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Do the Rich and Businesses Pay their Fair Share?
Critics of Bush's three tax relief plans charge that only the wealthy benefited from the reductions in marginal tax rates. But is this true? And more broadly, do the wealthiest Americans pay their "fair share" of the tax burden?
The evidence shows that all Americans, rich and poor, benefited from President Bush's tax cuts. The rich saw taxes on their dividends and capital gains reduced (as well as their income taxes), and personal income tax rates were slashed across the board, which encompassed every middle-class taxpayer. Even the poor, who generally do not pay income taxes, were rewarded with a higher Earned Income Tax Credit (EITC) and child tax credits.
Progressivity and the Tax Burden
Our tax system, however, is highly progressive, meaning that as one's income rises, a higher proportion of that income is taxed. Thus, those in the highest tax brackets contribute more to the overall tax burden even though there are far more people in lower tax brackets.1
Rising Federal Taxes for the Rich
The empirical evidence shows that the wealthiest citizens are also paying an ever-increasing proportion of all taxes collected by the federal government. Data from the Congressional Budget Office show not only that taxes on the wealthy have risen over time but that the 2001 Bush tax cut barely kept their share of the tax burden from rising further:2
Despite the accusation that it was the very wealthiest who benefited the most from the 2001 tax cut, their federal tax burden stayed level at best and increased at worst. Progressivity in the tax system rose and the wealthy now pay about six times more than the poor.
We can also look at the overall share of federal taxes paid to detect a similar pattern. For example:3
Overall, the poor paid about half as much of the federal tax burden in 2001 as they did in 1984, while the rich paid about 50 percent more. Even those in the middle class, often said to be hit hardest by increasing taxes, saw their share decline by about a third.
Raising Taxes on the Rich is Counterproductive
Despite these figures, many critics of the Bush tax cuts still insist that the rich aren't paying their fair share of taxes, and that marginal tax rates should be increased for those in the highest tax brackets.
Interestingly, though, historical examples show us that when marginal tax rates on the rich are higher than 30 percent, the rich actually pay less of the total tax burden, because they tend to shelter, hide or underreport more of their income to avoid those high rates. Alternately, when taxes are lowered on the rich, their share of the total tax burden climbs. Consider the following evidence from three major tax rate reductions:4
The Myth of Spending Cuts for the Poor and Tax Cuts for the Rich5
During the 2005 budget reconciliation debate, critics claimed that Republicans were cutting spending for the poor to pay for tax cuts for the rich; however, the facts simply do not support these overheated claims and the accusation that poor families are shouldering more of the tax burden while receiving less of the spending is empirically false.
The data clearly show that the tax burden is shifting annually up the income scale while spending continues to move down the scale; the people with the highest incomes are paying more of the tax burden while the poor are receiving more of the spending.
Moreover, the persistent increase in federal antipoverty spending fosters an unhealthy dependence on government. For example:
Furthermore, the mathematically impossible principle that income tax relief should be concentrated among families who pay no income tax prevents any consideration of legitimate tax relief or tax reform. Additionally, the misperception that higher tax rates induce substantially higher tax revenues among upper-income taxpayers translates into pressures for tax increases that harm economic growth without substantially increasing tax revenues.
Taxing the Untaxed Business Sector6
Some people believe it would be desirable to subject untaxed entities -- like nonprofit organizations -- that resemble businesses to the same income taxation as their for-profit competitors. The probable consequences of such a policy for federal revenue and the economy stem from the organizational structure of those untaxed entities.
Nonprofit organizations are exempt from income taxation if they are operated for charitable, religious, educational or other purposes specified in section 501(c) of the Internal Revenue Code; nevertheless, a number of nonprofit organizations are indistinguishable from businesses: they sell goods or services and use the receipts as the principle means of financing their activities:
With untaxed entities, however, the absence of shareholders would give managers other options for avoiding income taxes: reducing their taxable surplus by lowering their prices and by increasing compensation or other costs; and because of their structure, untaxed entities would be likely to yield less tax revenue than their share of economic activity might suggest:
For-profit firms that favor taxing untaxed entities as a way to level the competitive playing field might find that their competitors' prices were reduced even further; similarly, people who oppose taxation on the grounds that it would cause untaxed entities to raise the prices of socially beneficial services might find those prices falling instead.
Those reactions could impose a broader economic cost:
However, over time, taxing the untaxed business sector might ultimately achieve its objectives, but the market presence and impact of the untaxed sector does not result solely from the sector's exemption from income taxes -- they also derive from the organizational structure of entities in the sector.
The Rising Cost of Complying with the Federal Income Tax
In 2005, individuals, businesses and nonprofits were estimated to spend six billion hours complying with the federal income tax code, with an estimated compliance cost of over $265.1 billion. This amounts to imposing a 22-cent tax compliance surcharge for every dollar the income tax system collects, and projections show that by 2015 the compliance cost will grow to $482.7 billion.
However, the burden of tax compliance does not fall evenly on taxpayers. It varies by type of taxpayer, income level and state, but in 2005 businesses bore the majority of tax compliance costs.
According to the Tax Foundation:7
But as tax compliance grows, more and more businesses will end up paying their fair share.
Conclusion: "A Rising Tide Lifts All Boats"
President Kennedy once said that a rising tide lifts all boats, and he was right. When the economy grows, rich and poor alike benefit from rising wages, incomes, and productivity. Conversely, stagnation hurts all income classes simultaneously. The evidence from the 1960s through today illustrates that lower tax rates correlate with rising incomes for all sections of the population. Even cuts on capital gains and dividends, often though to benefit only rich stockholders, allow for greater investment and more job creation, which ultimately helps lower-income Americans. Though the wealthy pay an enormous share of the overall tax burden, tax cuts on their income would not only bring in more revenue, but would help lower-income Americans become more upwardly mobile.