How to Raise Revenue
Wall Street Journal
August 24, 2007
The Congressional Budget Office reported yesterday that the famously fearsome budget deficit is plummeting almost as fast as Congress's approval ratings. The deficit this fiscal year is expected to be $158 billion, a meager 1.2% of GDP. Since the Bush tax cuts of 2003, the budget deficit has fallen by $217 billion mostly because of a continuing torrid pace of revenue growth.
Quite a success story, but one that isn't likely to be embraced by House Ways and Means Committee Chairman Charles Rangel of New York. Last week he gave a sneak preview of his tax strategy for this fall by announcing he wants to put "more equity into the system." Mr. Rangel then provided the translation: It's time, he says, to "take a look at the upper [marginal tax] rate to see if there can be a more equitable distribution of the tax."
OK, let's talk equity. It's almost an article of faith on Capitol Hill these days that the Bush tax cuts tilted the income tax system in favor of the rich. If this were true, it would be reflected in the actual data on the distribution of the income tax.
For the Bush tax cuts to have been a give-away to the rich, people paying the higher marginal tax rates would have to be carrying a smaller share of the income tax load. But the IRS data indicate that they are not paying less. Instead, they are paying more -- lots more. More surprisingly, the richest 1%, 5% and 10% of the taxpayers are shouldering a larger percentage of the income tax burden at the federal level than the tax estimators said they would had the Bush tax cuts never materialized. The data nearby tell the story.
The preliminary 2005 data just released from the Treasury Department show more of the same. The amount of tax paid by those earning more than $1 million a year increased to $236 billion in 2005, up from $132 billion in 2003, the year of the tax cut. This was a 78% increase in taxes paid by millionaire households.
Another indication of the expanded tax base is that after the tax cuts there were more millionaires for Uncle Sam to tax. In 2003 about 182,000 Americans declared gross income of $1 million or more. In 2005 the number of millionaire households leapt to 300,000. The number of Americans with declared income of $10 million or more doubled to 13,000 from 6,000 in the years after the tax rate cuts. This is a "problem" only if Democrats have come to believe that earning money is an ignoble pursuit.
The boom in the stock and housing markets clearly had a lot to do with the expansion in the number of millionaires in America, but lower tax rates on capital gains and dividends also caused a huge jump in reported income. The National Bureau of Economic Research found an "unprecedented surge in regular dividend payments after the 2003" Bush tax cut. Likewise, the lowering of the capital gains tax was followed by a 150% increase in the amount of capital gains unlocked by the 15% tax rate. Lower tax rates expanded the tax base.
We hope that before "putting more equity into the system" Mr. Rangel also takes a look at the longer term picture on revenues and tax rates, because it shows that raising tax rates may not be a wise strategy. With a few exceptions, tax rates in America have been steadily falling for the past 25 years starting with the Reagan tax cuts of 1981. When Ronald Reagan entered the Oval Office in 1981, the highest tax rates on income, capital gains and dividends were roughly twice as high as today. The top marginal income tax rate in 1981, for example, was 70% compared to 35% today. These tax rate reductions haven't meant that the rich have escaped paying their "fair share" of taxes or that the burden has shifted to the middle class. The opposite has occurred. Over the past 25 years tax payments by the wealthy have continually risen almost in inverse proportion to the tax rates, as shown by the surprising results below. The real bite on the middle class comes from payroll and state taxes; include them and their tax share rises relative to the wealthy. So yes, cut those taxes, too.
The supply-side revenue effects on the rich are remarkable: Tax rates on higher incomes have been halved, but the federal tax share of the top 1% has nearly doubled. And the budget deficit has fallen. That's what happens when tax policy gets the incentives right.
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