Who Should We Tax?

As painful at it might be, there’s little doubt that the U.S. is going to have to ramp up the amount of money it takes from its citizens in the near future. Tax receipts from existing tax regimes alone are not going to be sufficient to pay for the fiscal stimulus plan and the financial system bailout, let alone new energy, health and education initiatives. Where will the money come from?

I had a post several days ago about the exploding fiscal gap and the likelihood that the middle class is in for a tax increase despite all the promises from politicians that it will never happen. Yesterday, Clusterstock had an excellent article which pointed out that social security receipts are vanishing much more quickly than forecast. It doesn’t take a genius to realize that somehow, someway the government’s revenue has to be increased. Forget about expenditures decreasing. That is not going to happen.

For the time being there is little that can be done. The country will have to be content to borrow to fund its yawning deficits but that alternative has practical limits. Sooner rather than later, the issue of how to get back to fiscal sanity is going to have to be addressed. When that time comes you can count on politicians proposing taxing the rich more just as surely as you can count on the sun coming up in the morning.

The post that I mentioned above made the case that the U.S. has a more progressive tax system than most European income tax schemes. This leads to the conclusion that there is little additional revenue to be derived from further taxes on upper income taxpayers and the income tax base either needs to be broadened or a new tax such as a VAT imposed. An article today in the NYT Magazine suggests that there is some money that can be raised via more taxes on the rich and provides some interesting historical perspective.

It’s well known that tax rates on top incomes used to be far higher than they are today. The top marginal rate hovered around 90 percent in the 1940s, ’50s and early ’60s. Reagan ultimately reduced it to 28 percent, and it is now 35 percent. Obama would raise it to 39.6 percent, where it was under Bill Clinton.

What’s much less known is that those old confiscatory rates were not as sweeping as they sound. They applied to only the richest of the rich, because yesterday’s tax code, unlike today’s, had separate marginal tax rates for the truly wealthy and the merely affluent. For a married couple in 1960, for example, the 38 percent tax bracket started at $20,000, which is about $145,000 in today’s terms. The top bracket of 91 percent began at $400,000, which is the equivalent of nearly $3 million now. Some of the old brackets are truly stunning: in 1935, Franklin D. Roosevelt raised the top rate to 79 percent, from 63 percent, and raised the income level that qualified for that rate to $5 million (about $75 million today) from $1 million. As the economist Bruce Bartlett has noted, that 79 percent rate apparently applied to only one person in the entire country, John D. Rockefeller.

It’s not a long article and also happens to be a well balanced discussion of the issue, take a look at it. Personally, I hadn’t thought about the idea of introducing more brackets into the mix. It makes sense and from an historical point of view isn’t revolutionary.

Reaching an accommodation on taxes is going to be difficult. Given that neither party wants to go on record in support of increasing taxes, it is probably going to require some external stimulus to force the issue. Unfortunately, we’re probably sowing the seeds for that stimulus via the debt that the country is currently assuming.

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