LESSONS LEARNED #85: “The rich pay more than their fair share of income taxes to provide tax relief for the poor and middle class.” –Old Pithy

Posted by PITHOCRATES - September 29th, 2011

Investors Pay a Lower Tax Rate on Investment Income because Investing is Riskier than Earning Income

There’s a lot of class warfare going on right now.  It’s open season on anyone deemed to be rich.  You have President Obama saying the rich don’t pay their fair share of taxes.  That it isn’t right for Warren Buffett’s secretary to pay her taxes at a lower tax rate than her boss.  Statements like this can be very misleading.  Because Warren Buffett’s secretary pays nothing in tax dollars compared to what Warren Buffett pays.  But it sure fans the flames of class warfare.  Which helps when you want to raise taxes on someone.  (Or get reelected).  Because no one wants their own tax rates to go up.  Just those on others who make more than they do.

Except, of course, Warren Buffett.  And some other millionaire investors.  Who are asking President Obama to raise their taxes.  And he has obliged.  At least, he’s trying.  He wants to implement a millionaire’s income tax.  A little extra from those who can most afford it.  Of course, Warren Buffett won’t pay this millionaire’s income tax.  Because he doesn’t pay income taxes.  He’s an investor.  He pays capital gains taxes.

Investors pay a lower tax rate on capital gains than on income.  Because investing has risk.  Working doesn’t.  You never risk losing your income by working.  But you risk your capital by investing.  Hence the lower rate to encourage this risky behavior.  Investing in others.  Like entrepreneurs.  Some of who strike it rich.  Many more, sad to say, fail.  And investors lose everything they invested.  It’s a risky business for investors.  That’s why when their investments pay off they pay off big.  To cover all of those investments where they lost everything.  Raising tax rates on investors, then, would dissuade investment.  Stop the job and wealth creation these successful  entrepreneurs provide.  And deprive the treasury of all the tax revenue they would have created.

The Rich are Paying a Premium in Taxes for being Successful

Let’s look at some data.  Let’s mine some IRS tax returns.  See who is paying income taxes.  And who isn’t paying their fair share.  Let’s break the numbers down into 4 groups.

The poor and middle class (those earning up to $50,000 per year).  The middle class/upper middle class (those earning from $50,000 to $100,000).  The elite white collar and small business owners (from $100,000 to $500,000).  And the rich (over $500,000).  These breakdowns and labeling is not an exact science.  But it’s close enough for analysis.  Below we’ve graphed both percent of total income.  And percent of total taxes paid.  For each of these groups.  All data is mined from SOI Tax Stats – Individual Income Tax Rates and Tax Shares.  And crunched in an Excel spreadsheet.

These are the rich people.  Note that they pay a larger percentage of total taxes than their percentage of total income.  The red line is always well above the blue line.  On average their share of taxes is 8.54% greater than their share of income for the years graphed.  So the rich are paying a premium in taxes for being successful.

Of particular interest is what happens to the rich during a recession.  At both the early and late 2000s recessions their share of income tanked.  As did their share of taxes.  Their share of total taxes fell some 5% in the early 2000 recession.  With a third or so of all taxes coming from these rich, when they lose money so does the U.S. treasury.  This quickly revised those Clinton projected surpluses into deficits.  And it wasn’t anything George W. Bush did.  This was the fallout from the bursting of the dot-com bubble (it was the irrational exuberance that made all of this wealth and tax revenue in the first place.  That and the Lost Decade in Japan.  Not the Clinton tax rate hikes).  Rich people lost money; rich people paid less taxes.

And speaking of Democrat Bill Clinton, note how the rich got richer when he was president.  Not what you would expect from a Democrat.  The champions of class warfare.  But it is true.  While Bill Clinton was president the rich’s slice of the income pie grew approximately 10.51%.  Gee, I wonder what happened to the poor and middle class during this same time.

White Collar Workers and Small Business Owners have a Tax Share Greater than their Income Share

Now let’s take a look at the elite white collar workers and small business owners.  Management, professionals, doctors, lawyers, entrepreneurs, etc.  Here we see that they, too, pay a larger percentage of total taxes than their percentage of total income.  But not as much.  Their tax premium for success is not as great as it is for the rich.  It averaged approximately 3.42% for the years graphed.

