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On Income Tax Fairness

tax ch 2Our April Business Conditions Monthly report began the discussion of federal income taxes and equity. It reported IRS data showing that the top 20 percent of income tax filers paid 88 percent of income taxes in 2011.

Of course, the U.S. federal income tax is structured to be progressive, meaning tax rates generally rise as income rises. So, to assess the fairness of the tax system, it is important to know what share of total income the top 20 percent held.

Some will debate whether our tax code is too progressive — that our rates on upper incomes discourage economic activity — or not progressive enough. Others will debate whether or not a progressive system is the best one. Advocates of replacing the income tax with a value-added tax are pushing for a less progressive approach (although, some proposals do include some elements of progressivity).

The Congressional Budget Office has produced a very good overview of the current structure of the federal individual income tax using the same 2011 tax return data and it can be read here.

The chart above, from the CBO report, illustrates the concept of progressivity in tax structure. It is a good point of reference as the debate continues over the fairness of our tax structure.

2 Comments Post a comment
  1. Katy Delay #

    Why doesn’t the CBO include transfer income, e.g., Social Security, food stamps, welfare, disability, Earned Income Tax Credit, in their income figures? (At least I think they don’t.)


    April 28, 2015
  2. Those of us who have lived in countries with a value added tax know that it sucks and that it is as subject to manipulation and evasion as income taxes. Especially at the corporate level.

    That being said, there is still little doubt that in “normal” times (no war, no depression), a final retail sales tax (a tax on consumption that is not the value added tax) is the best tax, IF it can be collected in an Internet sales environment.

    For those worried about the non-progressive effects of a retail sales tax on the poor, the Earned Income Tax Credit offers a model: If your income is below a given level, file an income tax return anyway (just to establish eligibility for the rebate about to be described), and apply for a rebate calculated to equal the amount of sales tax that you paid over the previous year.

    For most wage and salary workers, for those retired, and for recipients of “passive” income (rents, dividends, capital gains, and the like), you no longer would have to file a federal income tax return (unless you wanted to apply for a sales tax rebate).

    The IRS could be shrunk to half its current size (someone has to administer collection of that national final retail sales tax), and that element of intrusion into the daily life of everyone else at least could end. The states would need beefing up in some cases (only a few states do not collect a sales tax), but they should administer the tax, adding the federal amount to the amount collected for states and localities.

    This is a debate that goes back to the earliest days of the Republic. Hamilton and followers wanted every farmer to maintain detailed bookkeeping records. Jefferson and followers thought that a people was blessed if it did not have to deal with tax assessors for at least five or ten years at a stretch. Remember that, until 1913, we did not have a federal income tax outside wartime. Yet, somehow, the Republic grew.

    Hamilton would say, “We need an income tax to fund all the projects that Big Government wishes to undertake, especially redistribution of income.” Jefferson would reply, “Yes, that is exactly my point entirely.”

    Think about it.–Walker Todd (among other things, an Enrolled Agent)


    April 28, 2015

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