Taxation

Americans have long been subject to class warfare waged by the wealthy, and have now been deeply immersed in the ideas of Supply-Side economics. This is one of the biggest problems in our country and the root of many American social issues as well as our international drive to expand our economy due to it's own internal failings.

Without external economic expansion our system would quickly fail due to the fact that it so strongly favors the wealthy.  In order to maintain a system that so strongly favors the wealthy the wealthy have to continuously expand the system, which is why our trade deficit keeps growing.

Without a growing trade deficit reforms would have to place that would rebalance the system to be more fair to all Americans. Conversely, by making the system more fair to all people the trade deficit can likely be reduced. A way to do this without using a planned economy is through tax reform.

This discussion depends on first dispelling some myths that have been created by American leaders in recent decades. The first myth is that all the money that a person receives through employment or business is money they are fully entitled to and that the taking of that money through tax is a form of theft. This is incorrect.

Our system works through a series of independent, individual interactions in such a way that the value of transactions are generally determined by approximation of their value relative to the entire system. Just because you get a paycheck for $1,000 does not mean that your work is actually worth $1,000 to the system, in fact your work may be worth much more then what you are paid, or it maybe be worth less, in most cases though the value of wages paid is lower than the value of the work being done, which is how profits are made possible.

Although many people, such as George Bush Jr.  claim that "redistribution of wealth" is a horrible thing, nothing is further from the truth. Every transaction in our system is a process of redistribution of wealth. When a corporate CEO fires 5,000 people and then takes home a $30 million bonus, that is redistribution of income (wealth).  It's taking money from 5,000 people and giving some of it to one person. How can George Bush say that redistribution of wealth is bad? What does he mean? He means that at some arbitrary point he wants to say that redistribution of wealth should stop, and that point is at a time when the wealth is shifted into the hands of the wealthy. The redistribution of wealth is a constant process in an economic system and it happens at many levels.

Many wealthy people favor redistribution of wealth only through the private system and not the public system because the private system provides secrecy and is inherently easier to manipulate, and the leverage of wealth tips the scales in their favor. In any capitalist private enterprise system the redistribution of wealth will inherently go from the poor to the rich. In any capitalist system money naturally flows from the disadvantaged to the advantaged.  If wealth is not redistributed back to the disadvantaged then the economic system becomes stagnant and to promote growth expansion is generally done by taking in new resources, which may be done by going to war. This is one reason why war was so common in Europe during the Middle Ages, because so many people were poor and they taxed the poor and there was no redistribution of wealth back to the poor so as the fortunes of the wealthy began to dwindle they had to go on conquest to obtain new wealth.

This is why tax reform is essential to building peace, because there is not enough redistribution of wealth in America from the top back to the bottom right now and so as our economy stagnates expansion and conquest of new resources becomes an attractive way to bring new wealth into the system.

In addition, many aspects of our system that contribute to the generation of wealth are never paid for by anyone.  For example, when a child goes to school and graduates high school knowing how to read and write and do math, that child has not been paid for that. They will likely be paid in the future for work that they do because of that knowledge, but their educated existence also allows other people to engage in commercial activity for which those people are paid, and it allows employers to hire them with a basic level of expectation. For example, Bill Gates would not have been able to become the richest man on earth if there were not many Americans who are well educated enough to know how to use computers. Bill Gates did not pay for the creation of his client base, our society did. Bill Gates was able to become wealthy because of society and all of the expenses that have gone into the creation and maintenance of American society including education, infrastructure, law enforcement, military protection, labor laws that give us time to spend using computers, etc.

In this way we see that Bill Gate's wealth is a product of society, not simply a product of his individual efforts. His accumulation of billions of dollars is only possible because of the efforts of all of the members of society that have created an environment in which he can accumulate wealth. Bill Gates knows this and its one reason why he supports estate taxes and gives to a large number of charity organizations.