Note that the recession didn’t have as great as an effect on them as it did for the rich.  They don’t have as much to gamble with.  The less risk the less reward.  And the fewer losses.  Besides, with small business owners slow and steady wins the race.  They pour all of their investment capital (i.e., their earnings) into their businesses.  And then work 80+ hours a week to wring out every last dime from that investment.

Some industries weather recessions better than others.  Some just get by.  Conservative by nature, they expand during good times.  But not too much that they can’t sustain the larger size during bad times.  For they aren’t rich enough to absorb large losses during really bad times.  Unlike rich investors.  So their income growth is flatter.  But more steady.

The Middle Class/Upper Middle Class have a Tax Share Less than their Income Share

Now the middle class/upper middle class.  Those earning from $50,000 to $100,000.  Typically those living well while still working for someone else.  Note that their share of the tax burden has been in a decline.  Much like their income.  However bad that is, they do pay a smaller percentage of the total tax than their percentage of total income.  The blue line is above the red line.  In other words, they have a tax discount.  A discount that has averaged 5.33% over the years graphed.

Interestingly, these graphs are almost the mirror image of those earning $500,000 or more.  Particularly strange is that their share of the income increases during times of recession.  Which probably reflects their incomes being a larger percentage of the remaining pie after the rich lose so much during bad economic times.

Did the Poor and Middle Class get Poorer under Bill Clinton?

And now the poor and middle class.  Whose share of the tax burden has also been in decline.  As has been their income.  But they, too, pay a smaller percentage of the total tax than their percentage of total income.  Their tax discount has averaged 6.62% for the years graphed.  Which is even more generous than that given to those earning $50,000 to $100,000.

Remember how the rich got richer under Democrat Bill Clinton?  Well as they got richer the poor and middle class got poorer.  Again, not what you would expect from a Democrat in office.  While Bill Clinton was president the poor and middle class’ slice of the income pie decreased approximately 11.85%.  Can this be true?

When the Rich get Richer the Poor get Fewer in Numbers

Well, yes and no.  If you look at the number of returns filed you find out something interesting.  Not only did income decrease for those earning $50,000 or less, their numbers shrank, too.  To illustrate this we’ve compared the number of income tax returns for our income group breakdowns for the years 1996 and 2000 (the beginning and end of the Clinton years for the data graphed).

There was a net decline of 8.85% of people earning $50,000 or less.  Where did they go?  To a higher income group.  The poorest earners in our breakout decreased in numbers.  While the higher income groups all increased in numbers.  Meaning when the rich get richer the poor get fewer in numbers.  In other words, a rising tide raises all boats.

The Best Way to Raise Tax Revenue is to let Rich People get Rich

So what have we learned?  First of all, the rich pay more than their fair share in taxes.  In fact, they pay a portion of the taxes of those earning less than them.  That is, the rich provide tax relief for the poor and middle class.

So the rich getting richer is good.  The richer they get the larger percentage of the total tax burden they pay.  And the more people they move from lower income groups to higher income groups.  By providing investment capital to entrepreneurs.  Who create jobs.  That give the poor and middle class better opportunity.

And the more jobs the more taxpayers there are.  So you have the rich getting richer and paying more taxes.  And these new employees in higher paying jobs paying more in taxes.

Now that’s good tax policy.  If your goal of tax policy is to raise tax revenue.  And if it is then the best way to do that is to let people get rich.

www.PITHOCRATES.com

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FUNDAMENTAL TRUTH #85: “The rich pay more than their fair share of income taxes to provide tax relief for the poor and middle class.” –Old Pithy

Posted by PITHOCRATES - September 27th, 2011

The ‘Rich’ Obama wants to Tax more already Pays the Majority of all Federal Income Taxes

Some people complain that too much wealth is concentrated in too few hands.  And they say that isn’t fair.  But you know what else is concentrated into too few hands?  Federal income taxes.  That is, who pays these taxes.  The top 10 percent of income earners pay about 70% of the taxes.  That doesn’t sound fair.  This 10% paying 70% of the tax bill.  While 90% only pays 30% of the tax bill.  No, this isn’t fair.  But that’s okay.  At least that’s what the 90% think.  I mean, we don’t hear them demanding to pay their fair share of federal income taxes, do we?

