As we sit in the middle of the debate on the “fiscal cliff,” some observations are relevant. So here are some points to help you make sense of the discussion.
Cutting spending is always difficult because people have become involved in the programs that might disappear. The task for Congress is to set priorities, determine the merits of the programs and whether to reduce or eliminate them. As we have seen over the years, cutting budgets is remarkably hard. The alternative is to increase revenues, mainly through tax increases.
Social engineering is one objective of the tax system with the central premise that those who have lots of money should pay more tax. So for years we have had progressive tax brackets, currently from 10 percent to 35 percent. The demographics are interesting, also. Based on the most recent annual IRS report, from 108 million tax returns filed in 2008, only 319,000 showed income in excess of $1 million and only 120,000 in excess of $2 million.
Another interesting statistic shows how much of the total tax paid comes from each part of the tax paying population. Again from the IRS report, the top half by income of all taxpayers paid 97 percent of all taxes. The top quarter paid 86 percent of the total taxes, the top 10 percent paid 70 percent, the top 5 percent paid 60 percent of all taxes and the top 1 percent of taxpayers paid 40 percent of all taxes collected.
The most recent debate has focused on raising taxes for those with higher incomes, but which segment? What is the target for the increases?
The simple fact is that the higher income brackets have fewer and fewer people in them and as a result, less total money to tax. For example, if you look at taxpayers with incomes above $200,000, the total number of tax filings is only 4.3 million. The money above $200,000 in which you might increase tax is $1.8 trillion. Raising the tax on this amount by 5 percent would add only $90 billion or so to the Treasury.
In a similar fashion, at the $1 million level, there are only 319,000 filings and the total money available to tax is $619 billion. Raising the tax by 5 percent on this amount would only add $31 billion to the Treasury.
Neither of these options are enough to close the budget deficit. Indeed, taxing incomes above $1 million at 100 percent (taking all their money) would only yield $619 billion and even that is insufficient. Not to mention that such high tax rates are not sustainable because people will simply stop earning money if they keep little or none of it. Just look at the recent turmoil in France as an example.
As an alternative, consider looking at the larger population. The total income for those below $200,000 is about $3.6 trillion and $5.65 trillion for everyone. By simple arithmetic, we would need another $5,800 from everyone to raise the same amount. However, the scary part is that everyone, on average, would need to pay $9,400 more just to close the deficit.
The simple fact is that so many more taxpayers are in the low and middle brackets that a small percentage increase in their tax brackets raises much more money than large percentage changes on those in the high brackets. We as a society may choose not to raise the taxes at the lower end because we feel it is unfair, but that does not change the arithmetic. Raising the higher tax brackets is much less effective than small changes to the middle and low brackets because it affects so many more taxpayers.
As we face questions about assisting lower-income citizens and raising more revenue for the government, we need to separate the social and emotional discussion from the simple facts about where the potentially taxable money lies and who pays it in taxes now. Let us all try to make sound decisions but based on the right facts.
Mark Sievers, president of Epsilon Financial Group, is a certified financial planner with a master’s in business administration from UC Berkeley. Contact him at firstname.lastname@example.org.