Mises Daily Articles
Slaves to the Tax State
The basis of communism is "From each according to his abilities to each according to his needs," a slogan that is the basis of a totalitarian society where neither life nor property is secure. The slogan shows itself in other ways too: when the communist manifesto was published in 1848, the second bullet point was a progressive tax system. The progressive tax system and the philosophy behind it, on the surface, seems to be the basis for the U.S. tax code today.
In 2004 individuals with a taxable income over $319,000 pay 35% of their marginal taxable income to the federal government whereas individual making $10,000 pay only 15% to the federal government. As offensive as I find this system, it is not the basis for taxation in the United States today. The real U.S. system is far worse.
The real basis for the U.S. tax code is the federal government taxes absolutely everything that it can, but responds to the abilities of powerful individuals and corporations to leave the system. This results in a maximum tax rate, not for the rich, but for the upper middle class, and a maximum tax rate, not for the nation's largest corporations, but for the medium sized ones.
An extremely obvious example of this is the corporate tax schedule. Corporations making over $18,333,333 pay 35% of their marginal taxable income to the federal government. Corporations making less money, for example $15,000,000, pay a larger fraction of their marginal income to the federal government, 38%.
The system is similar for individuals. I have the income of an average American taxpayer. On a marginal basis, I pay 25% of my income to the federal government, 6.75% to the state in which I live and 6.2% to the social security system and 1.45% to Medicare, putting me in about the 40% marginal tax bracket. Bill Gates' tax bracket is well below 15%. Bill Gates and most wealthy Americans make the majority of their money off of capital gains, not earned income.
The maximum long-term capital gains tax rate is 15% and this is only paid when stocks are sold. The net effect is Bill Gates', and other Billionaire's, wealth grows largely tax-free while people whose primary source of income is labor pay 40% or more of their income to the government in taxes.
Federal income tax complications such as the alternative minimum tax, which is affecting more and more middle class Americans, make this problem even worse. The effect of this tax system is to make the rich richer relative to the middle class. The only way the middle class can join the wealthy is by starting and selling companies or by very astute stock selection. Working hard at a job will only result in the government's taking most of your money.
Another blatantly regressive tax system is the social security system. As of tax year 2004 Americans pay 6.2% of their income below $87,900 into social security—the tax rate above $87,900 is 0%. This is the largest tax many lower-income Americans pay. While it does tax middle class and lower income individuals at a much higher rate than high income individuals, the net effect is to make the total federal individual income tax brackets choppy like the federal corporate income tax brackets.
As of 2004, ignoring deductions since they make the tax system even more complicated, individuals making $85,000 per year are in a federal plus FICA plus Medicare tax bracket of 35.65%. This tax rate goes down to 29.45% if they make over $87,900 and then up to 34.45% if they make over $146,750. The federal total tax burden peaks at 36.45% for individuals making over $319,000 per year. It is hard to rationalize this sort of a system with any progressive tax rate argument.
What are the reasons for this system? The "rich" have more options than the rest of us. They have lobbying power with the federal government, and perhaps more importantly they can leave the U.S. Tax system. They could, for example, move to Germany and give up their U.S. citizenship as emerging markets investment manager J. Mark Mobius did.
The capital gains tax in Germany, as well as many other countries, is zero. The U.S. must keep its capital gains tax rate somewhat low, or many wealthy Americans, and their capital would flow to other lower tax countries. Most Americans do not have the option of fleeing from high tax America; they must go where their jobs take them. This is the same reason that governments give special tax breaks to corporations to locate within their state or city. The corporations have the option of locating in many different places; their employees must go where the jobs are.
The only real check on the federal government raising income taxes on working Americans is the one the U.S. government realized during the Kennedy Era; slaves are not generally very productive workers. Before 1963, the top marginal tax rate in the United States was 91%. If the government taxes its populace at a 0% tax rate, it does not raise any money, but if it taxes its workers at a 100% tax rate, it does not raise much money either – why work when you get no rewards for it.
The theory of supply side economics and the Laffer curve drove federal marginal tax rates from 91% in 1963 down to 28% when Ronald Reagan left office. Since more people were willing to stay in the work force, the federal government's tax revenues drastically increased due to these tax cuts.
Unfortunately, the federal government's spending increased even more during the same time period. While the theory of supply side economics, and the federal government's desire for more revenue, was used to drive taxes lower during the Reagan era, it is unlikely to drive income taxes significantly lower today. It would be hard to argue that George W. Bush's top federal marginal tax rate cut from 39.6% to 35% will change many workers' behavior.
It is very likely that for the foreseeable future the extremely wealthy in the United States will have a much lower tax burden than the average American. One possible solution to this problem would be tax treaties between governments to create a worldwide uniform tax code to eliminate what has been called "unfair tax competition." I am sure that this is the solution that most governments would favor since they could then raise taxes on all of us without any competitive limits: the cartelization of the looter class.
Another solution, which I strongly favor, is lower taxes for everyone, especially the middle class. After all, the US currently has an higher individual tax rate than most every former communist society, including Russia and Vietnam. Surely we can do better.