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News Can Income Tax Rate Hikes Close the Deficit? (interesting article)

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  1. Jun 27, 2010 #1
    AUTHOR: William Ahern, Director of Policy and Communications, The Tax Foundation

    Ed. Note: Our Fiscal Future has invited distinguished guest bloggers to share their views about how to get the nation on a sustainable fiscal path. The views presented are their own, and do not necessarily represent the views of the Committee on the Fiscal Future of the United States or any of the organizations sponsoring this website. We welcome and encourage constructive conversation about the fiscal issues facing America, and hope you’ll join the conversation.

    When David Walker was head of the General Accounting Office, he changed the agency’s middle name from Accounting to Accountability, but the concept doesn’t seem to have caught on in Washington., available at TaxFoundation.org.
     
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  3. Jun 27, 2010 #2

    phyzguy

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    I find it interesting that during the 1950s, a period when the US experienced a previously unheard-of level of prosperity and economic growth, that the top US income tax rate stood between 84& and 91%, as compared to 35% today. (see reference below). US tax rates are both among the lowest in the industrialized world and lower than they have been during most of US history. While it may not completely close the deficit, we definitely need to pay more taxes.

    http://en.wikipedia.org/wiki/Income_tax_in_the_United_States
     

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  4. Jun 27, 2010 #3
    There is a big difference between what bracket you fit in and what you actually pay. Also, those are marginal rates not average tax rates so be carefull when doing comparisons. I personally have no problem paying additional taxes when ALL cost cutting measures with regards to spending have been considered first. I have yet to see that prerequisite adequately considered.
     
  5. Jun 27, 2010 #4
    Evo very sorry about that, I should have known better. Here is a link to the entire article: http://www.ourfiscalfuture.org/can-income-tax-rate-hikes-close-the-deficit/ [Broken]
     
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  6. Jun 27, 2010 #5

    russ_watters

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    And at the same time, the fraction paying zero or negative income tax is the highest in recent memory, by a large margin:
    http://www.cbsnews.com/stories/2009/04/15/politics/otherpeoplesmoney/main4945874.shtml

    The article says 43% for 2009 - it was 47% in 2010. That's a really big problem.
    I agree and I think our deficit situation demands it. So to me, the natural thing to do is to start with that 25% of our population that used to pay income taxes and make them pay income taxes again. To put it in perspective, if that quarter of our society that now freeloads but didn't used to is made to pay an average of $3000 a year, that would add $100 billion dollars to the federal coffers.
     
  7. Jun 27, 2010 #6
    Hey wait, don't these other countries that pay higher taxes still have enormous deficits? I don't think paying more taxes is going to solve the problem.
     
  8. Jun 28, 2010 #7

    Ygggdrasil

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    I take issue with the idea that these people are freeloading. While these people may not owe any federal income tax, income tax is not the only federal tax. For example:
    (source)

    Indeed, since the 1960s, the decreases in income tax for the lower and mid tax brackets have been offset by increases in the payroll tax (see fig 1 from ref 1, attached. Note that the x-axes are not linearly scaled). While it may be the case that the income tax rate on these individuals may be too low, it is certainly not the case that they are freeloading.

    Furthermore, interpreting the statistic that 47% of households owe no federal income tax (compared to ~21% from 1950 to 1990) can be a bit tricky. I agree with russ that this statistic is a sign of big trouble, but for different reasons.

    While it is true that tax rates for the lower-middle class have fallen since the 1960s (average federal tax rates for the second quintile decreased from 13.9% in 1960 to 13.0% in 2000 to 9.4% in 2004)(1), it is also true that the ability of this group to pay taxes has decreased as well. Indeed, since the 1960s, income inequality has risen in the US. For example, share of aggregate household income controlled by the lowest income quintile has decreased from 4.1 percent in 1969 to 3.6 percent in 1997, while the share to the highest quintile increased from 43.0 percent to 49.4 percent. If you look at the top 5% of households, the increase is from 16.6 percent to 21.7 percent (2). More strikingly, the top 0.1% of households went from earning 2.5% of the total share of income in the 1970s to 9% in 2000 (1). Therefore, since the 1960s, we have seen a redistribution of wealth toward the rich.

