Imagine a scenario. Your child has worked hard their whole academic career, and they’ve gotten a full ride scholarship to a top 10 University. You’ve saved up for their college, so now you have a relatively large sum of money to use as you see fit. Do you, beaming with pride, reward your child by buying them a car? Or do you take the money, and buy a car for your other child who dropped out of college and is living in your basement? After all, the successful child doesn’t really need it as much; they will do just fine in life. You can even take it a step further. You can ask the successful child to send home part of their paycheck after college to help support their less ambitious brother.
If we think the latter option won’t negatively impact the successful child, we’re kidding ourselves. No one wants their hard work and successes punished, especially when they can look over and see failure generously rewarded. Some people will struggle with the same ferocity to rise above a world that seems to be against them. But most will die a little inside, and not try so hard when they know their efforts won’t get them what they deserve.
Our “progressive” tax system is set up in such a way as to punish the successful child. When the Supreme Court recently reaffirmed Congress’ ability to encourage good behavior through taxes, they didn’t mention that success was a bad behavior. Yet time and again Congress has used its power to punish its citizens for their personal success.
The list of exemptions that are phased out based on income goes on for miles. You have the Personal Exemption, Itemized Deductions, the Earned Income Tax Credit, the Child Tax Credit, the Child and Dependent Care Credit, the Adoption Credit, the American Opportunity Credit, the Hope Credit, the Lifetime Learning Credit, the Education Tuition and Fees Deduction, Coverdell Educational Savings Account Contributions, the Student Loan Interest Deduction, the Education Savings Bond Program, the Saver’s Credit, Roth IRA Contribution Limits, Traditional IRA Contribution Limits (Have own Qualified Plan), Deductible IRA Contribution Limits (Spouse has Qualified Plan), Taxation of Social Security Benefits, the AMT Exemption and the list goes on. The standard justification for all these phase outs is that when you reach a certain income, you no longer need “help” from the government. What income level is enough is the commonly debated topic, not whether the justification is valid. The fact remains that this is a disincentive, a punishment of success, justified in the name of the public good. But is punishing success truly in the public’s best interest?
The progressivity of the tax system doesn’t end with carve outs. The entire income tax is structured so that higher income earners pay a higher percentage than lower earners. Actually, when it’s all said and done, the income tax actually pays the bottom 40% of earners (in Soviet Russia, taxes pay you!). Almost half of the nation is actually getting paid by the government to earn the lower half of income. Not those below the poverty line, not the bottom 1%, but 40%. According to a study by the Congressional Budget Office, in 2009 the bottom 20% of earners got an average 9.3% bonus on their income through the income tax. For the next 20%, the bonus was 2.6% (combined the bottom 40%). The income tax is so “progressive” that the disparity between the rate the top 20% pay and the bottom 20% pay is 22.7%. Keep in mind this is only the income tax.
In reality, if you take the average total federal tax rate across the U.S. in 2009 (17.4%, which is the post 1979 low), then only the top 20% of earners are paying their “fair share.” The other 80%, a supermajority in Congress, are paying less than the average rate. If you compare the share of all income with the share of all taxes, the top 20% face a similar fate. They earned 50.8% of the nation’s income in 2009 and paid 67.9% of all federal taxes, making them the only group which paid a higher portion of taxes than their portion of income. In contrast, the middle 20% earned 14.7% of the nation’s income in 2009 and paid 9.4% of all federal taxes, and for the bottom 20% the numbers were 5.1% and 0.3% respectively.
This “progressivity” is much more pronounced than it was 30 years ago. In 1979, the top 20% of earners had 44.9% of the nation’s income versus 55.3% of all federal taxes. This disparity was only 10.4%, compared to the 17.1% today. The average federal tax rate for the bottom 20% of earners was 7.5% of income, compared to around 1% today. Is the bottom 20% of earners worse off today? If they are, wouldn’t the increased “progressivity” of the tax code over the time period raise alarm? After all, if you keep whipping a horse, they will learn to avoid that which gets them whipped, in this case economic success.
As Adam Smith put it in the Wealth of Nations, “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our own necessities, but of their advantages.” These principles of capitalism have catapulted the United States of America from a loose coalition of rebel colonies to the largest economic powerhouse in the world, in just over 200 years. Why then, at the height of our success, should we abandon these ideas?
CBO the Distribution of Household Income and Federal Taxes, 2008 and 2009: http://www.cbo.gov/sites/default/files/cbofiles/attachments/43373-06-11-HouseholdIncomeandFedTaxes.pdf
Tax Policy Center Briefing Book: http://www.taxpolicycenter.org/briefing-book/TPC_briefingbook_full.pdf
The Internal Revenue Service: http://www.irs.gov/
An Inquiry into the Nature and Causes of the Wealth of Nations by Adam Smith: http://www2.hn.psu.edu/faculty/jmanis/adam-smith/Wealth-Nations.pdf