When is a ‘fair share’ fair enough?
One of the central themes of the current presidential campaign season deals with taxes, specifically, federal income taxes.
At the stroke of midnight on December 31 of this year, the tax clock moves backwards to the year 2000 and marginal tax rates will increase for virtually all Americans with federal income tax obligations. The unsettling fact surrounding this incendiary issue is that the increases will occur automatically unless Congress and the president reach a compromise. As we have witnessed throughout the year, however, Republicans and Democrats are deeply divided on this issue, making the plunge over the “fiscal cliff” a distinct possibility, along with the recession that would almost certainly follow.
Republican presidential candidate Mitt Romney wants to cement into place all Bush-era tax rate reductions (those set to expire at the end of this year) and then cut them another 20 percent. The hope is that the lower tax rates will serve to create incentive for people and businesses, increase economic activity, and thereby produce greater stronger growth and the resulting higher tax collections.
Barack Obama wants to keep in place the Bush-era marginal tax rates for those earning less than $250,000 from a joint return or $200,000 for a single filer. The Democratic president feels this will keep the vast majority of the tax-paying population from experiencing a tax increase — of course, this ignores the likely end of the 2 percentage point reduction many now enjoy in the form of lower Social Security payroll taxes — and calls upon the wealthy to “pay their fair share” of federal income tax obligations.
Whether one believes in the Obama or Romney position, the fact is that with higher marginal tax rates remaining in place as income rises for both policy stances, the U.S. will continue to have a progressive federal income tax system. As such, by the very design of our tax system, higher income categories will be required to pay a greater share of total federal income taxes.
Under such a system, one might logically ask precisely what constitutes one’s “fair share” of federal income tax obligations given an inequitable distribution of earned income. Stated differently, knowing approximately what share of total taxable income (adjusted gross income or AGI) various income groupings earn (say, the highest 1 percent, the highest 5 percent, etc. of returns) could politicians then agree on what share of total tax payments that income group should be called upon to pay? In this way, each group’s “fair share” would be agreed upon (approximately) in advance and incentive to produce would not be sacrificed for the sake of higher tax obligations and increased government spending.
To examine this issue, the most reliable source of information comes from an IRS publication called Statistics on Income. Unfortunately the data comes out with a huge time lag, with the most recent statistics being for tax year 2009.
In 2009 the top 1 percent of federal income tax returns based upon (positive) AGI required a minimum current dollar income of $343,927. This top 1 percent earned 16.93 percent of all AGI in tax year 2009, which was down significantly from 22.83 percent of all AGI in 2007 and a minimum current dollar AGI of $410,096 — indicating that even “the rich” were negatively impacted by the last recession.
With the top 1 percent of tax filers earning 16.93 percent of all AGI in 2009, what would seem to be the “fair share” this income group should pay as a percent of all federal income taxes? Given the very nature of a progressive income tax system, it is virtually assured that the share of taxes to be paid for this group (or other groups with relatively high earnings) will be greater than their 16.93 percent share of income. But in an attempt to maintain an incentive to work and not be overly burdensome, how much higher should that share of total AGI be? Would 25 percent higher be reasonable? Fifty percent? How about 100 percent, which would place their “fair share” of total tax obligations at 33.86 percent? In fact, the actual share paid was 36.73 percent, better than double their share of total AGI earned.
Perhaps when setting tax rates, politicians of both parties might start from this different perspective; not one based upon either a reward-the-rich or soak-the-rich political mindset. By establishing tax obligations for various AGI categories in this fashion, decisions could be more reasonable, justifiable and fair.
Dr. James Newton serves as chief economic advisor to Commerce National Bank and is an auxiliary faculty member in economics and statistics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not necessarily reflect those of Commerce National Bank or OSU-Marion/Newark.