Essay on Taxation

[Ziggy Stardust]

Here is an essay I have been working on about taxation. I am not too versed in economics, in all honesty, so most of the data taken from this is mined from various government reports, and a conversation with an economics professor. I would appreciate it if people here would rip into it in every way possible. I am attempting to make a strong argument, so I would like everything from nitpicks to counterarguments to more data sources.

Since the Reagan years, income inequality in the United States has widened dramatically. Data compiled by the Congressional Budget Office (CBO) shows a clear trend, with not only most of the wealth concentrated in the richest households of America, but also the most growth. Since 1979, the average after-tax income for the wealthiest 1% of the country has more than tripled (after inflation). However, even within that 1% can be found massive inequality: the bottom half of this 1% saw their average incomes only double after inflation, while the top 0.1% and 0.01% of the country saw increases of 294% and 384%, respectively.

For comparison, the average after-tax income increase for the entire country during the same time period was approximately 50%. The income for the lowest quintile increased about 11%, while the middle 20% of America saw their household income go up only by about 21%. In 2006, the total income for the richest 0.01% of the country (defined as the 11,000 American households that make over $8.6 million) was higher than that for the 24.1 million households that make up the poorest 20%.

In fact, according to a 2003 report in the Quarterly Journal of Economics (“Income Inequality in the United States, 1913-1998,” by T. Piketty and E. Saez), the share of the national income held by the wealthiest 1% has more than tripled since the 1970s. In 2006, 23% of the national income went to the super-rich, the highest concentration since 1928, and the second-highest in the history of the federal income tax. It is roughly equal to the income share going to the bottom 40% of the population.

According to the CBO, the overall effective federal tax rate in 2006 was 20.7%. However, the American tax system is progressive: households in the bottom fifth of the income distribution paid 4.3% of their total income in federal taxes, with the rate for the middle quintiles at 9.9%, 14.2%, 17.4%, while the top fifth paid 25.8% of their income. The richest 1% faced an effective rate of 31.2% (the only income group to see a decrease in their tax burden since 2005).

While the rich do pay a disproportionate share of federal taxes (the top 1% pay 28.3% of taxes, while the bottom and middle quintiles pay 0.8% and 9.1%, respectively), it is worth noting that the wealthiest Americans get nearly half of their income from capital gains (the sale of stocks, bonds, and other assets), which receive preferential tax treatment. The tax rate on capital gains is 15%, less than half the current top 35% marginal income tax rate. According to the testimony of then-CBO Director Peter Orszag before the U.S. House of Representatives Committee on Ways and Means in September 2007, this “creates opportunities for tax avoidance and complicates the tax system.”

In addition, social insurance and payroll taxes for the highest quintile of the income distribution are 5.8%, considerably less than the 8.5% paid by the lowest, and the 9.4% by the middle, quintile. This is because “the wages in that quintile are above the maximum income subject to Social Security taxes and in part because capital income is a larger share of income at the top. Social insurance taxes account for the largest share of taxes paid by households in all but the top quintile.”

Although the average income for the super-rich has increased dramatically since 1979, their effective tax rate has remained fairly constant (between 25% and 28% for the top quintile). During the same period, the top marginal tax rate has dropped from 70% to 35%, according to a 2003 Internal Revenue Service report published in the Statistics of Income Bulletin. According to Professor Edward N. Wolff, a professor of economics at New York University and a senior scholar at the Levy Economics Institute of Bard College, “Total taxes as a share of comprehensive income increases steadily from 14% at the tenth percentile to 28% at the 90th percentile, but then falls off sharply to 22% at the top.”

On the other hand, the rich are generally not beneficiaries of government transfers, such as social security and unemployment insurance, or public spending, such as schools and roads. The poor and the middle class are the primary beneficiaries of government expenditure. In fact, the 34% of the income distribution pay more in taxes than they directly receive in benefits, according to Wolff. However, government expenditure reduces overall income inequality by fuelling income growth in the middle class, which is beneficial for the country as a whole.

[Teebs]

I've had a quick glance through it, don't have time to think about it properly since I'm revising for my university exams, but it provides a pleasant break... I study PPE at Oxford and half of my degree is economics, so I do know a bit about taxation and the economics behind it.

Some points:

1) Your 'essay' has no conclusion. You're just listing statistics about tax in the USA. I wouldn't even call that an essay. This also makes it hard to make any critical points about what you've written because a series of facts can't be argued against (assuming they're not made up ), you need some analysis of what those facts actually mean.

