Vague ideas about the income tax

Many of us have a vague idea that the income tax is more or less “progressive,” meaning that those with higher incomes pay a larger share of income than those with smaller incomes.  Of course there are some unfair loopholes, but on the whole these people would like to see the income tax cover a greater share of government revenues. Of course, those of us who actually look at how taxes work know that the income tax makes no sense at all, and is only very vaguely related to income.

In fact, a new-to-me report shows that among the richest (top quintile of income), effective average tax rates range from less than 3.8% (for the cleverest 10% of these affluent taxpayers) to 18.6% (for the most tax-burdened tenth of this group).  For the “middle class” (third quintile), the range is from -4.5% (meaning that refundable tax credits exceed otherwise-taxable income) to 9%.  (Exactly what definition of income applies here is not clear; it’s based on the “Urban-Brookings Tax Policy Center Microsimulation Model (version 0509-4),” which I haven’t examined.)

Of course this weirdness is the result of many “loopholes” and special provisions.  In theory it would be possible to eliminate them and come up with a simpler tax, but in front of each loophole stands a lobbyist (and/or a legislator favored by a lobbyist).  U S Senators Ron Wyden (D-Oregon) and Judd Gregg (R-New Hampshire) have introduced S-3018, which will do away with many(pdf) (but not all(pdf)) of these provisions.

The mortgage interest deduction stays, which maintains a subsidy for real estate speculation. The deduction for corporate-paid interest would be limited to the amount in excess of inflation, which appears to mean that a corporation, upon issuing fixed-rate bonds, would have no way to know in advance how much interest they’ll be able to deduct.  Perhaps this will encourage inflation-indexed bonds?  Also, it is not clear what the effect  would be if we enter an (unlikely) deflationary period.

I see this as simply one more illustration that the tax on earned income (including revenue from investments in real capital) is a hopeless mess.  A tax on privilege (or, what is effectively similar, on the income from privilege) would be much more straightforward and encourage balanced economic growth.  Unfortunately, those who hold privilege have great resources to fund lobbyists and other professionals to block to adoption of such a tax.

ht Forbes via Yglesias (indirectly from Felix Salmon)

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One Response to “Vague ideas about the income tax”

  1. Jeff says:

    How is the mortgage disaster, and drop in home prices, likely to be corrected if people can’t get a new job? There are a large number of individuals that previously lost their homes and many more will unless the USA starts producing something more then excuses. It is time to adjust the trade deals with the Chinese. For crying out loud, our primary trade partner is a communist nation.

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