Op-eds

Five Myths about Taxes

by Steven R. Weisman, Peterson Institute for International Economics

Op-ed in the Washington Post
April 14, 2013

© Washington Post

 


"I paid my income tax today!" So went one of Irving Berlin's lesser-known patriotic jingles. "I never felt so proud before/To be right there with the millions more/Who paid their income tax today!" Few share Berlin's enthusiasm, as grumbling about taxes reaches a crescendo on April 15. Let's topple some tall tales about taxes before writing checks to—or getting refunds from—the dreaded Internal Revenue Service.

1. The income tax is a big-government Democratic scheme.

The first income tax in the United States was enacted under the first Republican president, Abraham Lincoln. Before the Civil War, Republicans were the party of big government, supporting high tariffs, infrastructure spending, and centralized bank regulations.

Once the war began, Treasury Secretary Salmon Chase feared that mounting deficits would spur inflation. Banks, which were funding the war, demanded action to ensure US solvency, and tariffs, the country's main source of revenue, had reached a peak. "Chase has no money, and he tells me he can raise no more," Lincoln complained in 1862.

Initially 3 percent on incomes above $600 and 5 percent on incomes above $10,000, the income tax was intended to assuage class resentment of industrialists getting rich by supplying the Union. The tax was repealed after the Civil War, reenacted in 1894, declared unconstitutional in 1895, then reinstated with Theodore Roosevelt's support. Republican William Howard Taft backed the ratification process that led to the Sixteenth Amendment, adopted in 1913. Democrat Woodrow Wilson signed the tax into law that year—and Democrats have been more inclined than Republicans to raise rates since.

2. The income tax dampens work and entrepreneurship.

In his 1990 autobiography, Ronald Reagan recalled that his longtime obsession with cutting taxes began in the 1940s, when he would stop making movies each year when his soaring marginal tax rate made it not worth the effort. Most economists agree that for many individuals and businesses, extremely high taxes discourage some economic activities. But how high must taxes be to have that effect? Liberal economists argue that taxes don't discourage work for most people until marginal rates reach 60 or 70 percent. Conservatives disagree, saying that taxes must fall for the economy to rise.

Whether tax cuts generally spur economic growth and tax increases generally dampen it is debatable, however. Economic expansion was significant in the 1950s, when tax rates were at historic highs. Tax cuts signed by John F. Kennedy and Reagan were followed by sustained growth. But growth that followed tax increases under Presidents George H.W. Bush and Bill Clinton was greater than after George W. Bush's tax cuts.

The nonpartisan Congressional Research Service reported in December that, for upper-income taxpayers, at least—"job creators"—cutting taxes has "little association with saving, investment, or productivity growth." That report was revised after Republicans attacked an earlier version, but its conclusion was unchanged.

3. Taxes became less progressive because of the Bush and Reagan tax cuts.

The tax code is indeed less progressive at the top because of falling rates for the wealthy. The top marginal rate fell from 91 percent in the 1950s to 70 percent in the 1960s and 1970s, and again in the Reagan era to a low of 28 percent. It went back up to 39.6 percent in the 1990s, down to 35 percent after tax cuts under George W. Bush, and is now back up to 39.6 percent for families making more than $450,000.

But whether the tax code as a whole is less progressive is unclear. That is because the drop in the rate paid by those at the top is offset by dramatic declines in taxes paid by lower-income households. Many low-income families receive income supplements from the Earned Income Tax Credit, the child credit, and other targeted benefits.

"Advocates of progressive taxes have both lost and won recent tax battles," Eugene Steuerle, cofounder of the Urban Institute–Brookings Tax Policy Center, told me. "Middle- and lower-income classes always get some share of tax cuts but little or no share of tax increases, helping to maintain roughly the same progressivity in the federal tax system throughout most of the post-1980 period."

4. The US corporate tax—the highest in the world—makes the United States less competitive.

The US corporate tax rate is 35 percent. When added to state and local corporate taxes, this is indeed the highest in the world. But the effective rate, or the rate corporations pay after taking advantage of loopholes, is lower—27.1 percent, or about the same as other advanced economies, according to the Congressional Research Service.

The Simpson-Bowles deficit commission said last year that the tax "hurts America's ability to compete." (A study by my colleagues at the Peterson Institute for International Economics uses a different calculation to make the same point.) But the taxes paid by US corporations are tiny compared with their peers around the world—only 1.9 percent of the national economy, compared with an average of 2.8 percent for other advanced countries—partly because of the proliferation of limited partnerships and other businesses not subject to the tax. In fact, less than half of US business income is generated by corporations subject to the tax, down from 80 percent in 1980.

5. Forty-seven percent of Americans pay no taxes.

The Tax Policy Center's estimate that 46.4 percent of households pay no federal income tax blew up in the face of 2012 GOP presidential contender Mitt Romney after he cited it in a talk to donors. But the center also noted that nearly two-thirds of households that paid no income tax did pay federal payroll taxes for Social Security and Medicare. In addition, more than half of those who paid neither income nor payroll taxes are elderly; more than a third have an income under $20,000; and everyone who drives, smokes or drinks pays federal taxes on gasoline, cigarettes or beer.

Citizens for Tax Justice, an advocacy group, found that if all federal, state and local taxes are accounted for, the poorest 20 percent of Americans pays 17.4 percent of its income in taxes while the wealthiest 20 percent pays about 30 percent. Given Romney's disdain for the 47 percent, it's ironic that one reason poorer Americans pay fewer taxes is that Republicans added tax credits for them in order to get Democratic votes for overall tax cuts of 2001 and 2003.



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