By Dr. James M. Dahle, WCI Founder

MickelsonThere is a lot of talk in the media about tax policy. Unfortunately, no one seems able to make any kind of dispassionate statement or argument about it. One side keeps talking about “fairness” and the other side keeps talking about “class warfare.” Of course we all want our tax system to be fair, and of course none of us want class warfare, or any kind of warfare for that matter. It's like abortion; who wants to be anti-choice or anti-life? We also tend to make the mistake of not caring about what those who make more than we do are paying. “It doesn't affect me,” or “Everybody making more than me is rich so they SHOULD pay a whole bunch more in taxes.” The recent dramatic increase on those with a taxable income over $1 Million in California (up from 9.3% to 13.3%) combined with the dramatic increase on the same folks in the federal tax code (up from 35% to 39.6%) and the new Obamacare tax (up from 0% to 0.9%) means an increase on the very well-to-do of 8.5% of their income.

Many people don't think anyone should have a marginal tax rate of 49.8% (it's not quite the 62%-63% Phil Mickelson thinks it is because part of the self-employment tax is deductible and the state taxes are deductible not to mention the fact that he can only do math in relation to par). Half of everything you earn going to income and payroll taxes? I don't think that's fair. But what is? Well, let's think about it from a rational standpoint.


Everyone Pays the Same Amount of Taxes 

One definition of fair might be that everyone pays the same amount. Since we all benefit the same from a strong military, the rule of law, a nice road system etc, it seems reasonable that we all ought to pay the same for it. There are 315 million people in the United States. In 2011, the US had revenue from income taxes of $1.27 Trillion. Divide that out and it comes out to $4,032 a piece. So if you have a family of 5, you pay $20K. That's your fair share. Even if we decide we just want to divide up the tax by the number of households (115 Million) that's about $11K per family. Of course, that's just using the revenue we collect. If we actually had a balanced budget, we'd need more revenue, about $22,347 per family or $8,158 per person.


Everyone Pays at the Same Tax Rate

Okay you admit, that's fair in a sense. But, you say, those who make more have greater capacity to pay more. It's only fair that the Exxon CEO pay more money than the guy who mows his lawn, even if they both benefit the same from the government. Wouldn't it be fair if the CEO had to pay at least the same percentage of his pay as the lawn mower? It's like tithing–10% for everyone, right? What would the rate be if there were a “flat tax”? Again, 315 Million households in the US, $1.27 Trillion is the revenue, and the average household had an income of something around $65K (the more commonly seen number, $45K is the median). $65K*115 Million = $7.48 Trillion. So we'd all need to pay 17% of our income (or 34% if we balanced the budget). That seems awfully high. No wonder the right thinks we have a spending problem. Using those percentages the median family making $45K is now paying $7,650 in taxes. Someone with an income of $1,000,000 would pay $170K in taxes, or about 22 times what the average household pays. Impossible to have a system like this? Not really. My state income tax is a flat tax, at least after your deductions.


How Progressive Should Our Taxes Be?

However, the system we have now is far more progressive than a 17% flat tax. As Mitt Romney famously made clear, 47% of taxpayers don't pay federal income tax. Thus the 53% must make up for all those households not paying their $11K share. The left would argue that those households are paying other types of taxes such as sales tax, property tax, and payroll taxes. It is true that the tax code is flatter (although still quite progressive) when you count in payroll taxes, especially Social Security since it is capped at an income of $113,700 ($7,049 for employees and $14,099 for the self-employed). The right would argue, however, that you shouldn't count payroll taxes, since they are in effect a form of forced savings. You get benefits in proportion to how much you put in. In fact, the SS benefit system is actually quite progressive, since you don't have to put much in to get significant benefits at the lower end, and then the benefits increase at a far lower rate than the premiums as you move up in income. Plus, those with significant income at the time of withdrawal are taxed on their Social Security benefits. Medicare, of course, is just a flat tax, 1.45% (2.9% for self-employed) for the same benefits for Mitt Romney and Joe the Plumber alike. Actually, with the new 0.9% Obamacaid Tax on income over $200K ($250K married), even the Medicare tax is progressive.


Tough Argument to Make

So those who would argue for even higher tax rates on high earners are left with a conundrum. They call for fairness, but their definition of fairness appears to be nothing more than that those who make more than them should pay more, and those with their income, or an income lower than theirs should pay less. Any objectively pre-meditated definition of fairness would call for a less progressive tax system than we had even before the recent changes increasing the progressiveness of the US system. If the “fair” answer is a progressive tax system, how progressive is progressive enough? It would seem to me that any fair system would require everyone to pay something. We have an alternative minimum tax for those on the high end of the income scale. I think it's time we had an alternative minimum tax for those on the low end of the income scale. Surely no one can object to paying $100 a year towards the protection afforded by the strongest military in the world and all the other benefits our government provides.


Taxing Spending

I'm not the first one to make these arguments. Proponents of the “fair tax” have argued that we should abolish our income tax system completely. Instead of taxing income, they argue, we should tax spending. Since those with a high income spend more, they'd pay more in taxes. Alternatives include a national sales tax and a value added tax. Experts estimate these taxes would have a rate of 15%-25%, which is pretty similar to that 18% rate I calculated earlier.

What do you think? What do you think a fair tax system would look like? If you think it should be progressive, what percentage of income should someone pay in federal income tax if they make $25K, $50K, $100K, $300K, or $1M? Comment below!