March 3, 2009

Meme First, Think Later

Okay, I admit that I'm sometimes guilty of the blogging sin described above. But this time it seems particularly annoying to me. So first, the meme that is being repeated all over the internets; I've traced it back to ABC News, which has this as its lead:
President Barack Obama's tax proposal -- which promises to increase taxes for those families with incomes of $250,000 or more -- has some Americans brainstorming ways to decrease their pay in an attempt to avoid paying higher taxes on every dollar they earn over the quarter million dollar mark.

A 63-year-old attorney based in Lafayette, La., who asked not to be named, told that she plans to cut back on her business to get her annual income under the quarter million mark should the Obama tax plan be passed by Congress and become law.

"We are going to try to figure out how to make our income $249,999.00," she said.

"We have to find a way out where we can make just what we need to just under the line so we can benefit from Obama's tax plan," she added. "Why kill yourself working if you're going to give it all away to people who aren't working as hard?"
Amazing! Atlas actually shrugging!

Well, maybe not so much. The lawyer here is not going on "productivity strike" until the government stops stealing all the fruits of her labor, like John Galt and his adherents did in Ayn Rand's preachy and contrived novel. The real-life lawyer is perfectly happy to keep on working and making money, but she doesn't want to pay the higher marginal taxes.

I assume, Reader, that you understand what a "marginal" tax is, in the context of a progressively-structured income tax system. I say that because it's not readily apparent that the high-income tax objectors, who threaten to diminish their own livelihoods for the purpose of starving the government of their taxes, are very clear about that particular concept. With that in mind, I think it is very instructive to look back to history, to see what yesteryear's tax structures were, in order to evaluate whether the tax objector is doing something that makes any kind of sense.

Now, back in the bad old days, there was quite a high marginal tax rate. But while I'm not at all pleased about the tax hikes, I don't see the Obama plan as reaching the levels of the bad old days. So I thought to go to the raw data and decide for myself.

First off, the Obama proposal, according to a decidedly non-liberal source of information, the Wall Street Journal, is "...increasing the top personal income tax rate to 39.6% in 2011 from 35%, while reducing the tax benefit from itemized deductions to 28% for couples who make $250,000." By doing this, the President hopes to generate an additional $118 billion in revenue. (We'll get back to that last sentence towards the end of this post.)

The best source for the historical marginal rates I found here at the Brookings Institution, and I confirmed the peak marginal rates at I have some idea of the Brookings Institution's political alignment but no feel for, but these are the sorts of data that are not subject to political fudging in their raw form. What we see is that marginal tax rates peaked in 1945.

What I did was to find the marginal rates for 1945, and add in some data of my own. More specifically, I show what the taxpayer's net income would be if the taxpayer topped out each income bracket (not counting state taxes). I used the rates for a married couple filing jointly. All figures are for taxable income, which means all of these figures apply after deductions and exemptions are applied to the gross income. I also included adjustments of the figures to 2009 dollars, using this handy-dandy little tool from the Bureau of Labor Statistics. Finally, I rounded off to the nearest whole dollar in all cases. Here, then, is the 1945 data:

