how marginal tax brackets work. The basic idea is that one's income is placed into multiple tax brackets, and different sections of that income are taxed at different rates.

What too many people mistakenly believe is that an American taxpayers puts their entire income into one bracket, and their entire income is taxed at that rate. That idea is flat-out wrong, and there are a lot of political arguments that depend on that misconception.

One of the most common ones is to lament or cheer that the top marginal tax rate in 1963 was 91 percent. Yes, it was, but so what? There were also 26 different brackets to get through first. The top bracket only kicked in after $400,000 for a married couple or $300,000 for a single person.

Adjusted for inflation, that's above $3.1 million for a married couple, or above $2.3 million for a single person. That's pretty much automatic earnings at that point, and very different from the 2013 tax bracket, where the 7th and final bracket kicks in at $450,000 or $400,000 to get a rate of 39.6 percent. There is no way to compare them in a way that is not arbitrary.

It is completely nonsensical to try to summarize how much the rich pay in taxes in a given year by dragging up the top marginal tax rate. I hear it from the left, and I hear it from the right, and it's wrong every time. The top rate tells us very little to the point of being nearly useless.

It doesn't even tell us what the rich paid in taxes.

Reject all political arguments that use the top rate as a shorthand way of identifying what people paid in taxes at that time.



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Bush tax cuts are the new normal

American progressives love the Bush tax cuts. You never hear them put it that way, but undoing most of them would be unthinkable to most liberals.

In 2000 the tax brackets were 15, 28, 31, 36 and 39.6 percent. By 2003 they were 10, 15, 25, 28, 33 and 35 percent, although the parameters for the brackets had shifted. While the reduction to the top tax bracket gets the most attention, the cuts at the bottom were rather large.

It's a bit complicated when we try to compare them. In 2000 the first bracket ended at $43,850 for a married couple filing jointly. In 2003, that bracket ended at $17,072. What that means is that the smallest bracket did not actually see a one-third cut for most low-wage taxpayers (unless all of their income fit in that under-$17,072 bracket) but it was a larger proportion than the cut to the top bracket, which was a little more than one-tenth.

So when you hear a critic say that most of the Bush tax cuts went the rich, they are correct in terms of dollars saved. They are not correct in terms of percentages.

There's an old parable about splitting up a restaurant check in proportion to one's income, and how when the  check is reduced (metaphorically, a tax cut) it makes sense to reduce it proportionally, but the critics will sound off about how the low-payers are not getting as big a discount as high-payers in terms of dollars paid.

That parable is rather important. Please read it.

The left hates the reduction to the top tax bracket, but they just love the reductions to the lower brackets. The lefty suggestions in Washington right now do not even consider snipping those cut. People are used to paying them, and President Barack Obama campaigned on not raising taxes to the poor and middle class. The rates are the new normal, and it's politically unpopular to consider messing with them.

Which is kind of funny, since the left swoons over speeches from Elizabeth Warren and Obama that reiterated the Oliver Wendell Holmes, Jr. quotation that "Taxes are the price we pay for a civilized society." Yes they are, so shouldn't everyone in the society be responsible for paying them?

The standard defense is that half of Americans who don't pay federal income taxes still pay taxes through sales tax and other indirect payments. Sure, that's true, but would the people making that argument accept the same logic when applied to corporations that do not pay income taxes, but do pay property taxes, sales taxes and payroll taxes? I'll wager they would reject that idea.

This tendency of lumping tax increases on the rich, but targeting everyone else when it's time for a tax cut, has given us an unbalanced progressive tax system. With such a high percentage of our taxes being paid by the rich, wouldn't it be proper to show a little gratitude towards the people who pay so others don't have to?

The biggest problem with the Bush tax cuts was not that they reduced the money the government has to work with too much, it's that they occurred in a vacuum and were not coupled with major reductions in spending.

I don't buy the line that Republicans should make a deal with the Democrats to increase the top tax bracket to 39.6 percent in exchange for spending cuts. There are two major problems here.

The first, as Kevin "Angus" Grier has beat into my head, is that our current Congress can't bind future Congresses to stick to the deal and there's no reason to expect the pledge to reduce spending would be honored.

