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Our Current Tax System

Our country’s tax system is incredibly complex, but let me here provide some basic information that I have found helpful.


Where does our federal government get its funding?

Sometimes a graph is worth a thousand words …

Two things to notice about this graph:

(1) Federal taxes are lower now than any time in the last 60 years.

(2) Over time, revenues have shifted from corporate income and excise taxes to payroll taxes (here called employment taxes), such as Social Security and Medicare taxes. (Chart of the Day: U.S. Taxes)


How do revenues compare to spending?

Again, I find a historical graph the most useful way to begin to answer this question …

Three things to notice:

(1) As a general rule, when tax revenues went down spending went up, and vice versa. (Yes, this is a statistically significant correlation. For more explanation of why, see The Politics of Bad Ideas: The Great Tax Cut Delusion and the Decline of Good Government in America, by Bryan D. Jones and Walter Williams.)

(2) On average, between 1980 and 2008 the deficit was about 3% of GDP. In previous eras, we went into debt during big wars and economic hard times, but paid it down afterwards. This is the first time in American history when we accumulated so much debt without something like World War II to account for it.

(3) The projected future increases are due to the combination of health care inflation and the aging of our population, which are expected to decrease tax revenues while driving up spending on Medicare, Medicaid, and Social Security. Future projections are, of course, always subject to confrontation with reality.


Are federal taxes progressive?

The simple answer is yes. Here’s a chart (from One of These Graphs Will Make You Angry About Rich and Taxes) showing the effective tax rates of different income groups, from the lowest quintile to the top 0.1%.

State and local taxes are, however, regressive. If you look at all the taxes people pay, tax rates are progressive in the first half of the income curve but pretty flat after that – meaning people earning over a million dollars a year pay about the same percentage of their income in taxes as people earning $80,000 a year.

If they get most of their income from investments, as many high-earners do, then their tax rate can be a lot lower than that. As Warren Buffet famously pointed out, his tax rate is about half that of most people in his office — who earn good salaries but don’t have as much investment income. (Stop Codding the Super-Rich)

On the whole, the percentage of taxes paid by each income group is remarkably similar to the percentage of the total national income it takes home. The top 1%, for example, earn 20.4% of all income and pay 22.1% of all taxes. The bottom 20% earn 3.5% of national income but pay 1.9% of taxes. With an average income of just slightly over $1000 a month, who is going to begrudge them that small subsidy? (All Americans Pay Taxes)

So yes, federal taxes are progressive, but not hugely so.


Are taxes too high?

I’ll let the Center for American Progress answer that one for me …


What’s going on with corporate taxes?

The United States has one of the highest corporate income tax rates in the world (35%). As charts #8 and 9 above show, however, corporations’ real tax rate – what they actually pay – and corporate tax revenues are lower here than in most industrialized countries.

The reason for this discrepancy is that our tax code is full of special provisions that allow corporations (or individuals) to reduce their taxes under certain circumstances – deductions, exemptions, credits, depreciation schedules, etc. Collectively, these provisions are called “tax expenditures,” meaning “spending in the tax code.”

Tax expenditures (both corporate and individual) add up to more than $1 trillion a year. That’s almost as much as we spend on Social Security in a year and a half. It’s as much as we spend on Medicare in two years. It’s enough to pay for all of our military expenses for 15 months. It’s a lot of money.

Because our official corporate income tax rate is so high, corporations have a strong incentive to do everything they can to reduce their taxable profits. Big corporations therefore spend a lot of money on accountants, tax lawyers, and lobbyists. The incentives here are really skewed. Often a big company can get a better return on investment by manipulating tax laws than by improving its business – especially if it can get tax provisions that favor it over its competitors. And small companies don’t have as much lobbying leverage, so they are likely to pay the 35% official rate on more of their income.

As Lawrence Lessig explains in his new book Republic, Lost, Congress is invested in the current system. Corporations spend a lot of money lobbying Congress for tax provisions, including donating campaign funds. If we had a simple, fair, and stable tax system, these donations would dry up. (Lawrence Lessig on How Money Corrupts Congress – and How to Stop It)


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