    Since the rich now account for more of the income than they did in the 1960s, it is natural to expect a greater tax burden to fall on the rich. Therefore, the decreases in tax rates for the top earners are particularly troubling. Indeed, in 1960, the top 0.1% of earners earned ~3% of the total income and accounted for ~8% of taxes paid. In 2004, the top 0.1% of earners more than doubled their share to the total income to ~7% but accounted for only ~11% of taxes paid (1).

    However, it is also important to consider whether increasing the tax rates on the wealthy is a realistic option? Unlike in the 1960s, it is much easier for wealthy individuals and corporations to move offshore to evade such taxes, so it seems unlikely that we'll be able to achieve the high tax rates used in the 1960s. While taxes on the wealthy must definitely increase, taxes other individuals will probably need to shoulder a greater tax burden than they have historically, despite being less able to pay these taxes than in the 1960s. Furthermore, these limitations mean that it is even more important to keep government spending in check. Finally, the high income inequality seems to be an underlying problem contributing to all these issues, and therefore, any policy that wants to be effective in the long term must address this issue.

    References:
    1. Piketty and Saez. 2007 "How Progressive is the U.S. Federal Tax System? A Historical and Intenational Perspective." Journal of Economic Perspectives 21: 3-24. http://elsa.berkeley.edu/~saez/piketty-saezJEP07taxprog.pdf
    2. US Census Bureau. http://www.census.gov/hhes/www/income/data/inequality/middleclass.html
     

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  9. Jun 28, 2010 #8
    That's probably because most of the competition to the U.S. had just been bombed out from World War II and was rebuilding. Remember the U.S. economy stalled around the end of the 1950s, and then the 1970s were fraught with inflation and rising unemployment.

    Another thing I remember reading somewhere is that those top tax rates applied to those earning around $2 million. I don't know if they meant literally $2 million (which back in the 50s was probably like $30 million today) or the inflation-adjusted equivalent of $2 million, but either way, that's still a lot higher than what the top marginal income tax rates apply to today.
     
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  10. Jun 28, 2010 #9
    Is it so much a redistribution of wealth though, or just that the pie has gotten larger, with the higher earners earning more of the pie as it grows larger? Just because the lower-earners may be responsible for a smaller share of the pie than they used to does not mean that their wealth and standard of living haven't continued rising, right? (because the pie grows bigger).

    Sort of like a person who owns 100% of a $100 million company but then it grows to a $5 billion company of which they now own 30%. They may own a smaller share, but the pie has gotten a lot bigger.

    Also, is income inequality a bad thing? A free society will always have an unequal outcome. Striving for equality of outcome just will disincentivize effort.

    I have no empirical way of knowing, but I'd also think that during economic booms, it is natural for the wealth to concentrate at the top more because so many new companies are started that mint a bunch of new multimillionaires and billionaires. The 1950s, 1960s, and 1970s didn't have the levels of wealth creation, like through IPOs for example, that occurred in the 1980s, 1990s, and 2000s.

    Wouldn't the top 0.1% of earners be the super-rich who earn most of their money through things like dividends, which are from corporations that are already taxed though?
     
  11. Jun 28, 2010 #10

    Office_Shredder

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    The question of how much everyone pays in taxes is one of comparing relative wealth, not absolute wealth, so whether the pie is smaller or larger is irrelevant, it's the share of the pie that counts
     
  12. Jun 28, 2010 #11

    russ_watters

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    Ygggdrasil, the OP is about the federal budget deficit and the only tax that affects it is the federal income tax.
     
  13. Jun 28, 2010 #12

    mheslep

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    Do you have a source for that?

    That doesn't mean that people actually paid those rates on gross income. Income can be diverted. The historical details are probably complicated, but we can look at actual revenue received from income taxes over time and see revenues were not significantly higher in the post WWII period than now.

    Federal Income tax in 2005 dollars:
    _a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_i_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_g_g_g.png

    Federal income tax as a % of GDP:
    _a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_i_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_a_g_g_g.png

    Note that US business tax rates are near the highest in the industrialized world.
    http://upload.wikimedia.org/wikipedia/commons/3/36/Income_Taxes_By_Country.svg [Broken]

    I don't follow in what sense that cant be true, as before the 1913 income tax amendment the US had no federal income tax for the previous 124 years.

    Why can't the answer be we need less federal spending?

