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boring tax stuff

30 Aug 2004

Rich on the CBO tax report:

Everybody is paying less in taxes under the new tax laws. But the high income tax payers are accounting for a higher portion of total income tax receipts. It has to be one of two things. Either there are more people in the top 20%, or the top 20% is recording more income. In other words, we’re creating wealth.

That conclusion doesn’t logically follow, and I’m going to use this as an excuse to try to give an explanation for the ramifications of the Bush tax cuts and the CBO report on their effects.

Rich seems to overlook that we have a tax structure in brackets – taxes for everyone can decrease across the board while the “share” still increases and decreases for different brackets. Which is precisely what happened, as we see in the breakdown by quintile:

change in income tax rate
change in income tax share

You can clearly see that everyone’s income tax rate went down, but the share for the highest quintile goes up consistently. This doesn’t mean we’re “creating wealth”. This CBO report focuses on the effect of the change in tax policy, not tax revenue intake. It just means we’ve shuffled things around a bit so everyone pays less on the aggregate, but the highest quintile pays more as a share of income tax than they did previously. Whether or not this tax policy is creating any wealth or not would require an entirely different (and much more difficult) analysis.

That the highest quintile is actually paying more income tax is what a lot of conservatives are harping on when they accuse the SCLM of presenting an incomplete picture of the CBO report. But, the truth is that the CBO report includes the complete picture, and they want us to ignore it. How is it that the tax burden was shifted to the middle class if the rich are actually paying more income tax? Easy: payroll taxes. This is best illustrated by a very crude, simplified example:

Before Tax Cuts
Income
($/yr) 		Payroll
Taxes Owed
($) 		Income
Tax Rate
(%) 		Income
Taxes Owed
($) 		Total
Taxes Owed
($) 		Tax Burden
(% of income) 		Tax Share
(% of tax revenue)
Imaginary Rich Guy 200000 20000 60 120000 140000 70 82.35294118
Imaginary Middle-Class Guy 50000 20000 20 10000 30000 60 17.64705882
After Tax Cuts
Income
($/yr) 		Payroll
Taxes Owed
($) 		Income
Tax Rate
(%) 		Income
Taxes Owed
($) 		Total
Taxes Owed
($) 		Tax Burden
(% of income) 		Tax Share
(% of tax revenue)
Imaginary Rich Guy 200000 20000 40 80000 100000 50 80
Imaginary Middle-Class Guy 50000 20000 10 5000 25000 50 20
Changes
Change in Tax Burden
(% of income) 		Change in Tax Share
(% of tax revenue)
Imaginary Rich Guy -20 -2.352941176
Imaginary Middle-Class Guy -10 2.352941176

Here we see two hypothetical people, one rich, one not, to which there are applied two different income-tax rates and one fixed sum of payroll taxes. Naturally payroll taxes are not actually fixed, but they are a flate rate (15% or so) levied up to a certain amount of your income ($70k or so). Since it only applies to a certain fixed portion of income, as it pertains to high-income households, it’s basically a fixed tax of a small amount that pales in comparison to their income tax.

As you can see, a hypothetical income tax cut is enacted in the “after” chart, from 60 to 40% for the rich guy, and 20 to 10% for the middle-class guy. Note that as a result:

  • Income tax rates went down for both individuals
  • Tax burden went down for both individuals
  • The rich guy now pays a larger income tax rate than the middle-class (4x the rate, as opposed to 3x the rate)

And yet, we see that because of the fixed presence of the payroll tax, this actually results in the middle-class guy paying a larger percentage of our hypothetical 2-person’s tax base. This is because income taxes are not the whole story, and payroll taxes are the biggest tax burden facing low and middle class taxpayers. Thus, an income tax cut, even across the board, benefits the wealthy, because it affects them far greater, and shifts the tax shouldered from the backs of the wealthy to the middle-class.

Comments

rich — August 31, 2004 at 18:48 · reply

Chris, don’t juggle numbers unless you’re wearing Kevlar gloves; you’ll lose fingers. It’s not that difficult to analyze. If your effective rate for the quintile goes down, as it did, but your share of the total taxes went up, there’s only a couple of possible explanations. If total receipts went down, then other quintiles’ effective rates must have declined more than yours (ie, they got a bigger cut).Since liberals have been endlessly pointing out that the wealthiest quintile got the biggest cut, we know that isn’t the case. The other option is that receipts either remained the same or increased. In either case, for the effective rate to decrease, and for share to increase, there are only two possibilities. Either the other quintiles got a bigger cut (already disproved) or the upper quintile reported more income. (ie created wealth)

If you can find another possibility, by all means, share it with the rest of us.

cwage — August 31, 2004 at 19:12 · reply

Chris, don’t juggle numbers unless you’re wearing Kevlar gloves; you’ll lose fingers. It’s not that difficult to analyze. If your effective rate for the quintile goes down, as it did, but your share of the total taxes went up, there’s only a couple of possible explanations. If total receipts went down, then other quintiles’ effective rates must have declined more than yours (ie, they got a bigger cut).