1945 Dollars 2009 Dollars
Bottom of BracketTop of BracketMarginal RateNet At Top of Bracket Bottom of BracketTop of BracketNet At Top Of Bracket
$0 $2,000 23%$1,540 $0 $23,460 $18,064
$2,000 $4,000 25%$3,040 $23,460 $46,921 $35,660
$4,000 $6,000 29%$4,460 $46,921 $70,381 $52,317
$6,000 $8,000 33%$5,800 $70,381 $93,841 $68,035
$8,000 $10,000 37%$7,060 $93,841 $117,302 $82,815
$10,000 $12,000 41%$8,240 $117,302 $140,762 $96,657
$12,000 $14,000 46%$9,320 $140,762 $164,222 $109,325
$14,000 $16,000 50%$10,320 $164,222 $187,683 $121,055
$16,000 $18,000 53%$11,260 $187,683 $211,143 $132,082
$18,000 $20,000 56%$12,140 $211,143 $234,603 $142,404
$20,000 $22,000 59%$12,960 $234,603 $258,064 $152,023
$22,000 $26,000 62%$14,480 $258,064 $304,984 $169,853
$26,000 $32,000 65%$16,580 $304,984 $375,365 $194,486
$32,000 $38,000 68%$18,500 $375,365 $445,746 $217,008
$38,000 $44,000 72%$20,180 $445,746 $516,127 $236,715
$44,000 $50,000 75%$21,680 $516,127 $586,508 $254,310
$50,000 $60,000 78%$23,880 $586,508 $703,810 $280,116
$60,000 $70,000 81%$25,780 $703,810 $821,112 $302,404
$70,000 $80,000 84%$27,380 $821,112 $938,413 $321,172
$80,000 $90,000 87%$28,680 $938,413 $1,055,715 $336,421
$90,000 $100,000 90%$29,680 $1,055,715 $1,173,017 $348,151
$100,000 $150,000 92%$33,680 $1,173,017 $1,759,525 $395,072
$150,000 $200,000 93%$37,180 $1,759,525 $2,346,033 $436,128
over $200,000use $250,000 for calculation94%$40,180 $2,346,033 $2,932,541 $471,318

Note that the very top rate had a caveat, that the total income tax could not exceed 90% of the total income, so at $560,000 ($6,568,893 in 2009 dollars), your marginal rate dropped back to 90%. There were no deductions to speak of in comparison with today's tax code, but even then the complexity of the process of determining taxable income made Judge Learned Hand, one of the smartest lawyers in American history, glaze his eyes over in utter mystification.

Now, this is a big, scary-looking chart with lots of data in it, but the overall picture is of a progressive tax that progresses somewhat steeply and reaches a very high marginal rate of taxation at fairly high levels of income.

Now, you might say that this is not realistic since 1945 was the last year of the war, and of course taxes are going to be higher during the war. Of course, an Obama supporter would be quick to point out that a) we are at war now, and b) the obviously very high marginal tax rates did not stop the wealthiest Americans from working as hard and as long as they could to win the war, and they made quite a bit of money along the way doing it -- a great many of them in the form of serving as government contractors, building airplanes and tanks and guns and stuff. But I'll not opine on this dispute just yet. After all, we have data from peacetime available, too.

1958 was a year of peace for the United States of America. Dwight D. Eisenhower was in the middle of his second term in office. Korea was a memory and Vietnam was still a problem for the French. The Cold War represented an ongoing expenditure of governmental resources, but there was good diplomacy going on too and a three-year test ban was signed during 1958. And perhaps most importantly, 1958 was a year of recession. Here, then, are the marginal tax rates for 1958, following the same format and using the same criteria as I had prepared for 1945:

1958 Dollars 2009 Dollars
Bottom of BracketTop of BracketMarginal RateNet At Top of Bracket Bottom of BracketTop of BracketNet At Top Of Bracket
$0 $4,000 20.0%$3,200 $0 $29,224 $23,379
$4,000 $8,000 22.0%$6,320 $29,224 $58,448 $46,174
$8,000 $12,000 26.0%$9,280 $58,448 $87,672 $67,800
$12,000 $16,000 30.0%$12,080 $87,672 $116,896 $88,256
$16,000 $20,000 34.0%$14,720 $116,896 $146,120 $107,544
$20,000 $24,000 38.0%$17,200 $146,120 $175,344 $125,663
$24,000 $28,000 43.0%$19,480 $175,344 $204,568 $142,321
$28,000 $32,000 47.0%$21,600 $204,568 $233,792 $157,809
$32,000 $36,000 50.0%$23,600 $233,792 $263,015 $172,421
$36,000 $40,000 53.0%$25,480 $263,015 $292,239 $186,156
$40,000 $44,000 56.0%$27,240 $292,239 $321,463 $199,015
$44,000 $52,000 59.0%$30,520 $321,463 $379,911 $222,979
$52,000 $64,000 62.0%$35,080 $379,911 $467,583 $256,294
$64,000 $76,000 65.0%$39,280 $467,583 $555,255 $286,979
$76,000 $88,000 69.0%$43,000 $555,255 $642,927 $314,157
$88,000 $100,000 72.0%$46,360 $642,927 $730,599 $338,705
$100,000 $120,000 75.0%$51,360 $730,599 $876,718 $375,235
$120,000 $140,000 78.0%$55,760 $876,718 $1,022,838 $407,382
$140,000 $160,000 81.0%$59,560 $1,022,838 $1,168,958 $435,144
$160,000 $180,000 84.0%$62,760 $1,168,958 $1,315,077 $458,524
$180,000 $200,000 87.0%$65,360 $1,315,077 $1,461,197 $477,519
$200,000 $300,000 89.0%$76,360 $1,461,197 $2,191,796 $557,885
$300,000 $400,000 90.0%$86,360 $2,191,796 $2,922,394 $630,945
over $400,000Use $500,000 for calculation91.0%$95,360 $2,922,394 $3,652,993 $696,699

