As expected, this week the Joint Select Committee on Deficit Reduction (the “Super committee”) failed to come to any agreement on what measures would be recommended to reduce the budget deficit by $1.2 Trillion. Therefore, automatic spending cuts are scheduled to begin in 2013. The major rating agencies did not undertake a further downgrade of U.S.debt as a result of the impasse.
Much of the deadlock revolves around whether tax increases will accompany spending cuts in order to move closer to a balanced budget. At the same time, across many cities in the US, protestors are demonstrating against a combination of things like outrageous executive bonuses and the perception that the distribution of wealth in the country is becoming more skewed towards the top income earners. I have seen signs both on the news and in person saying “we are the 99%”. Before you go creating your own sign and joining the movement, let’s have a quick review of the math.
According to a recent study going back to 1922, the peak level of wealth disparity was in 1929, when the top 1% of households controlled 44% of the country’s wealth. In 2007, it was 34.6%. Therefore the concentration of wealth in the country is down over the long run, although it has risen significantly since the 1976 low of 19.9%.
Now let’s move on to income taxes. According to the National Taxpayers Union, for the 2009 tax year, the top 1% of household incomes paid 36% of total Federal income taxes. This is approximately in proportion to the overall level of wealth that they control. The top 10% of taxpayers paid over 70% of the total.
In 1999, the top 10% of taxpayers paid 66% of Federal income taxes. Therefore, over the last 10 years, the proportion of taxes paid by the top 10% of taxpayers actually increased.
The top 10% can pay at most 100% of the income taxes. So the current argument comes down to what number between 70% and 100% they should pay.
The top 10% starts lower than many people might think. For 2009, Adjusted Gross Income on your Federal tax return of $112,124 would put you in the top 10%. This is within reach of many households, particularly for a married couple where both spouses work. For a family of four who are fortunate enough to enjoy this level of income, I suggest their lifestyle is comfortable but not extravagant. For the 90% below this level, things are more challenging.
The current stalemate about taxes is annoying, and it is likely that some combination of tax increases and spending cuts will be needed to achieve any meaningful reduction in the budget deficit.
Increasing taxes on the top 1% may be part of the solution. Over the last 10 years, the top 1% paid a relatively stable proportion of taxes, while the tax burden on the next 9% has increased. But there are simply not that many people in the 1% to where they can be expected to pay the tax burden for the entire country.
How about increasing taxes on the top 10%? The problem here is that the top 10% includes many dual-income families, and this group already pays a disproportionate amount of Federal income taxes (9% of taxpayers are paying about 44% of the taxes).
Another part of the solution might be to replace part of the income tax with a consumption tax. This would capture some tax revenue from the underground economy of people currently working for cash, when they eventually go to a store and spend the money they have earned but not declared as income. As the election approaches over the next 12 months, particularly in light of the Super committee’s failure, taxes are going to be a pivotal issue. Hopefully there is a chance for true reform.
Bill Hansen, CFA
November 23, 2011