How we can prevent the wealthiest of our wealthy from exempting virtually unlimited billions from tax.
The right’s favorite rationale for lowering the taxes rich people pay can make sense, but only if you believe that fairness demands taxing the first dollar of a person’s income at the same rate as the billionth.
The right has been trotting out, for years now, the notion that America’s top 1 percenters pay way more than their share of the nation’s personal income tax burden. One recent iteration of this comes from a UCLA economist, another from the congressional Joint Tax Committee.
I don’t know what drives me crazier about this perennial fable, the eagerness those bamboozled by it repeat it or the unwillingness of those on the left to aggressively take it on.
Apologists for a top-heavy America typically articulate this canard in one of two ways. Some simply state the percentage of America’s total personal income tax paid by the top 1 percent and stop there. I usually hear cited a figure around 35 percent. But this varies by the speaker’s distance from the original source. I’ve actually heard the figure pegged at 47 percent by a somewhat drunk and very angry 1-percenter at a cocktail party.
I have a standard response whenever I hear someone start throwing around one of these numbers. I ask the speaker what percentage of total income flows to the top 1 percent. More often than not, the speaker doesn’t know.
Remarkable, huh? For all those fond of this rich-pay-more-than-their-fair-share canard know, those poor over-burdened souls in the top 1 percent could have a larger share of the nation’s income than tax burden, but they haven’t even stopped to consider the possibility.
Actually, those top 1 percent souls don’t have a larger share of the nation’s income than tax burden, and that brings us to the second, more sophisticated version of the canard, the version that compares the ratio of the percentage of the income tax burden borne by the 1 percent to the percentage of total income flowing to the 1 percent.
In other words, if the 1 percent bears 34 percent of the income tax burden and its share of income stands at 17 percent, this “tax-to-income ratio” would be 2.
On its face, this ratio appears a better indicator of how heavily the 1 percent get taxed than the tax share of the 1 percent figure standing alone.
In reality, it isn’t.
Admittedly, the misleading nature of the tax-to-income ratio can be harder to grasp. So stick with me here.
Start by considering what the tax-to-income ratio would be in the two opposite extreme scenarios of income distribution: an entirely equal distribution where every household has the same income and an entirely unequal distribution where 100 percent of the income flows to the top 1 percent.
In the first scenario, the top 1 percent would pay 1 percent of the total tax and receive 1 percent of the total income, for a tax-to-income ratio of one-to-one. In the second scenario, the top 1 percent would pay 100 percent of the tax and receive 100 percent of the income, again for a tax-to-income ratio of one-to-one.
Real life, of course, falls in between these two extremes. And in this real life we have a progressive federal income tax rate structure. Income in higher brackets gets taxed at a higher rate than income in lower brackets.
As a result, people with lots of income — the 1 percent — will pay a share of the nation’s total income tax paid greater than its share of total income. We should expect no less.
Most of us instinctively understand this basic relationship, and that’s what makes the misleading nature of the tax-to-income ratio so hard to grasp. People tend to assume the ratio reflects the progressivity of our tax structure. It does, but it also reflects the unequal distribution of our national income. And the impact that our income distribution has on the tax-to-income ratio dwarfs the impact of our tax structure’s progressivity.
To understand all this, try considering what happens to the tax-to-income ratio if we start with a perfectly equal income distribution and gradually make things more unequal. We know that as the distribution of income starts to become unequal in favor of the top 1 percent, the tax-to-income ratio increases. But we also know that at some point, as income becomes increasingly concentrated in the top 1 percent, the ratio must decrease, because it ultimately will return to one-to-one when 100 percent of the income flows to the top 1 percent.
This means that the ratio conservatives ballyhoo as “proof” of a tax structure’s unfairness to the rich can change even if the tax structure does not. Think about that for a second. The greater the 1 percent’s share of our income, the more the 1 percent can claim that they’re paying more than their fair share.
Wait, this gets even zanier. Consider this example: Suppose 50 percent of total income is flowing to the top 1 percent and the remaining 50 percent of total income is distributed evenly among the bottom 99 percent.
Now consider the same split between the top 1 percent and bottom 99 percent, but assume the entire share of the bottom 99 percent flows to the second 1 percent.
In the first case, the bottom 99 percent will pay as a group much less in tax than in the second, because many bottom 99 percent taxpayers in the first scenario will sit in the lowest income brackets and face lower tax rates.
So, in effect, the more evenly the 99 percent divvies up its share of total income, the more 1 percenters can argue that they’re paying more than their fair share.
The bottom line? Unless you believe that fairness requires a tax system where the first dollar of a person’s income is taxed at the same rate as the billionth, the percentage of the total income tax paid by the top 1 percent will exceed the percentage of the income that flows to them. Trying to read some significance into how those two percentages differ amounts to utter silliness.
A far more logical approach to determining tax fairness would be to look at the concentration of wealth at the top over time. If an increasingly greater portion of our wealth is concentrating in the hands of a few at the top, that tells us all we need know about the fairness of our tax system.
In this light, our tax system looks anything but fair. The share of our national wealth held by the Forbes 400 has tripled in just the last three decades.
Bob Lord, an Institute for Policy Studies associate fellow, practices law in Phoenix.