The Graduated Income Tax System

In my last commentary I discussed at length the history of the graduated income tax in the US and demonstrated that far from being a new socialist, or European idea, it had been with us for almost one and a half centuries and is as American as apple pie.

The radical opponents of this time honored idea (and I call them radicals rather than conservatives because it is hardly conservative to try to abolish a system that has been so time honored) argue that there is something wrong with a large portion of the population not paying any tax or even for a small portion of the populace to pay the bulk of the taxes. They chose to ignore the old axiom; “you can’t get blood from a stone.”

Beyond that they pretend that it is offensive to the principles of Capitalism, apparently being unaware that Adam Smith, the early apostle of capitalism, wrote in 1776 in his seminal treaty on capitalism, The Wealth of Nations, “The necessaries of life occasion the great expense of the poor. . . . The luxuries and vanities of life occasion the principal expense of the rich, and a magnificent house embellishes and sets off to the best advantage all the other luxuries and vanities which they possess. . . . It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion.” It is rather interesting to note that Adam Smith espoused a graduated tax.

But none of this deters our modern radicals from proclaiming the unfairness of that which is both practical and just. Ari Fleisher, George W. Bush’s former press secretary for example wrote an article in the Wall Street Journal of April 16, 2007, “The income tax system is so bad, and increasingly reliant on a shrinking number of Americans to pay the nation's bills, that 40% of the country's households -- more than 44 million adults -- pay no income taxes at all. Not a penny.” I do not know whether this is accurate, but even if it is, it is not true that it is “INCREASINGLY reliant on a shrinking number of Americans to pay the nation's bills.” As I demonstrated in my previous article, according to the US Treasury department, our tax system as early as 1860 relied on a small number of the wealthy to pay the taxes and under the law of 1923 less than 1% of the population were expected to pay any tax at all. Fleisher goes on to complain that the richest (I assume he doesn’t mean the richest, but rather those with the largest taxable income since income taxes are based on income and not on wealth) 1% of Americans pay 37% of all our taxes. 10% of taxpayers pay 71% and 40% pay 99%. He goes on to complain that those who make under $43,200 carry only .09% of the income tax burden. Again I don’t know whether these figures are accurate, but assuming that they are, what does Mr. Fleisher propose, that we double the tax on people who often work two jobs and barely have enough to pay their rent, their medical bills, put food on the table and educate their children. But of course these people pay much more taxes than Mr. Fleisher gives them credit for, since they not only pay federal income taxes, but payroll taxes, sales taxes, real estate taxes, excise taxes and possibly local income taxes as well. Our tax system has over the years become not more progressive, but rather much more regressive and Mr. Fleisher and his cohorts, against all precedent, want to tax the have-nots more and more so that the billionaires, who are increasing their wealth as a percentage of the total wealth in the country, and whose after tax income is steadily increasing, can accumulate even more. But even this remains misleading, for the rich make most of their income from capital gains, which are not taxed to the same extent as income made from the sweat of one’s brow.

In order to see the extent of the gap in the income of Americans the following figures from the US Census bureau are instructive: The top 20% of Americans make 49.7% of total income. The next quintile made 23.3%. The middle quintile 14.8% or to put it another way the top 60% made 87.8 percent of total income in the US. The bottom 40% made 12.3% of income.

One can easily see that even if we had a flat tax, with everyone regardless of income paying the same percentage, the top 20% of earners would still be paying almost 50% of the federal income taxes. And while the graduated income tax is often described as redistributing income, it does so rather ineffectively, if at all, as can be seen from the figures below showing income distribution after taxes. As can be seen the difference for after tax income is miniscule. The top 20% have 46.2% of income, the next quintile have 22.3%, the middle 15.6%, the bottom 40% end up with 16%.

As for wealth as opposed to income, according to Forbes - September 17, 2008 edition - to become one of the 400 of the richest people in America one has to have a net income of $1.3 billion. Over the past year their combined wealth increased by $1.57 billion. The richest has a net value of $57 billion and would be worth $90 billion if he had not given away much of it to charity. The second richest is Warren Buffet with $50 billion, who had this to say about our tax system, when addressing a group of 400 wealthy individuals, “The 400 of us [here] pay a lower part of our income in taxes than our receptionists do, or our cleaning ladies, for that matter. If you’re in the luckiest 1 per cent of humanity, you owe it to the rest of humanity to think about the other 99 per cent.”

Mr. Buffett said that he was taxed at 17.7 per cent on the $46 million he made last year, without trying to avoid paying higher taxes, while his secretary, who earned $60,000, was taxed at 30 per cent.

Not only are the rich not being overtaxed, it appears that the richer you are the smaller the percentage of your income goes to pay federal taxes. While we appear to have a graduated income tax, the lower capital gains tax more than makes up for this discrepancy, as do the innumerable tax deferrals and exemptions available only to the rich.

Even with some small restoration of fairness, as proposed by President elect Obama, we will be a long way from restoring our traditional graduated tax system, which has kept us from becoming a class structured society, and has kept us economically successful.