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.

Posted by Jim Newton on Aug 14 2012. You can follow any responses to this entry through the RSS Feed. Comments can be made below.