Are taxes really too high?

This post was motivated by this article, linked to by a Facebook fwiend. Thanks, Lea: http://money.cnn.com/2009/09/30/pf/taxes/who_pays_taxes/index.htm.

This is an extremely important statistic. The article itself, however, does not do justice to the real problem, which is linked to the huge disparity between the upper 20% of income-earning families, and the remaining 80%. The article also does not talk about the various major exemptions and credits that exist, which also explains why no taxes are being paid.

First, some terms: (1) a proportional tax is one which affects an entire population evenly; (2) a progressive tax is one which affects those who make a higher income more than those with a lower income; and (3) a regressive tax is one which affects those with a lower income more than those with a higher income. Second, some important concepts: (1) there is a basic "living cost" that is always factored into consumption formulas, which is a minimum cost for living in the country; (2) the income tax code is, in fact, progressive in theory; and (3) the I.R.S. and the Justice Department are under-funded and under-manned for the scope of duties they must fulfill.

This article states that 47% of income-earning families pay no taxes. To this, I say: "Yeah. Your point being?" Raising the tax rate isn't going to solve the problem because there is no problem here. No problem, you say? Yes, no problem, I say, for many, many reasons.

Let's start with the theoretical reasons. Classical economists have said, for a long time, that the wages of workers should not be taxed. This is because taxes on wages mean lower consumption, and, thus, lowered demand. However, if the wages are already at subsistence level, then workers will push for higher wages in order to compensate for the tax rate. This means that prices will rise accordingly. So, for the classical economists, higher taxes on wages will result in a lower real wage. That's bad. This analysis also applies to Keynesians. So, the less taxes on wages, the better. Please note, I'm using the term "wages".

Let's go to the realistic reasons. Many people don't end up paying income taxes because their income is tied up with tax-deductible expenditures. Mortgage interest, mortgage insurance, property taxes (to the local government), medical insurance payments, and education loan interest are some of the biggest deductions from income tax that most young adults can utilize in order to drop their taxable income or amount of taxes. Presuming, for a moment, that a family is able to increase their income over time, and continue to make all of the above payments, income taxes are going to drop on the family when student loans are paid off, and the mortgage insurance is no longer necessary (at around 20% of principal paid). Under the current economic atmosphere, though, many American families are over-burdened with mortgage debt and extended student loans; those loans mean that they will be able to claim the deductions for longer than what was likely intended. And let's not forget the deductions that are possible for 401(k) and IRA contributions, or children. (There are too many children in the United States; another rant for another time.)

Why is this not a problem? Because you can still tax wealth. The wealth held by the 10% of Americans at the top are largely in the form of investments, trust funds, and other forms of capital. The income that is earned from these investments is best described, in economic terms, as rent; it is money "created" from contractual terms that drains income from the economy, and out of the consumption-production cycle. Rent is the sort of thing that ought to be taxed heavily -- progressively, even -- as it sabotages the efficiency of production in the economy. Economists from Smith to George argued heavily for the near-punitive level of taxation of rent, in order to discourage it. Rent can come in many forms, but is generally known in common parlance as "capital gain".

So, how can we make up this "problem" with decreased revenues from income tax? Simply bump up the capital gains taxes. Among the 10% of Americans with 85% of the wealth, the top 10% of those people own nearly 50% of the nation's wealth (which is 1% of all Americans). If we raise the capital gains proportionally, this will discourage these Americans from investing. Instead, in order to balance things, I propose that capital gains be treated independently from income, and that the capital gains tax be progressive, like income tax. Thus, the 1% of Americans that hold 50% of the wealth will be taxed more heavily than those Joe Everydays that only do a handful of stock trades a year. Income from rental properties should also be treated as capital gains; however, mortgage interest and property taxes should be deducted from that income as actual expenditures for the maintenance of the properties.

Of course, the entire situation could be fixed if: (1) universal health care existed, which would eliminate the need for a health insurance deduction; (2) real wages would rise, thus pushing more American families into the "taxed" population; and (3) state universities stopped charging outrageously for an education that is next-to-necessary to get a job that pays reasonably well. In fact, if real wages went up, you could probably lower the cost of social programs, which, in turn, would permit more tax revenue to be put towards retiring existing debt.

But, what would I know?