The redistribution of wealth is not "stealing from the rich to give to the poor" as so many people claim. It is:

1. A way to maintain the health of the economic system
2. A way to recalibrate our imperfect economic system and justly compensate those who have not been properly compensated by the intrinsic functioning of the system
3. A way to pay for public needs by those who can most afford it

A person's wealth is in many ways measure of the degree to which they have taken advantage of society. Those who have taken the most advantage of our society also have the most responsibility to pay for the needs of society.

This is why graduated taxes are not only essential, but they are also very just. In fact a capitalist system without redistribution of wealth is unjust.  society.  The only way to avoid the need for redistribution of wealth through taxation is if people are paid according to the value of their labor in relation to its overall contribution to the entire economic system in the first place i. e.  a planned economy in which there are no profits, and even that would be insufficient because not all value added to the system comes through paid labor.

Keeping these things in mind, that redistribution of wealth is not only just but also essential to maintain good system health, it is apparent that tax reform is essential in the United States.

I have laid out an analysis of income and taxation here:

In Depth Analysis of American Income and Taxation

It should be understood that our current taxation system is not built on justice or proper compensation, it is built on the encouragement of growth and the encouragement of the collection of wealth. These things are essential for progress, but progress is achieved by allowing the wealthy to gain an unfair portion of social wealth. It is the fact that you can gain more then your fair share that drives progress, but it must be recognized that the wealthy, by definition, do have more then their fair share of the wealth that society has created.  Our system is similar to something like a competition where everyone is supposed to collect gold and put it into a pile.  Then, the person who collects the most gold gets to keep half of all the gold collected.  Sure, the competition is technically legitimate, and the incentive encourages people to "work hard" but the fact remains that the "winner" receives more then his fair share of the wealth that was created by the group.

I will again refer back to President Theodore Roosevelt.  Roosevelt stated:

"…the National Government should impose a graduated inheritance tax, and, if possible, a graduated income tax.  The man of great wealth owes a peculiar obligation to the State, because he derives special advantages from the mere existence of government.  Not only should he recognize this obligation in the way he leads his daily life and in the way he earns and spends his money, but it should also be recognized by the way in which he pays for the protection the State gives him.  On the one hand, it is desirable that he should assume his full and proper share of the burden of taxation; on the other hand, it is quite as necessary that in this kind of taxation, where the men who vote the tax pay but little of it, there should be clear recognition of the danger of inaugurating any such system save in a spirit of entire justice and moderation. "

"In its incidents, and apart from the main purpose of raising revenue, an income tax stands on an entirely different footing from an inheritance tax; because it involves no question of the perpetuation of fortunes swollen to an unhealthy size.  The question is in its essence a question of the proper adjustment of burdens to benefits. "

http://www. taxhistory. org/TR/1906.htm

Roosevelt argued in favor of a graduated income tax not only on the ability of the more wealthy to pay, but as he says here, on the basis that a graduated income tax is a matter of making the proper adjustments in relation to burdens and benefits.

Roosevelt also states that the current system, the one that was in effect when he wrote this, unfairly put too much burden on the poor and middle class.  He goes on to say though that care has to be taken not to put too much burden on the wealthy either.

Andrew Mellon, the same man who also has ties to the fascist powers of Europe and was also our nation's treasurer and one of the founders of Supply-Side economic theory, made another argument in regard to taxes, which is worthy of consideration as well.  Mellon stated:

The fairness of taxing more lightly income from wages, salaries or from investments is beyond question. In the first case, the income is uncertain and limited in duration; sickness or death destroys it and old age diminishes it; in the other, the source of income continues; the income may be disposed of during a man’s life and it descends to his heirs.

Surely we can afford to make a distinction between the people whose only capital is their metal and physical energy and the people whose income is derived from investments. Such a distinction would mean much to millions of American workers and would be an added inspiration to the man who must provide a competence during his few productive years to care for himself and his family when his earnings capacity is at an end.

Here Mellon argues that it is fair for income tax on labor (earned income) to be lower than income tax on investments (capital gains).

