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Are Taxes on the Rich Too High?

David Callahan

The wealthy are remarkably adept at feeling vicitimized, despite their unprecedented income gains over the past few decades and their unparalleled level of political clout in a democracy where money equals free speech. 

An AP article this morning in USA Today will surely feed these misplaced class grievances even more. The article, based on analysis of data since 1979, reports that wealthy families "are paying some of their biggest federal tax bills in decades even as the rest of the population continues to pay at historically low rates." In 2013, "The top 1% of households, those with incomes averaging $1.4 million, will pay an average of 35.5%."

This finding echoes a New York Times analysis earlier this year, which reported that after the tax hikes in the "fiscal cliff" deal, along with a new Medicare surcharge that is part of Obamacare, "the country’s top earners now face a heavier tax burden than at any time since Jimmy Carter was president."

It should be noted that these articles only focus on the federal tax burden. Many of the wealthy also live in California and New York, two states with high top state income tax rates—13.3 percent and 8.8 percent respectively. As well, many wealthy families live in Northeast communities with extremely high property taxes. 

So are taxes on the rich now too high? 

There are a few ways to answer that question. First, while it's true that taxes on the wealthy are higher than they've been in thirty years, it's also true that such taxes are still below levels typical in earlier periods. As the Times notes: "In fact, the total federal tax rate is still vastly lower for the very rich than it was at any point in the 1940s through 1970s."

Critics who say that high taxes on the wealthy undermine incentive and depress economic growth need to explain why the postwar boom barrelled forward despite record high levels of taxation on top earners. (Indeed, the basic argument that high taxes discourage effort has always seemed backward to me. If you want to clear, say, $1 million a year after taxes, you'll have to work more—not less—in order to do that when taxes are high.)

Second, while taxes on the rich are higher than in recent decades, it also true that after-tax income is way up, too. As the AP story notes: 

Average after-tax incomes for the top 1% of households more than doubled from 1979 to 2009, increasing by 155%, according to the CBO. Average incomes for those in the middle increased by just 32% during the same period while those at the bottom saw their incomes go up by 45%.

Yes, the rich are paying higher taxes, but they're still coming out way ahead of most Americans.

Third, there are huge disparities in taxes among the rich, with some high earners still wildly undertaxed—like the hedge fund managers and private equity partners who benefit from the notorious "carried interest" loophole. Even after the fiscal cliff deal, income on capital gains will still only be taxed at 20 percent, nearly half the rate of the top income bracket.

And as it happens, the richer you are, the more likely it is that your income comes primarily from capital gains. As the story notes:

the Internal Revenue Service tracks tax returns for the 400 highest-paid filers each year. Those taxpayers made an average of $202 million in 2009, the latest year available. Their average federal income tax rate: 19.9%.

While one might debate whether taxes on the W-2 rich are too high or just right, they are certainly way too low on the Schedule D crowd. 

Still, even though there remains plenty of room for yet higher taxes on the rich, raising taxes on the middle and upper middle class also must be a priority. Taxes on these earners are now near a historic low, as the Times reported last year, and that is simply unsustainable as the Baby Boomers retire and the United States faces growing global competition.

When Congress raised taxes on households making over $400,000 as part of the fiscal cliff deal and made the Bush tax cuts permanent for other earners, it locked in some 82 percent of those cuts and deprived the U.S. Treasury of some $4 trillion in revenue over the next decade. 

The big problem today is that not the rich are overtaxed, but that everyone else is undertaxed.