A Tax Epiphany: I just realized something I should have understood four years ago. Ever since the Bush tax cuts were first discussed in the 2000 campaign, I’ve been persuaded by claims like the following:
CBO Report: Bush Tax Cuts Tilted to Rich
By Vicki Allen
Reuters
Saturday 14 August 2004
WASHINGTON – One-third of President Bush’s tax cuts have gone to the wealthiest 1 percent of Americans, shifting more burden to middle-income taxpayers, congressional analysts said on Friday.
The report by the nonpartisan Congressional Budget Office and calculations by congressional Democrats based on the CBO findings fueled the debate over the cuts between Bush and his Democratic challenger in November, Sen. John Kerry.
Using the CBO’s figures, Democrats in Congress said the top 1 percent, with incomes averaging $1.2 million per year, will receive an average tax cut of $78,460 this year…
In contrast, the report showed that households in the middle 20 percent, with incomes averaging $57,000 per year, will receive an average cut of $1,090…
The CBO report said about two-thirds of the benefits from the cuts went to households in the top 20 percent, with an average income of $203,740…
Democrats said the CBO calculations, which they requested, confirm the view of independent tax analysts that the tax cuts enacted in 2001 and 2003 have heavily favored the wealthiest taxpayers.
Let’s consider a thought experiment where the government decides to cut the income tax by 50%. In particular, it decides to cut everyone’s income tax burden in half, so that everybody pays only half as much in income tax as they used to. The multi-gazillionaire who paid $4 gazillion in income taxes now pays $2 gazillion less; the working family that paid $1,000 gets a tax cut of only $500. As above, it seems like the gazillionaire gets a pretty sweet deal, and “the rich” (suitably defined) may very well receive most of the benefits.
What’s important to see, however, is that the new system may be just as progressive as the old. If before the cuts, the top 1 percent of income tax payers paid as much as the bottom 20 percent, then after the cuts, they’ll still pay as much as the bottom 20 percent–both tax burdens will just be half as much as before. In terms of the total tax burden, since everyone’s fell by half, the proportion borne by the top 1 percent will be unchanged. In other words, a tax cut which offers disproportionate benefits to the wealthy, in absolute terms, may be perfectly equal in relative terms, and may represent a progressivity-neutral change to the tax code. The absolute benefits are disproportionate only because the wealthy’s tax payments were disproportionately large to begin with.
That’s why, for example, the Bush tax cuts can plausibly be described as progressive–as long as one is looking solely at the income tax. (More on this below.) The rich may receive much greater absolute amounts than the poor, but that doesn’t imply anything about their share of the tax burden. And according to other analyses of the CBO figures, the share of the income tax burden borne by the wealthy in fact shifted slightly upward, and that of the poor fell.
I came to these conclusions after reading Steven Landsburg’s piece in Slate, which has provoked an energetic response by John Quiggin at Crooked Timber. Quiggin, as I understand him, makes three (non-ad-hominem) arguments against Landsburg’s analysis.
One argument is that Landsburg’s piece is “hopelessly biased” because it employs the “presentational trick” of separating relative and absolute reductions in taxes. Suppose the wealthy pay a 40 percent income tax, and the poor pay 10 percent; these rates are then cut to 30 and 5, respectively. Quiggin notes that the high-earners have “[c]learly . . . gained twice as much, relative to pretax income”; their rate fell by 10 points, while the poor’s tax rate fell by only 5 points. But that’s just another way of restating the initial claim. What Quiggin doesn’t accept is that the wealthy’s share of the tax burden has increased; they’re still paying three-fourths of their previous tax bill, while the poor are only paying half. This result is made even more clear if we cut the rates further, to 20 and 0. The wealthy have still saved twice as much as the poor, relative to pretax income–but since they now bear all of the tax burden, it’s hard to describe that as deeply unfair.
A second argument, which Quiggin mentions in passing, is that the rich pay less in taxes than the rates would imply, because they have more access to sharp lawyers and tax loopholes. That’s true, and that’s a problem, but it also doesn’t imply anything at all about a change in the tax system–which may or may not increase cheating. If the wealthy only paid 2/3 of what they were supposed to before, then after a proportional change they’ll still be paying 2/3 of what they’re supposed to–which means their actual share of the tax burden will be unchanged. (Lowering marginal tax rates on the wealthy would, if anything, diminish this effect, since it reduces the financial incentive to cheat.)
A third argument, and ultimately the only successful one, is that the income tax doesn’t tell the whole story. The taxes that have been cut in recent years–on Income, corporate income, and capital gains–are borne primarily by the rich, while the taxes that weigh most heavily on the poor, like sales taxes and the Social Security payroll tax, have largely been left unchanged. Thus, no matter how progressive your income tax cuts might be, the net result to the system might be a greater burden on the poor. In fact, if you fill in the ellipses from the Reuters report above, the Congressional Democrats found that the share of the tax burden of the top 1 percent has fallen by about 2 points to 20.1 percent, while the share of the middle quintile of taxpayers has risen from 10.4 to 10.5 percent. So the Bush tax cuts were slightly imbalanced in their effects–but not dramatically so, as Landsburg’s graph shows here.
None of this is to say that equal absolute reductions, like cutting everyone an equal $300 check, would necessarily be wrong. In fact, I thought the $300 rebate was the best part (some would say the only good part) of the Bush tax cuts. But we can’t pretend that equal absolute reductions are the only neutral way to cut taxes. The fallacy here is to look at the tax cut as if it were a spending program, cutting $78,000 checks to the wealthy and $1,000 checks to the poor; if we assume a completely neutral tax system beforehand, such a spending program would rightly be reviled. Under our system, though, the revulsion ignores the fact that we’re starting from an already-progressive base. Since we’re already extracting more money from the rich, giving everyone an equal check isn’t a neutral change–it increases the redistributive aspects of the system, shifting money from rich to poor.
Again, more redistribution may be a good idea. (Under certain limits, since high marginal rates have distortionary effects.) But it’s one thing to say that the tax system ought to be more progressive than it is now; it’s quite another to assume that equal proportional reductions will make it worse.