In terms of justness this is definitely correct. Earned income should be the least taxed form of income, precisely because it is earned and a person is limited in how much they can earn by the hours in a day that they are able to work. With capital gains a person can earn income while not even working and the theoretical limit on how much you can earn is virtually infinite (well its limited by our economy).

However, what we have seen is that if the government taxes in this way, which is just, then it is not as beneficial to the economy, so we have made compensations that are not just, which allow favoritism towards the wealthy, in order to promote growth of the economy.

There is a third thing to consider as well, and that is sales tax. Sales tax also taxes the poor at a much higher rate than the wealthy. This is because poor individuals spend a higher percentage of their money than wealthy individuals.

The table below shows Consumption Rates for 1998:

What this shows is that spending as a percentage of income goes down as income goes up, which should be common sense.  This shows those making under $30,000 a year spending more than what they earn, which can be due to not reporting all income and/or the use of credit.

This also means that tax cuts for the wealthy may be less effective then tax cuts for the poor and middle class because the poor and middle class spend a larger portion of their income, and by doing are more active in the economy.

It also shows that sales taxes tax the poor at a higher rate than the wealthy relative to income.

All of these things need to be kept in mind when designing tax reform.

What I have attempted to establish here is that a graduated income tax is certainly justifiable and that taxing capital gains at a lower rate than income is not necessarily just, but it is deemed important to promote growth. It is also important to note that while a graduated income tax may tax the wealthy at a higher rate based on income, that sales tax taxes the poor at a higher rate based on income.  In addition, the Social Security tax is the largest growing tax of the post-war era and it falls predominately on the middle class.

The graph above shows the federal income tax rate on the top tax bracket since the time that the income tax was instituted.  This graph is only marginally useful though because the definition of taxable income has changed constantly and the tax brackets below the top are not represented.  The vertical line in the graph indicates a major change in the nature of the income tax.  Prior to the early 1940s the income tax fell virtually exclusively on the wealthiest Americans.  Through the mid 1920s only between 2% and 5% of Americans who had income paid any income tax.  The top tax bracket was cut during the 1920s, leading up to the Great Depression.  When FDR came into office the top tax bracket was once again raised, but the majority of Americans still did not pay any income tax.  Ever since the 1960s taxes have increased on poor and middle income Americans and been reduced on wealthy Americans.  

The Income Tax Turns 90:

http://www. taxhistory. org/Articles/1913_form_1040.htm

As the above graph shows federal receipts increased dramatically during WWII and have stayed relatively consistent overall since that time, however the source of revenues have changed considerably.  The share of tax burden paid by corporation have decreased since the 1950s while Social Security taxes, which fall disproportionately on the middle-class due to the income cap on Social Insurance taxes, have greatly increased.

This graph just shows the relative significance of the various sources of federal income in greater detail.

With all of that in mind, what needs to be done in order to reform our tax system and promote good economic health for our country is to greatly increase the marginal income tax rate and capital gains taxes should be graduated as well based on combined income.

The income tax brackets that I propose would be something like this:

The way that capital gains would be taxed is that anyone who’s combined earned income and capital gains income is under $300,000 a year would have their capital gains taxed at the rate equal to their earned income and capital gains combined. Anyone who's combined capital gains and earned income is over $300,000 a year would simply have their capital gains taxed as 30%. The current capital gains tax is 28%.

This type of taxation would promote a healthier economy by placing a more fair tax burden on those receiving extremely high income, opposed to the current plan and Bush's plan that sets a low top margin which effectively creates a flat tax for the wealthy. At the same time a plan like I proposed would create a tax cut for everyone making under $500,000 a year.

By taxing dividends in the manner that I have proposed low income earners would not be penalized for capital gains income in the way that they are now, making capital investment more attractive to lower income individuals, as well as lower tax rates which would free up more capital for investing, purchasing, and saving.

Note 1/1/2003: I have written an updated proposal on taxation and economics:

The Economy Web- Understanding Capitalism