2) You kind of imply that taxes are alright because they fuel income growth in the middle classes through government expenditure. You need some kind of mechanism or evidence for how/why government expenditure fuels income growth in the middle class and then you need to justify why that is good for the country as a whole.

3) Nitpicking, but if you're going to quote a source it's often better to put the full source as footnotes or create a citations list at the end and just put something like Orszag1 (imagine the '1' is small superscript) or Orszag (2007). Reading the full background to a source in the text breaks up the flow.

Having said the above, the impression I have is that what you're trying to go for is whether rich people should be paying more taxes. Things you need to think about on both sides are:
-Their mobility (if they can go and live somewhere with lower tax easily then increasing their taxes is a poor idea). Rich people are likely to be more mobile than poor ones, but on the other hand I don't think there's anywhere with the advantages of the US that has lower tax.

-Their elasticity of labour (whether they work less when they get paid less - a tax increase effectively reduces pay), this is the disincentive effect that rightwingers like to talk about. There have been a few studies on this:
Break (1957) - as many people work harder as work less when taxes go up.
Burtless & Hausman (1978) - low disincentive effect on men, but much more of one on women.
Don't ask me to give you the full reference, no way I can remember it.

-Benefits the rich can get from government spending, you've already established that direct benefits are low, but indirect benefits do exist. For example, infrastructure and education both come from tax revenues and the rich certainly benefit from an educated population.


The economic theory on income taxation says that the rich should actually pay lower marginal tax rates than the middle, for example, Conesa & Krueger (2005) IIRC found that a flat tax rate of approximately 17% with a $9500 allowance was optimal. The theory behind it though is based on the assumption that people's income is purely based on their ability (in which case you want the rich to work as much as possible) and that there is a disincentive effect (which is theoretically very plausible but empirically somewhat dubious).

In thinking about the structure of the income tax system you have 3 main questions:
1) How much should be raised altogether.
2) How should the burden be split between different people.
3) What are your goals for the tax revenue (this should have an impact on the previous two).


I've probably missed points out, but I hope that helps. Provided me with a nice break from South Asian politics.

[FireNexus]

Teebs has it right. What point are you trying to make? How does the presented evidence tie into that point? If you don't have a clear conclusion supported by your evidence, your readers might get the wrong idea, and the essay itself is boring.

[Ziggy Stardust]

Teebs has it right. What point are you trying to make? How does the presented evidence tie into that point? If you don't have a clear conclusion supported by your evidence, your readers might get the wrong idea, and the essay itself is boring.

Sorry, I forgot to elaborate, this is by no means meant as the final essay. This is merely the only part of an expected essay on taxation that I have completely written up (I have another couple of pages of just random notes and quotes on a Word document, I just haven't gotten around to formalizing that part yet). This is only one part of what I hope will be a larger project.

[Ziggy Stardust]

1) Your 'essay' has no conclusion. You're just listing statistics about tax in the USA. I wouldn't even call that an essay. This also makes it hard to make any critical points about what you've written because a series of facts can't be argued against (assuming they're not made up ), you need some analysis of what those facts actually mean.

As I said in the previous post, that is my fault; I forgot to explain how this isn't in any way meant to represent a final product. I plan on adding more substantial analysis, don't worry.

2) You kind of imply that taxes are alright because they fuel income growth in the middle classes through government expenditure. You need some kind of mechanism or evidence for how/why government expenditure fuels income growth in the middle class and then you need to justify why that is good for the country as a whole.

Indeed, I threw that in because that is how Professor Wolff explained it to me, actually. I tried to find something to back it up with, but I wasn't sure where to look. Any suggestions?

3) Nitpicking, but if you're going to quote a source it's often better to put the full source as footnotes or create a citations list at the end and just put something like Orszag1 (imagine the '1' is small superscript) or Orszag (2007). Reading the full background to a source in the text breaks up the flow.

Oh, yes, I understand how to properly format essays. This is just an ad hoc compilation so far, I will format it when the times comes.

-Their mobility (if they can go and live somewhere with lower tax easily then increasing their taxes is a poor idea). Rich people are likely to be more mobile than poor ones, but on the other hand I don't think there's anywhere with the advantages of the US that has lower tax.

