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Tax Rates: Are The Rich Really Different?   (January 19, 2007)

In response to yesterday's entry on maximum tax rates, knowledgeable reader Michael M. noted that the more telling statistic is the effective tax rate: (i.e. what people actually pay)
As a tax professional I can assure you that comparing highest statutory income tax rates year over year is meaningless. A better comparison would be average effective tax rates for example or gross income tax receipts in real dollars.
Michael was kind enough to send over some links to CBO (Congressional Budget Office) data:

CBO Publications

Here is the link specific to the historical average effective tax rates from 1979 to 2001:

Effective Federal Tax Rates, 1979-2001

The top 1% had an effective rate of 37% in 1979, which dropped a bit to 33% in 2001. The bottom 20% paid 8% in 1979 and 5.4% in 2001. In other words, everyone's effective tax rate dropped by about 2% or 3%. That's about a 10% drop for the top 1% and a 30% decline for the bottom 20%. Sounds good, but then if your tax bill was $500, a 30% drop works out to $150. Not bad, but not much. If your tax bill was $5 million (remember we're talking about the 1% who owns 60% of all productive assets in a $13 trillion economy with a net worth around $50 trillion) then a 10% drop in your tax rate comes to $500,000. Not much if you own tens of millions in assets, but nothing to sneeze at, either.

Tax cuts have clearly cut everybody's taxes. Fair enough. But if Social Security and Medicare go belly up or get slashed to the bone, who gets hurt? Not the top 1%.

Taxes sound boring, but they're as important as the spending side of the ledger. Look carefully at the chart in yesterday's post and say we're not facing a monumental deficit crunch. We are.

Now take a look at this chart of taxes paid as a share of various nations' GDPs and note that we're at the bottom, along with Japan. Now Japan has a Defense Force, but the U.S. has a global military with bases in dozens of countries around the world. The U.S. spends roughly as much on its military as the rest of the world combined, so you have to wonder how we can carry such a burden and yet pay no more than Japan, percentage-wise.

It is also worth noting that if we paid a bit more, say as much tax (as a percentage of GDP) as our neighbors to the north (Canada) or our confreres to the far south (Australia), we wouldn't have monstrous deficits as far as the eye can see.

Various pundits are happy to "eliminate the deficit" by cutting military spending in half. Nice, but get real. It isn't that easy. If your buddy or son or brother is the one flying the plane or on the ground, you want the best for them, and the best is expensive. Yes, there is massive waste in Pentagon spending, but probably less than in Medicare. Yet it is a rare pundit who breezily advocates cutting Medicare in half to "eliminate the deficit." I would say we get more for our money with the Pentagon than we do with Medicare. And by the way, Social Security and Medicare together dwarf military spending. You can't solve the deficit crises looming just ahead by cutting an aircraft carrier or two. You either raise more revenue (taxes) or you take an axe to Social Security and Medicare. There is no Plan B.

One last observation: if you know any Swedes or Danes (we have friends in both countries) then you know they get along quite well paying about 50% of their incomes in taxes. If you're a working parent, there's no comparison; you want to pay the 50% tax and get childcare paid/subsidized by the government. I know the low-tax propaganda machine has brainwashed the vast majority of Americans, but it isn't that simple. In fact, it's kind of like claiming you're going to cut military spending in half, presto-magico.

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