Again, there were no deductions to speak of. Note also that these were the tax rates for 1954 to 1963 -- a period of time embracing war, peace, and war again, a period of time encompassing boom, bust, and boom again, a period of time during which both parties at times held the White House, and for which Democrats gained and kept control of Congress. Now, there had been lower taxes in the early 1950's when Republicans were stronger in Congress and at times controlled it, but especially at the higher income levels, the numbers weren't hugely different from what the Democrats did when they had the power. And the general shape of the progressive tax curve here is similar to that of 1945 -- it curves upward at a reasonably sharp rate, levelling out as it reaches its peak.

So, those were the bad old days from the mid-1940's to the early 1960's. There were ups and downs, but in general, I think it's fair to say that overall, this period of time saw an enormous growth of the American economy. It's hard for me to say that high taxes prevented the economy from growing or rebounding from a recession -- simply put, America kicked major economic butt for a generation despite crushingly high marginal tax rates on the very wealthy. It almost makes you think that, from a big-picture perspective, crushingly high marginal tax rates on the very wealthy don't matter all that much.

Which, of course, it doesn't, because we're not talking about all that many people here -- less than 1% of the total population has ever paid the top rate of income tax in the post-war period.

The next step would be to compare the above rates with the rates put in place by the "Bush Tax Cuts" of 2001 and then to conclude by looking at Obama's proposed new tax structure. But there's an apples-to-apples problem here, though. By the mid-1960's, Congress really got into tinkering around with deductions and exemptions and the difference between gross income and taxable income began to really increase. The prevailing school of thought was to build incentives and disincentives for a variety of economic behaviors to encourage people to, among other things, buy houses, give money to charities, start their own businesses, provide health insurance to their employees and children, and so on.

The result of it is that by now, depending on how many incentives you take advantage of, the average middle-class homeowner can easily knock off nearly twenty cents on the dollar of gross income to these things and seriously depress taxable income. But even if we were to look at deductions, the impact of the deduction on taxable income varies based on the gross income earned by the taxpayer, so even if Andy and Bob have identical $10,000 mortgage interest deductions, if Andy's income is otherwise higher than Bob's, he will receive a different benefit from that deduction than Bob will. So "net income" becomes less and less a figure describing what actual take-home income is and it becomes more and more a construct of tax law.

What's more, taxpayer behavior has become substantially more varegiated by the first decade of the twenty-first century. Plenty of high income earners have been locked out of the home buying market in major urban areas because prices have risen out of sight. There are more self-employed people now than in the 1950's, and they face a hugely different and more complex regime of taxation issues. So, we have to simply accept that we're looking at a "taxable income" that is somewhat more amorphous than what Joe Sixpack was earning in the 40's and 50's.