There was a great article I read recently about this subject, I will have to dig it up. Thanks for the reminder.

-Their elasticity of labour (whether they work less when they get paid less - a tax increase effectively reduces pay), this is the disincentive effect that rightwingers like to talk about. There have been a few studies on this:
Break (1957) - as many people work harder as work less when taxes go up.
Burtless & Hausman (1978) - low disincentive effect on men, but much more of one on women.
Don't ask me to give you the full reference, no way I can remember it.

Thank you, I will look into those; I have heard references to this before, but as I said, I don't know much about economics, so I wasn't sure how relevant it would be.

-Benefits the rich can get from government spending, you've already established that direct benefits are low, but indirect benefits do exist. For example, infrastructure and education both come from tax revenues and the rich certainly benefit from an educated population.

That's true. I was hoping posting this would bring someone on these forums to tell me more about the rich's side of things. I do want to get both sides in, I just only know how one side is affected from my own experience.

The economic theory on income taxation says that the rich should actually pay lower marginal tax rates than the middle, for example, Conesa & Krueger (2005) IIRC found that a flat tax rate of approximately 17% with a $9500 allowance was optimal. The theory behind it though is based on the assumption that people's income is purely based on their ability (in which case you want the rich to work as much as possible) and that there is a disincentive effect (which is theoretically very plausible but empirically somewhat dubious).

Interesting, I will find that study.

I've probably missed points out, but I hope that helps. Provided me with a nice break from South Asian politics.

Thank you, I have some direction for the next stage of writing this. Hopefully you will be able to keep giving me advice as this goes on.

[Jalinth]

I'll echo some other people here in terms of whether this is really an essay. I'm also not positive exactly why is this about taxation per se rather than income inequality.

Other things to mention on the taxation front.
1)The 1986 reform (a pinnacle and key achievement in the Regan era) was actually a good thing. Trying to bring the tax code closer to the "pure" model - broad base and low rates. Got bastardized pretty quickly but was a real improvement over the pre-1986 IRC code.
2) What about the Laffer curve? It is an important piece of the supply sider's arguments. Problem is that I've never seen any analysis of when it stops working (I accept that it does hold, but only at the upper end of the tax rate spectrum. Moving from 5% tax to 0% will not increase overall tax revenue as a matter of simple logic). The impact of tax decreases on people's income drops steadily as rates comes down - 95% to 90% means your income doubles. 35% to 30% is a much small increase. So the relative impact of the incentives get smaller and smaller and therefore reduce the potential for growth.
3) Tax systems tend to get "corrupted" by politicians, interest groups and lobbyists. One aspect of an "optimum" tax code is one where you have horizontal equality - don't discriminate or favour selected business sectors and thereby distort market signals. But look at most tax codes - Canada is a good example where it has been steadily "Americanized" by more and more one-off deductions, credits, allowances, the list goes on. So these days, $100 of economic profit might bring you zero tax, $150 tax, recovery of $30, or anything between depending on what business you are in, write-offs, special allowances, etc...
4) Have you looked at the US' tax expenditure analysis? Pretty interesting - they try to carve out benefits made through the tax code as if they were actual spending by the government. It might help

[Simon_Jester]

The economic theory on income taxation says that the rich should actually pay lower marginal tax rates than the middle, for example, Conesa & Krueger (2005) IIRC found that a flat tax rate of approximately 17% with a $9500 allowance was optimal. The theory behind it though is based on the assumption that people's income is purely based on their ability (in which case you want the rich to work as much as possible) and that there is a disincentive effect (which is theoretically very plausible but empirically somewhat dubious).

I'd argue that to make matters worse, this theory is dangerously flawed unless it takes into account the secondary effects. For instance, setting up taxes that way concentrates wealth in the hands of people with high incomes, including wealthy heirs whose income is based on the abilities of people who are already dead and no longer contributing.

My view is that if you let extreme wealth disparity pop up, incentive structures get shot to hell. Then you see situations where the basic assumption of capitalist economics breaks down: it is no longer true that everyone is best off if everyone follows their own personal interests. For the people at the low end of the scale, banditry becomes more profitable than honest labor, and everyone ends up worse off except the successful bandits. At the high end, people have enough money to manipulate the rules of the system that tell them how they are permitted to make more money- which is where you get things like latifundia or speculation in credit default swaps, which are good for the people who own them (at least temporarily) but bad for the general public in the long run.