    It seems to me any discussion on balancing budgets with tax increases should at least include a passing reference to (1) the http://politicalbooks.files.wordpress.com/2009/07/laffer-curve1.jpg" [Broken] to at least consider that there may be a point at which increasing rates actually reduces revenue, and (2) the fact that increasing tax rates depresses GDP. Obama's economics director Romer has one of the more widely cited papers addressing the latter issue.

    BTW, hopefully all US citizens are aware that federal tax rates, income and others, are indeed increasing as of Jan 1, 2011, so we may get an illustration of the effects of (2) very soon.
     
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  14. Jun 28, 2010 #13

    mheslep

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    Not the only, not even the majority, but the largest single tax source:

    [PLAIN]http://www.taxpolicycenter.org/briefing-book/background/numbers/images/Numbers_Figure-1_What-are-fed-govts-sources-of-revenue_3.gif [Broken]
     
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  15. Jun 28, 2010 #14

    mheslep

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    The OP's reference answer's the OP's question: no.

    http://www.ourfiscalfuture.org/can-income-tax-rate-hikes-close-the-deficit/ [Broken]
     
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  16. Jun 28, 2010 #15

    chemisttree

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    The source for the 91% top rate is http://en.wikipedia.org/wiki/Internal_Revenue_Code_of_1954" [Broken]. It is interesting to note that the upper bracket that paid 91% started at 7.5 million in 2008 dollars.

    I wouldn't mind going back to that tax rate but then again I'm certainly not in that income group.
     
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  17. Jun 28, 2010 #16

    mheslep

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    I expect an extreme federal top rate would eventually end up doing the same thing it does when the states try it: cause people to leave (or just close the doors).

    http://www.state.nj.us/governor/news/news/552010/approved/20100218a.html


    Maryland acted similarly with a high top rate and found net revenues actually fell, and with those people gone, probably irretrievably so.
     
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  18. Jun 28, 2010 #17
    No. Because at times like these, you need to get the economy moving - you need to stimulate it, and the only way to do this is to increase spending. Less spending means less jobs and basic economics will tell you this leads to deflation.

    According to wiki:

    Perhaps the solution is to increase the tax rate of highish earners and create new tax brackets for very high earners (perhaps at 50%) and the ultra wealthy (perhaps at 65%). Given the wealth distribution in the US, I am sure this would work... (maybe it would even be possible to get rid of the 10% tax rate too with this arrangement - it's crazy to tax people who are living below the poverty line).

    As I mentioned above, ruthless spending cuts will depress GDP further. The only rational alternative is to increase taxes.
     
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  19. Jun 28, 2010 #18

    mheslep

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    The US stimulus I and II totaled over one trillion dollars. Visibly it hasn't stimulated much. In any case the link between Keynesian government spending and increased GDP is weak; the detrimental link between increasing taxes and depressing GDP is strong in the literature. I'll provide Romer's reference in a moment.
    Edit:
    "[URL [Broken] MACROECONOMIC EFFECTS OF TAX CHANGES:
    ESTIMATES BASED ON A NEW MEASURE OF FISCAL SHOCKS[/URL]
    Christine Romer, David Romer (C Romer is the Obama administration's chief economic adviser)

    Concludes a dollar of tax cuts yields about three dollars of GDP increase; the reverse is also true.
    Why did you choose to ignore the prior sentence referencing the Hsing paper:
    Given the very recent results in Greece, I think raising taxes as the main response to a huge budget defecit is insane.
     
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  20. Jun 28, 2010 #19

    apeiron

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    The US economic realities are that it has borrowed recklessly to stave off financial collapse and now has the new problem that it must earn more just to pay its interest charges.

    Currently, it is in the interest of the US's creditors to offer unnaturally favourable terms on this debt. But that could change.

    The US needs to find more tax dollars, yet also needs to feed its growth. The question is at what stage does a "kick-start" stimulus become a continuous life-support machine?

    The choice was made to borrow trillions (and hope the rest of the world, China in particular, would forgive the debt rather than demand payment).

    The rest of the world, China in particular, probably will expect something in return for keeping the patient alive (apart from a continuing market of avid US consumption).

    What could this be I wonder? China has said it needs another 10/20 years to build up its internal markets, industrialised its countryside, complete the transfer of technology and world political power from West to East.

    At some stage in this journey, it will cease to make sense to prop up the US. The life support machine of dollar-based debt can be switched off.

