FUNDAMENTAL TRUTH #75: “Lower income tax rates generate more tax revenue by making more rich people who pay more income taxes.” -Old Pithy

Posted by PITHOCRATES - July 19th, 2011

The top 1% of Earners pay close to 40% of all Federal Income Taxes

Poor people pay little income taxes.  Rich people pay a lot of income taxes.  Everyone else pays somewhere in between.  The tool to make this happen is the progressive tax system.  Government designed it so that people with more income pay more taxes.   Via progressive tax brackets.  And the current (2010-2011) brackets (for head of household) are:

  • 10% on first $12,150
  • 15% on income from $12,150 – $46,250
  • 25% on income from $46,250 – $119,400
  • 28% on income from $119,400 – $193,350
  • 33% on income from $193,350 – $379,150
  • 35% on income over $379,150

If you earn $8,000 you owe $800.  Simple.  If you earn $83,600 you owe $15,668.  If you earn $450,000 you owe $131,435.  If you earn $2,500,000 you owe $848,935.  See the pattern?  Earn more.  Pay more.  Almost as if you’re penalized for being successful.

Of course, low-income people often don’t pay any federal income taxes.  In fact, a lot of people don’t.  About half.  Thanks to tax credits, deductions and exemptions.  But when you’re a rich CEO earning a multimillion dollar salary there aren’t enough tax credits, deductions and exemptions to avoid your taxes.  That’s why the top 1% of earners pay close to 40% of all federal income taxes.  Something we should thank them for.  Instead of demonizing them.

The higher the Top Marginal Tax Rate is the more the Rich avoid paying Income Taxes

There are no Mom and Pop hardware stores anymore.  The big box home improvement stores like The Home Depot, Lowe’s and, for those of you old enough to remember, Builder’s Square put them out of business.  Because of greedy consumers like you.  And me.  Who want to get the best value while shopping.  And if we can buy something of equal quality at a lower price we do.  We work hard for our money.  We spend it carefully.  Wisely.  And we don’t pay more for something when we can get the same for less elsewhere.

It’s the same for rich people.  When they shop.  And when they invest their wealth.  Or their ability.  They look at their options.  Create a new business?  Work at an established business?  If you’re highly skilled you can earn a lot of income.  Which rich people take into consideration.  But there are costs.  Payroll taxes.  Employee compensation and benefits.  Compliance and regulation costs.  And, of course, the progressive tax system.

The higher the top marginal tax rate the less incentive they have to start or run a business.  The less incentive they have to create jobs.  And the more likely they won’t start or run a business.  Instead they’ll invest their money and pay the simpler and (so far) lower capital gains tax.  And this is what happens.  The higher the top marginal tax rate is the more the rich avoid paying income taxes, leaving the middle class to pick them up.  Just like you avoided that Mom and Pop hardware store on your way to The Home Dept.  And with an abundance of government debt available, the rich can invest and live on interest.  Sitting on the sidelines.  Watching the rest of us struggle to find a job.

You don’t need Employees to live on Interest Income

So, the progressive tax system is a way to make rich people pay more.  To transfer the tax burden to them.  And it does.  To a point.  But if you try to tax them too much they’ll just drop out of the economy.  And take their jobs with them.  Which is a double whammy.  We lose some of that generous 40% of income taxes they pay.  And we lose who knows how many thousands of jobs.  And taxpayers.  Thus transferring the burden the other way.  Away from the rich.  To those less able to afford it.

The progressive tax system is supposed to make paying taxes easier on the poor.  The less you earn the less you pay, leaving you with more money for the necessities of life.  Whereas the rich can afford to pay more so they do.  But a flat tax is a progressive tax, too.  The more you earn the more you pay.  For example, going to a 15% flat tax, our sample earners above would change their taxes owed as follows:

  • $8000:  $800  →  $1,200
  • $83,600:  $15,668  →  $12,540
  • $450,000:  $131,435  →  $67,500
  • $2,500,000:  $848,935  →  $375,000

It’s still progressive.  And, yes, the rich will pay less individually.  But there will be more of them.  For this lower income tax rate changes the dynamic.  It will be more profitable to get off of the sidelines and get back into the economy.  Because a flat 15% income tax rate will beat or equal the capital gains tax.  And the profit from creating or running a business will blow away the earnings on a portfolio of treasury bonds.

Better still are the jobs.  You don’t need employees to live on interest income.  But you need them to run a business.  More jobs mean more taxpayers.  So more rich people are back in the economy earning income and paying income taxes.  And more employees are working.  That’s more payroll taxes.  And more personal income taxes.  In the end, the numbers win.  More jobs.  More GDP.  And more federal tax receipts.

Keeping People Poorer and more Dependent on Government

If the goal of government tax policy is to raise tax revenue, the logical thing to do would be to design a tax code that creates more rich people.  A lower top marginal tax rate does this.  So does a flat tax.  Such a tax policy will create incentives to earn income instead of living on capital gains from investments.  Each rich person will pay less income tax individually but there will be far more of them paying income taxes overall.  And they will create jobs.  The more jobs there are the more payroll taxes and personal income taxes there are.

History has shown that cutting tax rates has done just that.  The Mellon tax cuts of the 1920s.  The JFK tax cuts of the 1960s.  The Reagan tax cuts of the 1980s.  The Bush tax cuts of the 2000s.  So if the record shows that lower tax rates produce more tax revenue, why are we always trying to raise the top marginal tax rates?  Simple.  Politics.

Being in politics is the closest you can get to being part of an aristocracy in the United States.  Unless you’re born a Kennedy.  Whether its ego or the graft, people aspire to be in the privileged few.  Life is better there.  If you have no talent or ability.  Other than being able to tell a pretty good lie.  So you use class warfare to get the masses to support you.  And the progressive tax system.  Which keeps people poorer and more dependent on government.  Like it used to be in the old days when there was an aristocracy.

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