Liberal critics of the deficit reduction and tax reform plans that surfaced over the past couple of weeks have been blasting them for the sin of cutting tax rates for the rich at the same time they’d slash spending for the rest of us. I understand why the left would object to cuts in government benefits and services, but their complaints about the tax cuts are way off base.
Here is Nobel Prize winning economist Paul Krugman writing in The New York Times about the plan offered by Erskine Bowles and Alan Simpson, the co-chairs of President Obama’s fiscal commission: “So how, exactly, did a deficit-cutting commission become a commission whose first priority is cutting tax rates, with deficit reduction literally at the bottom of the list?”
First, you need to know the code. Krugman is talking about marginal tax rates—the rate you pay on the last dollar of income you earn. And it is true that both Bowles and Simpson and a second deficit panel chaired by Alice Rivlin and Pete Domenici would cut marginal tax rates for the rich (and, as many critics never quite mention, for most everyone else as well).
But both plans raise average tax rates for high-earners, and by quite a bit.
Nearly every economist believes that, all else equal, low marginal rates are better than high rates. That’s because while all taxes throw some sand in the economic gears, low rates throw in somewhat less and thus are more economically efficient. With low rates, people are more likely to make decisions based on economic fundamentals. When rates are high, they make choices just to save taxes and can make some really stupid decisions.
But Krugman is not making an efficiency argument. I suspect he knows better. He is making a fairness argument. But if you want to talk fairness, it is pointless to look at marginal rates. Instead, you want to look at average tax rates. In other words, what share of their total income do people pay in taxes and how does that compare to what others pay?
And if you ask that question, you get a completely different answer than the left claims. The Tax Policy Center calculated average effective federal tax rates-- including individual and corporate income taxes, payroll taxes and estate taxes-- for both plans. It turns out that under both Bowles-Simpson and Rivlin-Domenici, average rates go up—and not down—for high earners (and for nearly everyone else, for that matter. They are deficit reduction plans, after all).
Take Bowles-Simpson. While it proposes several reform alternatives, TPC looked the one that eliminates all deductions, exclusions, and exemptions except for the earned income credit and the child credit. Measured against current policy (that is, assuming the Bush-era tax cuts continue), the average rate under this plan would rise from 21.7 percent to 23.9 percent. To focus on the high-earners that so trouble the left, those in the top 20 percent would face an increase in their average rate from 26.1 percent to 28.5 percent.
The highest earning 0.1 percent of households would see their average rate rise from 32.9 percent to 38.1 percent. Thus, while their marginal rate would fall from 35 percent to 24 percent, their average rate would go way up. Those very top earners, btw, would pay about $500,000 more in taxes under Bowles-Simpson once the plan is fully effective in 2015.
Rivlin-Domenci does even better if progressivity is your thing. TPC found average tax rates would go up for every income group, except the lowest 20 percent. Those in the top 20 percent of earners would pay an average rate of 31.6 percent, compared to 26.4 percent under current policy. The top one percent would pay an average rate of 35.8 percent, compared to 29.9 percent under the Bush-era tax cuts, and the top 0.1 percent would pay 40 percent, up from 32.6 percent. Once the Rivlin-Domenici plan is fully effective, TPC estimates this group would pay, on average, $730,000 more in taxes than they would have in 2018 if the Bush tax cuts had been extended.
Some of the reasons why high earners would pay more under both plans: Capital gains and dividends would be taxed as ordinary income and capital gains would be taxed at death. This would be a big deal since investment income is a very large share of what high-earners make. In addition, these same households would also lose the benefit of many other deductions, credits and exclusions that both plans would curtail. Thus, they’d be paying more tax on, for instance, employer-sponsored health insurance, pension contributions, and mortgage payments.
The story is somewhat different if you prefer to compare these plans to tax law in the Clinton years. But even if you do that, the very highest earners still pay a higher effective tax rate under either of the reform plans. It is true, however, that many in the upper middle-class would pay slightly lower effective rates under Bowles-Simpson than if the Bush tax cuts had been allowed to expire.
We can certainly argue about whether either of these plans is progressive enough. And they could be easily adjusted to raise taxes more at the top or less at the bottom, if that is your taste. But to imply that they are a huge tax cut for the rich is plain wrong.
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