    The US can debate whether to tax its poor or its rich. That debate will be looking sadly academic.

    Oh, who is the source of all these alarmist quotes?

    http://www.peakoil.net/files/JOE2010.pdf

    And what do all those federal dollars actually get spent on?

    So forget fiscal kickstarts or even life support machines, the debt situation has more the look of a managed death.

    Of course, there are bigger forces at work than merely global economic competition, or even the global projection of military power and the economic fruits that follow in terms of colonisation. Climate change, peak oil and over-population.

    The ratchetting down correction is likely to be general to the planet, rather than particular to the US. The death will be that of bubble economics and nation-level power struggles. Which won't be so tragic if some new era economic thinking manages to takes its place.
     
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  21. Jun 28, 2010 #20
    Now come on Russ, if the Democrats ever agreed to such a thing - who would ever vote for them?:uhh:
     
  22. Jun 28, 2010 #21
    That's Keynesian economics, which itself is debatable (government could do no stimulus whatsoever and the economy recover fine on its own, historically the Keynesians claim we have never spent enough on stimulus and yet our economy has always recovered from recessions), which calls for trying to increase aggregate demand, and there are a few ways to do that:

    1) Direct fiscal stimulus by the government, which is very debatable. Japan tried spending more than $2 trillion on their $5.5 trillion economy between 1991 and 1995 and it did virtually nothing. In fact, certain economists say that Japan spent more than enough and if anything, all that spending has hampered the Japanese economy by raising up the debt, crowding out private-sector investment, and making too much of the Japanese economy dependent on the government.

    Some economists also say that the reason why stimulus did not work in Japan is that the Japanese did not flood their economy with the stimulus all at once, but instead spread it out over a few years.

    Well we are spending a tiny fraction proportionally on stimulus of what the Japanese spent, and we didn't flood the economy with it, it too is being spread out. The one good thing the Japanese did get however was that a lot of the spending went into infrastructure development. That's what was intended here, however from what I understand, it hasn't quite happened.

    To match Japan, the United States would need to spend probably around $6 trillion in fiscal stimulus and have to have a way to make sure it goes into infrastructure. This money would also need to flood the economy all at once, not be spread out.

    All-in-all, Japan has spent more than $6 trillion thus far and has the largest public debt of any country in the industrialized world.

    The United States cannot afford to take a risk like that. We enact $6 trillion in fiscal stimulus, that is out right dangerous.

    Here is a good article that gives more details: http://www.nytimes.com/2009/02/06/world/asia/06japan.html

    2) Demand-side tax cuts - these are tax cuts meant to do the same thing as direct government spending, just instead of having the government take on debt and find ways to spend the money, they give tax cuts to people in the hopes that they will spend the additional money.

    3) Helicopter money - this is kind of the same thing as the demand-side tax cut, but instead of per se giving tax cuts, the government takes on debt but instead of spending the money itself, it mails a bunch of checks out to the citizens (to create the effect of helicopters dropping money all over).

    The stimulus President Obama signed I believe is a combination of tax cuts and fiscal stimulus.

    One can also try to stimulate the economy via supply-side tax cuts, which are meant to stimulate investment and business growth (hence jobs). These taxes usually apply to the upper-income brackets (many small businesses file as individuals via S-Corporations), and corporate tax rates, and capital-gains and dividend tax rates.

    Most tax cuts are usually a combination of both supply-side and demand-side, although they may lean more one way or the other. For example, I believe the JFK tax cuts, which were meant to be demand-side, also included some supply-side. The Bush tax cuts also were a combination of demand and supply-side.

    Increasing taxes will likely depress GDP, not cutting spending of fiscal stimulus that hasn't done much as is and on paper is not near large enough anyhow. If anything, cutting spending will encourage economic growth because investors will stop being as concerned about the debt and deficit (although such spending would have to apply not just to the stimulus but also to government overall.
     
  23. Jun 28, 2010 #22
    Here is an interesting article addressing just that; according to Mr. Laffer, the mild amount of economic recovery being seen now is a result of the expected tax increases on the horizon. Time will tell: http://online.wsj.com/article/SB100...386610.html?mod=WSJ_latestheadlines#printMode

    Well it wasn't per se a question of mine, that is the title of the article.
     
  24. Jun 28, 2010 #23
    No, less government spending means fewer government-created jobs. Big difference. Most should realize that any money spent by government is taken out of the economy one way or another.