The second is that that wouldn't raise very much money. A report indicates that raising that top tax bracket to Clinton levels would provide the government with an additional $950 billion over the next decade. However, for the last four years the federal budget has added more than $1 trillion annually to the deficit. The math is all wrong.

That deal would just lead to higher taxes, and if history is any indicator, the additional tax dollars would not go towards paying off the deficit but instead would inspire new federal spending.
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Maybe it's good the rich have more political power

Whenever the mournful dirges start about the supposed death of American democracy and how the rich have too much power, I've never stopped and asked if that's always a bad thing.

This morning a book review from Tyler Cowen stirred an idea that will bring me blank stares and quiet frowns from my friends, but it's still important to ask. Do we really want the poor to have more political power?

The argument that the rich have too much influence over legislation is usually constrained to the realm economic issues, and it props up the myth that richer Americans on average pay a smaller percentage of their income in in federal income taxes as a result of their political influence. What about other issues?

Cowen references his mood affiliation fallacy concept, which means mistakenly rejecting an idea because it criticizes something you think deserves a better reputation. He wrote:

I would be falling prey to the fallacy of mood affiliation if I simply assumed the author wanted policy to be more responsive to the wishes of the poor and middle class. Still I can ask whether this would be a desirable end. Aren’t they less educated and less well-informed on average? Don’t they also care about politics less and derive less of their status from political processes and outcomes? Do I want them to have a greater say over social issues, including gay marriage? No.

We know that education correlates with both higher incomes and higher support for gay marriage, so that issue could regress under power redistribution. Cowen also listed contradictory wishes from the uneducated, such as wanting tariffs and cheaper goods. These are impossible and more power from uneducated voters would hurt the poor.

Matthew Yglesias made a similar point:

Needless to say, the disproportionate influence of the rich on the political system is also troubling from an accountability perspective. It suggests that elected officials will be more responsive to the objective needs of the prosperous at the expense of those whose objective needs are more pressing. But pining for a world in which policy outputs precisely reflect the views of the public is neither here nor there in terms of obtaining a better political system.

No one wants a system where the poor have no political power. However, believing that giving more political power to the poor will produce benefits universally is flawed and reads like a chapter out of The Myth of the Rational Voter. The average American leftist would have a tougher time passing the social issues he or she cares about if the poor had a larger platform and voted more


This should be uncomfortable idea for anyone who believes in representative government.
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We understood the context just fine

The dutiful left has come out of the woodwork to claim President Obama's famous "You didn't build that" remark I recently wrote about is being distorted, and his true message was about the need for government programs and infrastructure to exist.

Good grief, what a bunch of naive wishful thinking.

I quoted it in full context to make my point and came away with the same conclusion. He said that the government has given some amount of help to the people who build wealth, therefor they deserve no praise or credit for anything they created. Those things were a community effort and could have been created by anyone, and it's really the government who deserves credit.

Last month when he famously said the private sector is doing just fine, I chose not to write about it because it was such an obvious mistake. His supporters and staff said it wasn't something he meant, and I didn't feel it revealed any insight into his thought process. A lot of people went after him on it and they were wrong for it.

But this is different. This time President Obama and his supporters won't admit he said something stupid off the cuff. Instead, it's people like me who are at fault for misinterpreting his clear, straightforward message.

The noble thing for the president to do is take it back and say it came out wrong when he said it. I'm not asking him to crawl on his knees, just fess up and move on. But for some reason, he'd rather blame people like me for his folly.

Give it up people. The president said something stupid, don't blame us.
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Obama jumps the shark

Elizabeth Warren had so much success last fall with her stump speech about interdependence as an excuse for progressive taxes that this week President Barack Obama plagiarized it. He said:

There are a lot of wealthy, successful Americans who agree with me -- because they want to give something back. They know they didn’t -- look, if you’ve been successful, you didn’t get there on your own. You didn’t get there on your own. I’m always struck by people who think, well, it must be because I was just so smart. There are a lot of smart people out there. It must be because I worked harder than everybody else. Let me tell you something -- there are a whole bunch of hardworking people out there.

If you were successful, somebody along the line gave you some help. There was a great teacher somewhere in your life. Somebody helped to create this unbelievable American system that we have that allowed you to thrive. Somebody invested in roads and bridges. If you’ve got a business -- you didn’t build that. Somebody else made that happen. The Internet didn’t get invented on its own. Government research created the Internet so that all the companies could make money off the Internet.