Let’s look at some of the numbers.  From 2008 tax returns (see Table 2.  Returns with Modified Taxable Income [1]: Tax Generated, by Rate).

The first thing that jumps out at you is that the poor pay no income taxes.  Only the middle class and rich do.  The biggest income groups of taxpayers are those earning from $100,000 to $200,000.  And from $200,000 to $500,000.

Are these factory workers?  No.  Are these construction workers?  No.  These aren’t blue collar jobs.  These are white collar jobs.  And small business owners.  Currently in the crosshairs of the Obama administration.  Those ‘rich’ people who aren’t paying their fair share of taxes.  People who in fact pay the majority of all federal income taxes.

Those who don’t Pay Income Taxes are Dictating Tax Policy on those who Do

So why is president Obama so vilifying these most generous ‘rich’ people?  Because it’s the largest group of ‘rich’ people whose taxes he can raise.  From the same data let’s take a look at the distribution of income earners.  By looking at the number of actual tax returns filed by each group.

Interesting.  The distribution has shifted down to the lower income groups.  There are very few people earning $1 million or more and yet they pay a substantial amount of the total federal income tax.  While there are a great number of people earning less than $50 thousand who pay little to no federal income tax.

There’s another way to look at these numbers.  One person one vote.  Despite the amount of money you earn.  And the amount of taxes you pay.  Or the lack of taxes you pay.  So in essence what we have is those who don’t pay income taxes dictating tax policy on those who do.  Hence the appeal of class warfare.  Tax the rich?  Raise tax rates on high earners?  A millionaire’s tax?  Absolutely.  As long as I remain in the near 50% of those people who pay no income taxes.

Small Business Owners Earn a lot because they’re both CEO and Investor

There’s yet another way to look at these numbers.  With 70% of all taxes paid by those earning $100,000 or more let’s focus on these people.  We’ve summarized this data here (Taxable Income and Income Tax Generated are in thousands of dollars):

The sweet spot of tax revenue are the people earning from $100,000 to $200,000.  Who pay an effective tax rate of 17.91%.  And a good chunk of these are small business owners.  Who have S corporations.  Where their earnings pass directly to their private income tax return.  That’s why they earn so much.  Because they’re both CEO.  And equity investor.  But they don’t use those retained earnings to live an extravagant lifestyle.  No.  Instead, they use them to grow their business.  And create jobs.

Raising the tax rate on those retained earnings will not help grow these businesses.  In fact, it will prevent these businesses from growing.  And you don’t want to do that.  Because not only do these small business owners pay as much in federal income taxes as all the millionaires do.  They also create the majority of jobs in the American economy.

If you want Tax Policy that will Raise Tax Revenue don’t Raise Tax Rates on Job Creators

Is the purpose of tax policy to raise tax revenue?  Or politics?  When about half of the people pay no income taxes there is definitely a political aspect in taxing the rich.  But exploiting the political capital in the tax code defeats the purpose of the tax code.  Raising taxes.  Let’s look at a simple example.

Everyone agrees that lowering taxes helps businesses more than raising taxes.  That’s why even President Obama extended the Bush tax cuts to prevent a double-dip recession.  So let’s look at some numbers.  Let’s say we make it more business friendly out there.  Cut back on some onerous regulations that cost businesses.  Such as repealing Obamacare. Or some other costly legislation(s).  Not cutting taxes mind you.  Just cutting the costs on the job creators.

If we do this business-friendly deregulation let’s assume businesses respond.  They do well and grow.  And these small business owners earn more income.  So much that about 20% of them move up from the $100,000 to $200,000 income group to the $200,000 to $500,000 income group.  This group pays an effective tax rate of 23.3%.  Federal income taxes would increase approximately $100 billion with this growth in income.  Or an increase of 23.3%.  And that’s without cutting taxes.  Imagine what they could do if did cut taxes.

If you want good tax policy.  If you want tax policy that will raise tax revenue.  Don’t raise tax rates on job creators.  Instead, cut their costs.  Cut the cost of job creation.  Then watch the jobs they’ll create.  And the tax revenue they’ll pay.  Both the small business owners.  And their new employees.

 www.PITHOCRATES.com

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