No. With all due respect, you are confused. The CBO report is analyzing the effects of the legislation, period. The only income data it used was from 2001. It doesn’t have anything to do with tax receipts:

The analysis reflects the expected changes in tax burdens as measured by applying the tax law in effect in each year to the underlying incomes. It does not reflect any change in revenues that would result from changes in taxpayers behavior.

For example, the analysis would not capture any change in tax payments that could result if a lower tax rate on capital gains induced taxpayers to realize more capital gains.

The CBO report reflects the changes between post-tax-cut policy and pre-tax-cut-policy, nothing more. It has nothing to do with “generating wealth” insofar as economic stimulation. It’s an analysis of tax burden before and after legislation.

If you can find another possibility, by all means, share it with the rest of us.

That’s what this post is.

Will — September 02, 2004 at 16:15 · reply

Chris, I’ve done an analysis on this report and have reached the opposite conclusion. If I’m mistaken, please let me know.

cwage — September 02, 2004 at 20:27 · reply

In principle, everyone shoulder’s societies burdens to the extent at which they can, but there should be no mistake. In principle, Bush’s tax cuts disproportionately benefitted the wealthy.

On the contrary, it seems we hold the same opinion of both Bush’s tax cut and the CBO report.

Will — September 02, 2004 at 22:19 · reply

I’ve realized I was very mistaken. I’ve reread your conclusion and you’ve come up with a more sophisticated explanation of the shifts. Thanks!

Adam — September 03, 2004 at 17:10 · reply

Chris,

Your analysis is incomplete, because it doesn’t take into account the other half of payroll taxes that employers pay. It is safe to say that employers are in higher tax brackets than their employees and employers must deduct the cost of the matching payroll taxes from their income after overhead (which would normally be profit, and thus their income). In short, people in higher tax brackets pay double the payroll taxes as those in the lower brackets because they are business owners who must pay the matching payroll tax.

cwage — September 03, 2004 at 19:36 · reply

Your analysis is incomplete, because it doesn’t take into account the other half of payroll taxes that employers pay. It is safe to say that employers are in higher tax brackets than their employees and employers must deduct the cost of the matching payroll taxes from their income after overhead (which would normally be profit, and thus their income). In short, people in higher tax brackets pay double the payroll taxes as those in the lower brackets because they are business owners who must pay the matching payroll tax.

Not quite. Economists are nearly universally agreed that the burden of payroll tax paid by the employer falls on the shoulders of the employee. For example, Milton Friedman:

[The total tax for social security] includes what is euphemistically called “a contribution by the employer.” Again, this is mislabeling. It is no contribution by the employer: it is a compulsory tax and it isn’t paid by the employer; it is, in effect, paid by the wage earner. It is part of his wages that is sent to Washington instead of going to him. The form, the name, doesn’t change the substance.

Source: M. Friedman, “Transfer Payments and the Social Security System,” The Conference Board Record, New York, Sept. 1965, 11, 7-10

Adam — September 04, 2004 at 00:17 · reply

In a corporate structure, it would be easy to dismiss matching dollars as simply another tax on the wage-earner, but for small businesses that is not the case at all.

In the case of most small businesses and even some larger ones, the owner simply takes home what is left after tax, overhead, and staffing costs.

Following your argument to it’s logical conclusion, it would suggest that employers never pay taxes at all- they simply pass the taxes off to either the consumer or the wage-earner. If that’s your conclusion, I’m sure you’ll stand beside me and fight for the abolition of the corporate income tax, sales tax, excise taxes and all other taxes on either products or companies.

Rich B. — November 01, 2004 at 20:32 · reply

“Thus, an income tax cut, even across the board, benefits the wealthy, because it affects them far greater, and shifts the tax shouldered from the backs of the wealthy to the middle-class.”

Or not. You assume here that just because a slightly higher percentage of the tax burden is going to the middle-class than before, that suddenly “the tax is shouldered on their backs.” What nonsense. By your own scenario, 80% of the total burden is still going to the rich…hardly the burden of the middle class. What do you want from them? 90%, 95%, how about just taking all of their wealth and “redistributing” it as you commies call it (we regular folks call that STEALING).

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