With that said, here's what things looked like in 2002 for a married couple filing jointly:

2002 Dollars 2009 Dollars
Bottom of BracketTop of BracketMarginal RateNet At Top of Bracket Bottom of BracketTop of BracketNet At Top Of Bracket
$0 $12,000 10.0% $10,800 $0 $14,084 $12,676
$12,000 $46,700 15.0% $40,295 $14,084 $54,810 $47,293
$46,700 $112,850 27.0% $88,585 $54,810 $132,448 $103,969
$112,850 $171,950 30.0% $129,955 $132,448 $201,812 $152,523
$171,950 $307,050 35.0% $217,770 $201,812 $360,375 $255,589
over $307,050 use $500,000 for calculations 38.6% $336,241 $360,375 $586,834 $394,635

Now, this looks way different. Again, bear in mind that we simply can't do an apples-to-apples comparison between a modern tax regime and one from the 1940's or 1950's, because of the things discussed in the previous several paragraphs. There is in almost every case going to be substantial untaxed income for every taxpayer on the list; the minimum deduction and exemptions we would see here, for a married couple filing jointly, would be a deduction of $7,850 and an exemption of about $3,000 -- insulating nearly $11,000 in income from any taxation at all. But because we can't know for sure what the "average" taxpayer will do anymore, we're really not looking at the same things as we were above.

All the same, what we can say from this is that taxes were, in historical terms, really low in 2002, all across the board. Whether you were a low income-earner or a high income-earner, you paid appreciably less taxes and took appreciably more money home in 2002 than you would have in 1958. I could, if I really wanted to sink even more time into this post than I already have, do some charts in the middle to show the step-downs in the overall tax rates. Instead, I'll note that historically, both parties can take some credit for this -- the first big step-down took place under President Johnson in the late 1960's, and the second and third big step-downs took place under President Reagan in the 1980's. It's useful to see the top marginal rates graphed out over time:

Now, this is an interesting chart, but as you can tell from the tables I prepared above, looking at the full historical rates, the real action takes place in the middle of the tables, not the top.

So, winding towards my conclusion, let's compare what Obama plans to do with the current prevailing marginal tax rates. Again, because the proposal involves a change in handling deductions as well as taxing income, a true apples-to-apples comparison isn't really possible at this level of analysis. But here we go.

2009 RatesOama's Proposed 2011 Rates
Bottom of BracketTop of BracketMarginal RateNet At Top of Bracket Bottom of BracketTop of BracketMarginal RateNet At Top of Bracket
$0 $16,700 10%$15,030 $0 $16,700 10.0%$15,030
$16,700 $67,900 15%$58,550 $16,700 $67,900 15.0%$58,550
$67,900 $137,050 25%$110,413 $67,900 $137,050 25.0%$110,413
$137,050 $208,850 28%$162,109 $137,050 $208,850 28.0%$162,109
$208,850 $372,950 33%$272,056 $208,850 $372,950 33.0%$272,056
over $372,950 use $500,000 35%$354,638 over $372,950 use $500,000 39.6%$348,794

Obama's proposal to fiddle around with the value of the deduction is not insignificant; by reducing the impact of a donation to a high-bracket taxpayer, this increases taxable income. But it's simply not the sort of thing I can project here without making some assumptions about the taxpayer which may not be true and probably would not apply across the board to most taxpayers. It's also the reason why these tax objectors (remember them?) are aiming at $250,000 in gross income, so as to preserve the full impact of their deductions.

But the overall picture is one that we can see with sufficient clarity to analyze. The marginal tax rates are presently a little bit higher than what Bush had for us in 2002. But not really all that different. And more to the point, it is so similar that it counts in my mind as a "tune-up" and not a major or radical adjustment. What's really going to be interesting will be to see what impact the deduction valuation change will have on specific peoples' taxable incomes -- that may be the real issue here.

That, then, is the conservative misapprehension -- that these are huge and onerous tax increases being discussed. This is both inaccurate and wrong. It is inaccurate because what is really going on is a modest adjustment to the top tax bracket, and a rejiggering of the method of computing taxable income. "Same thing as a tax increase," the conservative in me grouses, and perhaps that's true. But especially when compared to historical tax rates, there isn't really that much to complain about.

That doesn't mean you have to like paying taxes, or like paying higher taxes if this affects you by bumping you up a bracket. But it does mean you ought to bear in mind that you aren't taking home six cents on the dollar that you might have back in 1945.