    And I don't think we're in any current danger of the U.S. government reducing spending enough for deflation to be our biggest worry.
    Baloney. Government spending depresses GDP. Government spending is a drain on the economy, despite the illogical nonsense claimed to the contrary by power hungry politicians.
     
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  25. Jun 28, 2010 #24

    Ygggdrasil

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    The pie has gotten larger, but most of the growth in wealth has gone to the more wealthy:
    (source)

    This modest growth of household incomes comes despite most households moving from consisting of only one wage earner to two wage earners. Perhaps it is misleading to label this as a redistribution of wealth (income increases in the upper segments of the economy did not come from decreasing income in the lower segments of the economy), but clearly the distribution of wealth in the US has changed significantly. Much of the growth in the US economy has gone toward the wealthy and relatively little has trickled down to the lower segments of the economy.​


    I agree; we should not strive for complete equality of outcomes. However, very unequal distribution of wealth (e.g. one person owns all the wealth, everyone else has nothing) is clearly bad for society as is a very equal distribution of wealth (communism). There is likely some optimum distribution of wealth between these two extremes. I argue that we are not at this optimum and are too far toward the unequal side of the continuum. This inequality is especially troubling from an economic point of view because most of the US economy is built on domestic consumption.​


    That was true in the 1960's but not so much today. From the Piketty and Saez paper I referenced in my earlier post:
    (source)

    In this light, the declines in income tax rates on the top earners look even more problematic.​


    Correct me if I'm wrong, but wouldn't increasing expenditures by spending a trillion dollars on direct stimulus or decreasing revenues by giving a trillion dollar tax cut have the same effect on the budget deficit (i.e. increasing the debt by a trillion dollars)? The only difference would be that direct stimulus increases this year's deficit while tax cuts increase the next year's deficit.​
     
    Last edited: Jun 28, 2010
  26. Jun 28, 2010 #25
    But isn't that to be expected? The big creations of wealth are for example when entrepreneurs start businesses. While this creates wealth for everybody, the owner of the business will get a huge amount for themselves.

    For example, if I start a company and grow it to where it is valued at $1 billion, well I am then a billionaire. Yes I have increased the wealth of society by creating jobs for all of my employees, but I created $1 billion for myself, even though I'm one guy.

    Well from what I understand, going by household incomes can be misleading. What one wants to look at are per capita incomes. Here is a link:

    http://tv.nationalreview.com/uncommonknowledge/post/?q=ZGQ4ZGM3MjYzNDc2MjA1NzBmMzEyYWQ2OTJjYzYyNjY= [Broken]

    This link also is informative I think:
    http://www.creators.com/opinion/thomas-sowell/income-confusion.html

    Also remember that income and wealth are two different things.

    Well again remember, the pie is not fixed. A wide unequal distribution of wealth does not mean that a few have everything and everyone else has nothing. It just means that of the wealth created in that society, most is concentrated at the top (which is probably normal in a free-market system).

    There's a difference between if I have $30 million and you have nothing and if I have $300 million and you have $30 million. Yes, wide disparity in wealth there, but by global standards, we are both wealthy.

    A wide unequal distribution of wealth is not bad as long as one is in a society where wealth is being created constantly. Even the poorest American is "wealthy" by Third World standards. Eating a McDonald's Big Mac might be a cheap, crappy food to an American, to a Third World person who eats beans and/or rice once a day, that's a big luxury (and even the beans or rice can be a luxury in some areas).

    So while wealth is concentrated at the top, the average American continues to get richer (which is done by the wealthy people---iPods, cellphones, laptops, Big Macs, etc...don't come from nothing).

    Well even so, why are the declines in tax rates on the top earners problematic? One should be allowed to keep their hard-earned money I would think.

    In terms of the deficit, I'd think so, you spend $1 trillion or give $1 trillion in taxes, you shorted the government $1 trillion one way or another. The question is which one is more effective at creating demand.

    Also, just some confusion on my part, but wouldn't tax cuts increase that year's deficit...? Or is it with tax cuts, you have to wait and see how much money is lost before calculating the deficit? So with fiscal stimulus, you known exactly how much you are blowing up the deficit that year, but with tax cuts, you have to wait and see how much revenue is lost, so it blows up next year's deficit...?
     
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