President Obama is attempting to use public goods to taint any hard work individuals have done that results in success. That is to say, any success the person has had that has had the slightest contact with something created by the government is now a full-fledged government creation. This misapplication of credit works the same way a virus assaults a living cell.

Mark Perry insists we also look at the way businesses have been destroyed by the government, such as the 13-year-old who went through the city to start up a hot dog stand only to be stomped by an unknown zoning issue. There's also the teen on Peaks Island, Maine who was hit with exorbitant fees to prevent him from competing with a taxi subsidized by the city.

Don Boudreaux, however, nailed this issue cold:

Government’s success at persuading taxpayers to fund the hiring of more teachers and the construction of new highways does not thereby give government (or teachers or highway workers) an open-ended claim upon the wealth of private citizens who benefit from these teachers or who use these highways.

He goes on to say that all of those government systems were built under a certain agreement, and the government has no right to come back and demand more than what was agreed upon.

Indeed, to take the president's logic seriously, we would have to see success in America as some kind of Faustian bargain, where individuals are free to sweat and toil in a wonderful market economy, but the moment anyone pulls ahead Mephistopheles draws near and takes it back.

Sometimes when I'm alone and the house is quiet I ask myself if I'd rather have president George W. Bush or Obama in office right now. While Bush has wasted oodles of taxpayer money and contributed to future deficits, I can't think of anything he ever said that was as half as outrageous as the communitarian nonsense from the O-man this week. I've never called President Obama a socialist, but I'm having a hard time interpreting what he said any other way.
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Can we find a definition of rich and stick with it?

This morning on NPR, Fresh Air host Terry Gross brought on guest Tim Dickinson who recently wrote an opinion piece in Rolling Stone masquerading as a news article on how American tax policy drives inequality.

Dickinson omitted a few pesky facts that challenged his thesis. Here's part of the exchange:

Terry Gross: "Have taxes become less progressive in the past few decades? And by progressive, I mean the idea that the more money you make the higher level you're taxed?"

Tim Dickinson: "The most important place where that's true is with investment income. In the tax reform of 1986, Ronald Reagan brought the top marginal tax rate down to 28 percent, which is far below where it is today, but he also brought the capital gains tax up to match it."

You see what he did? She asked him if taxes are less progressive, and his answer was to say they are in one narrow aspect. This misleads the listener into believing that taxes are less progressive in all aspects.

Dickinson's answers use a common trick people make when they barrage you with economic data to prove a point: they keep changing the parameters of the concept they are talking about. In this case, it's what group is counted as rich. In my last post, I showed how even when you include capital gains and dividends as income and factor in loopholes, the top 1 percent pays the highest tax rate in the nation, projected at 33.8 percent this year.

The Occupy Wall Street crowd set the line at the top 1 percent, and the interview starts with that parameter, but then Dickinson moves the goalpost to the top 10 percent. Then when he wants to make the point that rich people pay a lower tax rate, he moves it again to the top 400 earners with their tax average rate of about 17 percent.

He's not alone. Sometimes the line is moved to the top 0.1 percent. Irregardless, while there are a few anecdotal examples of rich people that have found a way to pay a lower tax rate, you have to leave out a lot of multi-millionaires to concoct a definition of "rich" that pays a lower tax rate on average. It's no different than holding up a handful of welfare cheats as proof that all people on government assistance are scammers.

The rich have received tax reductions in recent years, but so has everyone else. Some lefties like to point out that the top federal marginal tax rate in 1963 was 91 percent, but what they don't realize is that the lowest tax bracket at that point - the poorest of the poor - had to pay 20 percent. Please don't take my word for it, scroll through the numbers for yourself. You can go back to 1954 and see those same extremes were the same for everyone.

For comparison, In 2001 the lowest tax bracket was 15 percent and the villainous Bush Tax Cuts brought it down to 10 percent.

In the interest of fairness, if you want a further historical perspective, 1913 had 1 percent tax for the lowest and a 7 percent tax for the highest and by 1918 the poor had a 6 percent tax while the highest marginal bracket was 77 percent. Taxes have been all over the place and while one can argue they're not as progressive as they were in 1918, they're certainly more progressive than they were in the last 60 years the spotlight is focused on.