Now, here's the other thing. Liberals have their own problems with advocating this proposal. The argument in its favor is that this will affect only the ultra-rich, who make up something like .2% of all taxpayers, and they can afford it anyway because, well, they're ultra-rich.

Two problems with this. First, the higher-margin taxpayers pay a huge portion of the overall taxes that are collected. In 2005, the most recent year we can get this sort of data, the "top 1 percent of filers were paying nearly 40 percent of the federal income tax bill, while those in the 2nd to 5th percentile paid another 20 percent."

That means that the idea that we're talking about only one-fifth of one percent of Americans here is quite obviously incorrect -- out of 300,000,000 Americans, .2% would be 600,000 of them. I cannot believe that 600,000 people paid 40% of the Federal government's $2.15 trillion in tax revenues in 2005; that would work out to an average tax bill of $3.6 million for each of these allegedly ultra-rich taxpayers. Any rich person who intended to remain so would look at the prospect of paying $3.6 million in taxes with something akin to the look a prom queen would have at a fresh turd floating in the punchbowl -- and hire a small army of accountants and lawyers to reduce that tax obligation in any way possible.

If President Obama is going to raise $118 billion with this very modest-seeming hike in taxes, he needs to get a lot of taxpayers paying those higher marginal rates. 600,000 taxpayers paying a marginally increased rate of 3.6%, simply cannot raise $118 billion. That means that he's hoping the re-indexing of taxable income is going to create literally millions more top-bracket taxpayers. On paper, we'll all be getting richer, even though our incomes aren't rising, and as a result, we'll be paying higher marginal taxes.

So we're not just talking about a very small number of very rich people. We're talking about people who are at the "made it" end of the economic spectrum. We're probably looking at something like ten million or more people who currently are in the second- or even third-highest tax bracket getting un-deducted up into higher brackets, and that's how revenues will increase. This is some clever and interesting legislative legerdemain indeed -- and here I thought Obama had been kind of a lightweight in the Senate.

All of which begs the question -- if this comes to pass, is it worth it to artificially depress your income by reducing your productivity? Frankly, I think not. The highest marginal tax rate here still leaves you a bit more than sixty cents on the dollar (assuming your state does not tax it further, as mine will). I can see, looking back on the historical tax tables, how someone who is making nearly three million dollars a year (in today's money) might say, "You know what? Spending another day at my office and not with my family is only going to earn me 9% of what I'd be paid to do it. I already made three million bucks this year. So 'F' it, I'm just gonna take the next month off without pay." That makes sense to me.

What doesn't make sense to me is you take that same wage-earner who has brought home three million bucks in one calendar year already, and you expect me to believe that this person would be happy to bust his nut every day to make even more than that as long as his tax rate on his earning above the three million is only 35%. For 65 cents on the dollar, he's going to skip Christmas with his kids. But if you reduce that by increasing his marginal taxes to 39.6%, now, he's only bringing home 60 cents on the dollar, and he'd rather play Santa at that point. I just don't see the significance of that extra nickel of post-tax take-home pay having that powerful an effect, one way or the other, on someone who is already making super-good money.

Which is why I have a hard time believing that Atlas is really going to shrug here. Add to that the inherent difficulty of a small business owner knowing when she has made $249,999 that she can actually take home and the functional impossibility of such a person actually suspending her business. Obama is leaving plenty of room for people in even the highest tax bracket to appreciably increase their cash flow.

None of this is to say that I like the idea of the increased taxes. I don't. What I really don't like is the prospect of getting bracketed up by all of this, which is an effective tax increase. And I really don't like the fact that this will let Obama claim that there are suddenly lots of people making a whole lot of money and that this will create, through smoke and mirrors, the perception that America's income is becoming more polarized, not less. While I recongize that historically, this is still a pretty low tax, it's still money the government is taking from me, and all of the trappings in which the tax will come will, I fear, do more harm than good.

(This post was developed from an idea I originally posted in a comment thread at Lawyers, Guns, and Money, where they are aware of all internet traditions.)

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