As Congress grapples with the proposed stimulus package for the Covid-19 pandemic, watchers are concerned about the staggering overall amount. Where does the money come from? Various members of Congress and some governors are already calling for an increase in income taxes.
Politicians promise lower taxes on some and also that those who are rich should pay their fair share. The claim is that if only the rich paid more, there would be enough money for whatever programs the government wants to fund. The mantra is that "the 1%" should do more. How do we reduce complexity, lower taxes and ensure the taxation of “fair shares”? Difficult questions!
Certainly any change in tax law will soon be a hot political topic. Now would be a good time to briefly review the real structure that income taxes come from.
As the debate progresses, some considerations are made here, starting with definitions. At what level is someone rich? How do you measure this level? Is it income, wealth, influence, or some other measure? Does the current system achieve this goal?
We have had progressive tax rates in this country since the inception of income tax. The tax rate tables contain several levels (brackets). As your taxable income increases from one level to the next, the percentage of the tax increases. Some would argue that a flat tax rate is better and “fairer”, but the progressive system we have is well established and accepted. On the other hand, the alternative minimum tax that has existed for decades is essentially a flat tax. So we actually have both methods at the same time.
For an insight, I went to the IRS website and used their historical data to examine the inner workings of the tax system. The IRS uses certain dollar categories for the detailed data on the high end: income from $ 200,000 to $ 500,000, then up to $ 1 million, and finally above $ 1 million.
The results are interesting. Taxpayers filed more than 153 million tax returns. Only 540,960 tax returns were for income over $ 1 million and only 1,100,460 tax returns were between $ 500,000 and $ 1 million. As a percentage, this corresponds to only 0.35% or 0.72%, which corresponds to a total of 1.05%. Obviously there aren't many taxpayers in this high area. Even if you add the tier from $ 200,000 to $ 500,000, only 4.5% more is added. This means that those who earn more than $ 200,000 are only 5.5% of the taxpayers. I was surprised that the numbers on these levels weren't any bigger. Obviously, most taxpayers make less than $ 200,000.
The other interesting point is that the total tax paid by these top three levels was more than 61% of all taxes collected. 5.5% of the tax returns contributed about 61% of the total money raised. The progressive tax system clearly works. What then remains is a debate about whether that proportion is too much or too little.
The small number of taxpayers in the highest tax brackets raises another interesting question. How much money is there actually that could be subject to more taxes? I calculated the amount remaining after tax in each income category. This is the amount that may have more tax payable.
In the $ 1 million above category, an additional $ 1.24 trillion could be taxed. At the $ 500,000 level, another $ 191 billion appears for a total of $ 1.43 billion. At the $ 200,000 level, another $ 594 billion appears for a grand total of $ 2.03 trillion.
These numbers are also smaller than I expected. They represent the amount that may be taxed, not the actual tax. Note that tax has already been paid on these amounts. Even if the government taxes these amounts at 100% and thus claims everything, the additional amount hardly corresponds to the annual budget deficit of the federal government and corresponds to the spending of the stimulus package. Then what?
A tax system with a 100% tax rate on incomes over $ 200,000 would make a lot of money, but only for the first year because these people would adjust their circumstances to avoid this tax pain again. Why make more money when you can't keep something?
So far, no one has seriously proposed such a confiscating tax policy, but the numbers shed some light on the whole discussion. Put simply, the amount of money in the upper tax brackets would not solve the federal budget deficit on its own. What other options do we have? Promising lower taxes on some while shifting the tax burden on to richer taxpayers may not be as easy as it sounds, and yet it won't necessarily resolve the situation.
We should ask our elected officials difficult questions about how to deal with tax and spending problems.
Mark Sievers, President of Epsilon Financial Group, is a certified financial planner with a Masters in Business Administration from the University of California at Berkeley. Contact him by email at (Email protected).