Dickinson must have done a lot of digging through the data, so he knew how much more progressive taxes are today than in the last 60 years. The way he worded his answer shows that he deliberately altered his definition of rich to focus on the top 400 to a prove his point - a point that is completely reversed when the data set is expanded.
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Taxes are progressive enough

There is a lie being repeated that America has a regressive tax system, that the rich pay a lower percentage of their wealth than the middle class. Instead, we have a progressive tax system that has done a great job of keeping inequality in check.

As I've said before, there's nothing wrong with inequality. What we should focus on is the well-being of the poor, and the poor in America enjoy a high standard of living.

The recent Bruce Meyer episode of Econtalk made a compelling point that inequality is much lower than the pundits claim because they are merely looking at pre-tax income. Once you factor in taxes, consumer spending and government assistance programs like the earned income tax credit you see a much different picture observe.

Both the left and the right make the mistake of focusing on the top tax bracket in the past, which was higher than it is today, but affected few people. A much larger percentage of our federal taxes paid by the wealthy, and it's not just because they have more of the wealth. We are seeing lower taxes for the poor and middle class.

Enter Warren Buffet and the claim that he pays a lower tax rate than his secretary, whose income was never identified. He claimed he paid 17.4 percent while everyone else in his office pays 31 to 44 percent. Greg Mankiw said that isn't even true, but let's play along and say it is.

Is it fair for members of the left to use him as an example to "prove" that the rich pay a lower tax rate, like "Bob" did in an exchange we had in a comment section at For The Sake of Science last month? People rightly claim that taxpayers are able to use loopholes and write-offs to reduce their tax bill, and the rich have access to smart accountants who can exploit them, so could this stymie the progressiveness of the official tax rates?

The good news is that the hard data says otherwise. Using Warren Buffett as an anecdotal example is misleading, as we can see by looking at the effective federal tax rate that compares what people actually pay in taxes to their incomes. Here's what the Congressional Budget Office projected for this year:



It's plain to see that in reality, the five different quintiles fall neatly in line, with the top 1 percent that gets so much focus today paying the highest at 33.8 percent. It is a lie to say the rich pay less of a percentage of taxes than anyone else.

All is not lost for the left. They could simply abandon this bogus claim of a regressive tax system and instead focus on the gains that have come through lowering taxes for the poor and middle class and various "redistribution" programs like the earned income tax credit. That would allow them to sleep better at night instead of, in the words of Michael Munger, elevating the sin of envy to a virtue.
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What is Elizabeth Warren's point?

The lefties on my radar were enthusiastic this past week about a stump speech on taxes from "consumer advocate" and 2012 senatorial candidate Elizabeth Warren.

Warren's statement, which can be read by clicking the image at the beginning of this post or heard in the video at the end, does a great job of dismantling an argument that no one is actually making.

If I find someone arguing that rich people shouldn't have to pay any taxes, I'll be sure to send them to Warren's Den of Intellectual Dishonesty. But as it stands, she is getting a lot of mileage with empty rhetoric.

From The Economist:

Of course, not unlike a tea-party Republican making the case for small government, Ms Warren paints in over-broad, simplifying strokes. It is not actually true that "the rest of us" paid for the roads, the education of workers, or police and fire protection. Some of us paid for them, and some of us paid a lot more than others. Rich people, for example, have paid and continue to pay more than the rest of us.

I hear on NPR almost every morning the debate phrased as "should the rich have to pay a little more." Did I just wake up in Estonia? We already have a progressive tax structure, where the rich pay a higher percentage of their income in taxes, but the left seems to forget that detail and acts as if taxes are flat.

I understand and respect the progressive tax viewpoint. Wealth brings diminishing returns to someone's quality of life. In effect, the rich can afford to lose a bigger percentage of their money. That's a reasonable position.

But just how unbalanced are they willing to make the tax structure? Is there a point where they will be satisfied the rich has paid enough? We want details, not vague hand waving. I understand there are many other types of federal taxes than income tax, but the rich are already paying more of the taxes than anyone else, and here's Elizabeth Warren acting like they don't pay any.

Warren's rhetoric is a cover to justify arguments that unchecked amounts of wealth belong to the government because the government made a limited contribution to its creation.

