3 Inconvenient Truths About Taxes

A lot of the talk between now and Election Day will involve the economy, federal spending, and taxes. The "right" level of taxation, if there is such a thing, is often in the eye of the beholder. But when you hear political candidates railing about taxes, it may help to know some basic tax facts. Here are three of the most prominent statements about the need for tax reform, and the reasons they're either wrong or dangerously oversimplified.

1. Federal Income Taxes Are Too High. There are lots of ways to measure how much we pay in taxes. So, when someone says taxes are too high, make sure you understand exactly what measure of taxes they're talking about.

One yardstick is the tax brackets that set the percentage tax rates for various levels of income. In terms of tax rates, the top brackets are clearly low by historic standards. In 1944, there was a 94 percent tax bracket on income above $200,000. The top tax rate dropped to a low in 1988 of 28 percent on income above $29,750 a year. The top bracket then rose to 39.6 percent between 1993 and 2000, before the Bush tax cuts helped reduce it to today's level of 35 percent. Tax rates thus are lower than they've been, not higher.

Beyond tax rates, how much federal income tax do people actually pay? Here, low tax rates on capital gains and dividend income have reduced effective tax rates for many wealthier Americans. They also get the most advantage from popular deductions such as mortgage interest. But even lower-earning households have experienced reduced federal tax burdens. The Urban-Brookings Tax Policy Center calculated that in 2010, a typical family of four paid 4.6 percent of its income in federal income taxes--the second-lowest percentage during the past 50 years. The Congressional Budget Office (CBO) has issued similar findings. So, tax burdens are lower, not higher.

It's also relevant to look at the nation's tax burden in terms of the actual amount of federal taxes collected as a percentage of overall economic activity. In a 2011 study, the nonpartisan CBO issued a 40-year look at federal tax rates. It included individual income taxes, corporate income taxes, social insurances (Social Security and Medicare), excise taxes, estate and gift taxes, customs duties, and miscellaneous receipts.

In 1971, the total take from all these taxes equaled 17.3 percent of the nation's gross domestic product (GDP)--a common way of measuring the impact of taxation. In 1980, Americans were paying 19 percent of taxes as a percent of GDP. Tax burdens were in the 17 to 18 percent range for most of the 1980s and 1990s, but started rising in the late 1990s and topped out at 20.6 percent in 2000, the highest percentage in 40 years. It was also one of the few times when the government did not run a budget deficit.

Triggered by the Bush tax cuts and, more recently, by the recession, tax burdens fell during the past decade and bottomed out at 14.9 percent of GDP in both 2009 and 2010, their lowest levels in the 40-year period covered by the CBO report.

2. Poorer People Pay No Taxes. It's true that low-income Americans pay little or no federal income taxes, but that doesn't mean they don't have "skin in the game," to cite a widely voiced criticism. They do pay lots of other taxes. For most people, Social Security payroll taxes are their largest tax payments, and these tax rates are the same for all wage earners.

"The oft-cited figure that 51 percent of households didn't pay federal income tax in 2009 is a temporary spike caused by the recession," the liberal Center on Budget and Policy Priorities said in a recent report. "In 2007, before the economy turned down, 40 percent of households did not owe federal income tax." Further, many of these households are led by old and young people who are not in the labor force and thus should not be expected to earn enough money to trigger federal income taxes.

"When all federal, state, and local taxes are taken into account, the bottom fifth of households pays about 16 percent of their incomes in taxes, on average," the report said. "The second poorest fifth pays about 21 percent."

3. Closing Tax Loopholes is the Answer. The federal government provides tax breaks to individuals and companies each year that exceed $1.1 trillion. These so-called "tax expenditures" provide an attractive target for both liberals and conservatives to cite in explaining how their plans would save the government money while still allowing us to afford cuts in tax rates (conservatives) or increases in spending (liberals).

Here are the 10 biggest individual tax expenditure items and their annual value, as compiled in a recent Congressional Research Service report:

Employer health insurance: $164.2 billion

Employer pensions: $162.7 billion

Mortgage interest deduction: $99.8 billion

Exclusion of Medicare: $76.2 billion

Capital gains: $71.4 billion

Earned income credit: $58.4 billion

Deduction for income taxes: $54.0 billion

Estate tax exclusions: $51.9 billion

Child credit: $51.7 billion

Deduction for charitable contributions: $51.6 billion

A cursory look at these benefits makes it painfully clear that even modest reductions would be very controversial, and not just among those "special interests" that make convenient targets. There are a lot of solid reasons to overhaul our tax code. Painlessly recapturing huge amounts of federal tax revenue will not be one of them.

Twitter: @PhilMoeller



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