No More Juice to Squeeze

05/11/2012 8:00 am EST

Focus: TAXES

The government needs more revenue, but raising taxes isn't going to get us where we need to be, observes the staff at

In the current election campaign, there is a certain amount of focus on raising incomes taxes as a deficit-reduction maneuver. While we would agree that raising revenue is essential for a true solution to government deficit problems, there simply aren’t enough taxpayers to make a significant dent in the deficit, particularly millionaires.

The latest IRS government data on how income taxes are distributed among taxpayers comes from 2009. The 2009 data is significant ,because it is sharply different from 2008, as it is the first year after the financial collapse in the fall of 2008.

The following table illustrates the drop in revenue experienced by the government from 2008 to 2009, both in terms of total revenues and in income taxes:

Income Taxes Paid, $Billions                              2008                        2009
Total receipts                                                        $1,032                     $866
Top 0.1%                                                               $190                        $148
Top 1%                                                                  $392                        $318
Top 5%                                                                  $606                        $508
Top 10%                                                                $721                        $610
Source: IRS

As this table illustrates, the drop in income tax receipts in 2009 was sharp, due to the economic downturn and not any change in tax policy.

Granted, the number quoted here is the Adjusted Gross Income, which excludes mortgage and healthcare deductions from income. Note that the AGI numbers quoted include joint filings. Nevertheless, the numbers give a roughly accurate picture of the income distribution in the United States.

Income Distribution
To be in the top 0.1% of all taxpayers in 2009, an AGI of $1.4 million was necessary. There were 138,000 returns in this category.

To be in the top 1% of all taxpayers, an AGI on your 1040 was $343,927. There were 1.4 million in this category.

To be in the top 10% of all taxpayers, an AGI of $112,000 was necessary. There were 14 million in this category.

There are few persons filing joint returns with an AGI of $112,000 who feel like they are in the top 10% of all Americans in terms of income.

What defines the “middle class” anymore? If an income slightly above $100,000 on a joint return is all that is required to be in the top 10% of all taxpayers, where is the “middle class?”

New Revenue by Increasing Taxes?
The percentage of total incomes taxes paid by each of the income brackets is illustrated in the following table:

Percentage of Total Taxes Paid                          2008                        2009
Total                                                                       100%                      100%
Top 0.1 %                                                              18.5%                     17.1%
Top 1 %                                                                 38.0%                     36.7%
Top 5 %                                                                 58.7%                     58.7%
 Top 10%                                                               70.5%                     69.9%
Source: IRS

As this table illustrates, the top 1% of all taxpayers by income pay more than 1/3 of all income taxes. The top 10% pays 2/3 of all taxes.

What this means is that if significant tax revenue is to be raised, and it is to apply only to those “who can afford it,” it must come from those persons in the top 10% of the income distribution, or persons making $100,000 or more.

Potential Revenue from Income Tax Increases
Much of the rhetoric on income tax increases is focused on the so-called “Buffett Tax,” which loosely means a tax on millionaires.

Assuming that the distribution of income is roughly the same today as it is, and using the total actual income tax paid in fiscal year 2011, we can estimate the potential taxes paid by those in the highest tax brackets. The following table illustrates the math behind these assumptions.

Estimate of Taxes Paid in 2011                           2009 Percentage                   2011 Estimate, $B
Total                                                                                       100%                                      1,091
Top 0.1%                                                                               18.5%                                     202
Top 1 %                                                                                 38.0%                                     415
Top 5 %                                                                                 60.0%                                     655
Top 10%                                                                                70.0%                                     764
Source: calculations

This provides us with a rough estimate of the amount of taxes paid by each income bracket for 2011. What this shows is that the top 10% of all income tax filers paid $764 billion in income taxes for 2011 (estimated). They paid $610 billion in income taxes in 2009.

The table allows us to speculate on the potential revenue that can be derived by raising taxes on “the rich.”

Taxation of Millionaires
If the top 0.1% of all filers, those with more than $1.4 million in income in 2009, were to have their taxes doubled in the future, at best it would raise only an additional $200 billion for the Treasury. This would be less than 20% of the deficit.

Of course, doubling the tax on the top 0.1%, or any tax bracket, is politically impossible.

What would happen if the tax rate on those in the top 10% were increased by 500 basis points (increase the tax brackets by 5%)? This seems like a politically possible move (if the parties viewed compromise as something other than defeat.)

The following table illustrates the average tax rate of persons in each of the individual tax brackets for the years 2007 through 2009:

Tax Rates                               2007                        2008                        2009
Total Average Rate              12.6%                     12.2%                     11.1%
Top 0.1%                               21.5%                     22.7%                     24.3%
Top 1 %                                 22.5%                     23.3%                     24.0%
Top 5%                                  20.5%                     21.0%                     20.5%
 Top 10%                               18.8%                     18.7%                     18.1%
Source: IRS

What this table shows is that the average tax rate for millionaires has actually gone up in the past few years, with the total taxes paid about 24% for the top 0.1% in 2009.

However, if we increased the tax rate paid in 2009 by 500 basis points, and make the assumption that all of the increase becomes represented as new taxes (not a valid assumption in practice), then the following amounts might be raised.

Bracket   2011 Taxes (e)       2011 Income (e)    New Rate               New Taxes (3)
Top 0.1 %              202          831                          29.3%                                     243
Top 1 %                 415          1,727                       29.0%                                     501
Top 5 %                 655          3,193                       25.5%                                     814
Top 10%                764          4,219                       23.1%                                     975
Source: calculations

This admittedly simplistic approach illustrates a point, however. This approach only raises $211 billion in a single year, a truly minor amount when attempting to close a deficit of more than $1.2 trillion.

To truly raise taxes through the income tax system, the entire system needs to be changed. Simply raising rates is not enough. What really needs to be changed is how income is recognized and when taxes are paid on that income.

The President’s Report on the Buffett Rule
The White House issued a presentation on the so-called Buffett Rule, a proposal to increase taxes on millionaires. The report can be found here.

The proposal to raise taxes on millionaires is far more reaching than just raising tax rates. This report details numerous ways in which income is structured to postpone paying taxes on income received, such as the carried interest rule for hedge fund investors.

The White House claims that implementing a Buffett Rule taxing millionaires would raise $47 billion over ten years, or $4.7 billion per year. With the top 0.1% already paying approximately $202 billion in income taxes, the president’s estimate of additional revenue is even less significant than our own calculations of raising tax rates by 500 basis points.

But the “tax the rich” message is very powerful politically, despite its relatively minor financial impact on the deficit.

We believe that raising revenue is an essential element of solving the US federal deficit problem. Raising individual taxes of some kind is unavoidable in order to raise total revenue.

While we think that other, more creative ideas such as a value-added tax or the legalization of marijuana is also required, it seems inevitable that raising individual income taxes at some level will be required.

The problem is that there simply isn't enough potential in individual income taxes to make a significant dent in the deficit problem. No matter how politically powerful the agenda of raising taxes on the wealthy might be, from a purely financial standpoint, it is nowhere near enough.

The real elephants in the room, with respect to federal deficits, are Social Security and Medicare. But with no “evil villain” to attack, serious proposals for attacking these problems simply get ignored.       

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