So not only did the rich help pay for it, they paid for more of it than anyone else.

Keep a big hunk of it? Just how much are we talking about? This is drivel, and I have no idea what she means by "pay forward for the next kid that comes along" either.

Everyone should pay taxes Liz, not just the rich, and for all the reasons you mentioned.


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Day-to-day progressivism

Wish I'd thought of this - video maker asks college students to redistribute their grades to academically-poor students.

Not that this is a new idea, the concept isn't nearly as amusing when merely presented as a hypothetical compared to directly asking students.

During my unemploymeny days I would sometimes borrow a similar idea of progressive splitting of restaurant checks and pitch to my working lefty friends that we divide the check up by income, instead of by what we ate.

Some were amused, some changed the subject but none of them volunteered to give it a try.
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The trouble with balancing budgets through tax increases

I remember reading a personal finance book when I was fresh out of college that said people who think a bigger paycheck will solve their are sadly mistaken. If you don't see controlling your spending as the issue, you will always respond to increases in income with increased spending and never get out of debt.

That lesson came rushing back to me while watching this short video from the Center for Freedom and Prosperity:



Item number two in the video came with the claim that each new tax dollar brings with it a $1.17 increase in spending. If that is true, than raising taxes without controlling spending will never balance the budget because politicians will just spend it on new projects.

I'm reminded of the time Milton Friedman recalled a claim from John Kenneth Galbraith that every problem with New York City could be fixed if taxes doubled. Friedman said the tax revenue has tripled since then and all the problems are worse.
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Good news from Mark J. Perry

A lot of my lefty friends have been reciting the mantra that the rich don't pay enough in income taxes because some specific and atypical investment profits have low taxes.

I normally respond by saying the top 1 percent pays almost 40 percent of income taxes, and the bottom 50 percent pays zero. But leave it to Mark J. Perry to show that even while the top tax bracket has fallen, the percentage of income taxes paid by that same top group has risen steadily.


Of course, this is because of the "Harry Potter" effect of increased productivity and winner-takes-most market effects, but still, shouldn't my friends on the left see this graph as good news?
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A tax bracket question

I was listening to something Paul Krugman said over the weekend about putting more rungs in the tax ladder.



It occurred to me - why is the battle over what percent the existing tax brackets should pay, when it could be about how far apart the tax brackets are.

I do my best to understand the other side, and it occurred to me today that I never really added up everything I knew when I thought of historical top tax rates. I was aware that the top bracket has been absurdly high, but I never considered at what income those tax rates kick in. Combine that with how tax brackets work by sectioning ones income into different brackets, and how the very wealthy make a lot of money with very little additional effort and you should see a lot less elasticity if you simply raise the rate to get into the top bracket, say to $2 million instead of the $250,000 for families President Obama wants.

You will still have some loss of innovation as the loss in income from the tax discourages people from producing more, but the damage will be lessened as it becomes harder to into the tax bracket. The number of people helped is only less than 3 percent of the population, but keep in mind this is the most productive and innovative section of the population. It would be a much easier sell in Congress than dissolving the bracket, so I wonder why no one is trying it.
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The flat tax is the moderate position

I've had a passing thought lately about the flat tax - the idea that all taxpayers should pay the same percentage of their income. It has been explained well here and here. The flat tax is often cast as an extreme position, but I argue it's really the moderate position on taxation.

America instead uses a progressive tax, where people with higher incomes pay a higher percentage and people with very low incomes pay none at all. For example, the Tax Foundation reported last year that America's top one percent of tax returns made 22.8 percent of the adjusted gross income and paid 40.4 percent of federal personal income taxes.

Now consider this: In that same year under a flat tax the top one percent would have paid about 22.8 percent of federal income. The rich would also lose access to tax shelters and loopholes that help them pay less.

If the progressive tax is one side of the spectrum, than the opposite would be a regressive tax where the rich pay a lower percentage of their income than the poor. Even worse would be a tax completely equal in dollar amount regardless of income or exemptions, such as a tax that each person is required to pay $12,000 in federal taxes each year.

No one actually advocates for a regressive or equal tax, so the middle position - the flat tax, is falsely seen as a being an extreme position when in fact it rests flatly in the middle.
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