For Poverty, Tax Code Debate Offers Little Consensus
With the 50th anniversary of President Lyndon B. Johnson’s declaration of a “war on poverty” triggering new congressional debates on fiscal issues, prominent members of both parties are trumpeting plans to limit poverty. For Democrats, the Wednesday anniversary is entwined with questions about income inequality, a theme the White House says it will emphasize this year.
Some Democrats say a major factor in the unequal impact of the economic recovery is the distribution of federal taxes and the tax breaks they say have helped skew the code unfairly to benefit upper-income earners. But the tax code’s contribution to the growing trend of inequality is unclear. Even before most of the Bush-era cuts expired for upper-income earners at the start of this year, for instance, the top 20 percent of earners paid 69 percent of all federal taxes while taking home 52 percent of pre-tax income. The bottom fifth paid 0.4 percent and took home 5.1 percent of pre-tax income.
The average federal tax rate for all households in 2010 was 18.1 percent, according to the Congressional Budget Office, while the average rate for the richest 1 percent was 29.4 percent. That higher rate at the top is an essential element of the tax code’s progressivity.
But there’s a reason everyone from the new pope to the new mayor of New York seems to be talking about economic inequality: The gap between rich and poor has grown dramatically over the past few decades. And taxes have done little to blunt that trend. Between 1979 and 2010, the bottom 20 percent of households saw real after-tax income increase by 49 percent, while the top 1 percent’s after-tax income grew 201 percent over the same period, the CBO said in a December report on the distribution of federal spending and taxes.
The figures showing after-tax income has grown dramatically for those at the top illustrate that the tax code isn’t as progressive as it seems, said Jared Bernstein, a senior fellow at the Center on Budget and Policy Priorities and a former economic adviser to Vice President Joseph R. Biden Jr.
“I think about the factors driving inequality, the structure of the tax system is on the list, but it’s one of many — there’s globalization, declining unions, minimum wage issues, technological changes … unemployment.”
But even as economic inequality grew over the past three decades, so did the progressivity of the tax code, according to a Tax Foundation analysis of CBO data. The code’s progressivity dipped in 1981, after top marginal rates were cut from 70 percent to 50 percent but soon recovered with the Tax Reform Act of 1986. That law cut the top marginal rate again, from 50 percent to 28 percent, while making changes near the bottom of the income scale that made the code more progressive — increasing the value of the standard deduction and personal exemption and expanding the Earned Income Tax Credit.
The years since have seen repeated expansions of the EITC and the creation of other deductions, such as the Making Work Pay credit; those breaks disproportionately help lower-income earners.
“It’s been the changes at the bottom that’s what’s made it more and more progressive,” Tax Foundation Chief Economist William McBride said, noting that top rates have risen and fallen over the years while credits aimed at the poor have generally grown consistently.
Congress may be girding to look at the entire tax code over the next year, as some lawmakers look to advance the first broad overhaul in a generation. But for those looking at fiscal issues such as the minimum wage and unemployment insurance, the code provides a fertile field for potential offsets and tweaks aimed at amending the tax system to address what they see as a growing problem of the distribution of economic progress.
Of the top four federal taxes, individual and corporate income are progressive, while payroll taxes are fairly flat among groups and excise taxes are regressive. The wealthiest 20 percent of taxpayers paid 92.9 percent of income taxes in 2010. The top 1 percent paid 35 percent of income taxes in 2011, according to the IRS, and the CBO predicted in its December report that for that group, “average rates under 2013 law will be higher than in any year since 1997.”
As part of the deal (PL 112-240) to avoid automatic tax hikes and spending increases last January, Congress passed a law to raise rates for families making more than $450,000 annually, with the income rate going from 35 percent to 39.1 percent. A new tax under the Affordable Care Act (PL 111-148, 111-152) also took effect in 2013, imposing a 3.8 percent tax on the wealthy.
“The income tax during the course of my professional career has gone from a broad-based revenue raiser to a surtax on the rich,” said Douglas Holtz-Eakin, an economist and former CBO director. “So it’s hard to describe this as something that’s helping the rich.”
Critics, however, point to the preferential rates on capital gains — which are taxed at 15 percent for most taxpayers and at a graduated scale for the wealthy as of 2013 — as a major break for the wealthy. The low rate on capital gains and dividends and various breaks that disproportionately benefit upper-income earners, in part because lower-income earners are less likely to itemize deductions when they file taxes, are targets for groups like Citizens for Tax Justice, which advocates for a more progressive code.
“If you look at the tax code as a whole, it’s really almost not progressive at all,” said CTJ Legislative Director Steve Wamhoff, who noted state and local taxes are frequently flat and sometimes regressive.
“There are definitely specific things that help the extremely wealthy” in the federal code too, Wamhoff said. He points to the note by billionaire investor Warren Buffett, who says he pays a lower tax rate than his secretary because his income comes from capital gains.
Sen. Ron Wyden, D-Ore., who may become the next Finance Committee chairman, said a tax overhaul should form “a very, very substantial part of” the debate over economic inequality.
Wyden highlighted his prior efforts to overhaul the tax code, pointing to a plan he drafted with then-Sen. Judd Gregg, R-N.H., and Sen. Dan Coats, R-Ind., as he called for expanding a break rather than ending one.
“We tripled the standard deduction, which in effect for the working class and people of modest income would be a significant amount of tax relief,” Wyden said Tuesday.
Some Republicans say there may be a problem with unequal distribution of tax liability and breaks, but say that is a result of inefficiency and complexity in the code rather than because of the lack of progressivity.
Finance Committee member Sen. Rob Portman, R-Ohio, said taxes have a “huge role” to play in the debate over economic inequality because the tax system is stunting economic growth.
“It’s the most antiquated, inefficient tax code you could possibly imagine, so it needs a lot more improvement, and it’s urgent, because we’re losing good-paying jobs every day because of it,” Portman said.
Anti-tax advocate Grover Norquist said it’s a mistake to concentrate on inequality in the first place. “By focusing on the difference, you’re acting as if, well, if you shoot 100 of the richest people you’ve done a good thing,” Norquist said. “There are fewer people working, 100 dead people, but there’s less income inequality!”
Instead, the debate needs to be about the economy and employment, Norquist said, echoing Holtz-Eakin’s assertion that “the difference between being poor and not poor is having a job.”
In his campaign to overhaul the tax code, House Ways and Means Chairman Dave Camp, R-Mich., has promised to maintain current progressivity levels. Camp makes another point about taxation and the wealthy — that the complexity of the code itself inherently disadvantages middle-income taxpayers without the resources to find and use the breaks that apply to them.
“The complexity of the code hurts average Americans who cannot afford the best tax planners and accountants to take advantage of everything in the code,” said Ways and Means spokesman Michelle Dimarob. “The code needs to be simplified to treat all families more fairly.”
If lawmakers are interested in addressing poverty by looking at progressivity in tax distribution, they may find few real models outside the U.S. The Organisation for Economic Co-operation and Development already names the U.S. tax code as the most progressive in the world, even though the income disparity in the United States is roughly average, according to Gallup data.
Among 131 countries in the world, the wealthiest 3 percent of citizens control 20 percent of the wealth, according to a Gallup report using data aggregated from 2006 through 2012. In the U.S., the top 4 percent of earners account for a 20 percent share of income. Europe fared slightly better by that measure; there, the top 6 percent control 20 percent of income, even though European tax codes are considered more regressive because of the reliance on consumption taxes.