Income Tax Rates and "Fair" Alternatives

Is the Federal Income Tax fair? Is it graduated, flat, or something else? Are there fair alternatives that can actually bring in the same amount? We will focus on these questions.

The Tax Rate in 2001

The lower incomes do pay lower rates. The highest rate is about 30% and it is paid by those earning between $1 and $5 million. The super-rich, those earning over $5 million pay a slightly lower rate.

Now that we have the actual tax rates, we can compare them to alternatives that some consider "fair."

Note: This information considers income tax only. See payroll taxes.

See comparisons to other years.

Alternative #1: Equal Amount

Most people think that fair means equal. Does anyone think that fair means equal amount? For the federal government to raise the same amount using a equal amount tax, each person would have to pay about $6800.

The equal amount tax has some obvious problems. First it would raise taxes for the lower incomes (anyone earning less than $45,000.) forcing nearly 18 million more families into poverty. Next, it would be more money than than nearly 18 million people actually earn.

Alternative #2: A Flat Tax, or Equal Percent

Many have suggested that a flat tax would be fair. This sounds sensible, since everybody would pay an equal percent. But like the equal amount, the lower incomes (anyone below $100,000) would suffer a tax increase. And the lower one's income, the greater an increase they would suffer. Can the lowest incomes really afford that much of a tax increase?

What is the opportunity cost of taxes?

Alternative #3: Equal Tax on Consumption

Many people are now claiming that a consumption tax would be fair. Everyone would pay according to the resources they consume. We must remember that the portion of our income that we invest would no longer be taxed. As a result a consumption tax would have to have a higher rate to generate the same revenue. The rich invest a significant portion of their income, frequently more than half. The lower incomes spend most of their income, mostly out of necessity. This would result in lower incomes paying a higher effective tax rate. Is this fair?

Consumption Tax Rate

Alternative #4: Equal Burden

Another approach to fairness would be to ask all taxpayers to suffer roughly the same dent in their lifestyles. For example, if taxes force a middle class person to look for a house 10% cheaper than the ones they would like, then taxes should also force the rich to look for a house 10% cheaper than what they might have liked. Similarly, if a middle class person would have 10% of his income left over after his basic expenses, then a rich person also should have 10% left over after his basic expenses. This is what equal burden taxation might have looked like in 2001:

With an equal burden tax, every earning less than about $100,000 would pay less taxes, everyone earning less than $19,000 would pay no income taxes at all, and only those earning more than $1 million would see a tax increase. This would give the federal government the same revenues.

How did we determine the Equal Burden Rates?

We encourage all to try the procedure yourselves. We're sure you will come up with similar results. We took a list of basic expenses, and asked how much they would typically be for a poor couple, a rich couple, or a middle class couple. We interpolated our results. Here was our thinking:

1: The poor: We asked, "in most parts of America what is the lowest a couple could possibly pay for their basic expenses?" We assumed a poor couple would make about $10,500 per year.

Rent $400 / month
Utilities $25 / month
Household expenses $10 / month
Furniture etc. one $100 item / year
Food $1 / meal
Transportation $50 / month
Technology $10 / month
Clothing & Laundry $40 / month
Retirement account $10 / month
Entertainment $20 / month
Vacation one $240 vacation / year
Payroll Taxes 9.5%
State Taxes 0%
Medical $0

The Middle Class: We asked, "in most parts of America, what might the typical middle class couple expect to pay for their basic expense?" We assumed that between two incomes a middle class couple earned about $50,000 each year.

Mortgage $800 / month
Utilities $250 / month
Household expenses $30 / month
Furniture etc. one $250 item / year
Food $2 / meal
Transportation $600 / month / car
Technology $100 / month
Clothing & Laundry $100 / month
Retirement account 10% / year
Entertainment $100 / month
Vacation one $3600 vacation / year
Payroll Taxes 9%
State Taxes 0%
Medical $0

The Rich: We asked, "What is the most we could possibly image paying for the same basic items?" We assumed the rich made $1 million per year.

Mortgage $29,000 / month
Utilities $1000 / month
Household expenses $1000 / month
Furniture etc. one $2400 / year
Food $30 / meal
Transportation $6000 / month / car
Technology $500 / month
Clothing & Laundry $1000 / month
Retirement account $24,000 / year
Entertainment $2000 / month
Vacation six $2000 vacations / year
Payroll Taxes 3%
State Taxes 0%
Medical $0

We accounted for payroll taxes, for all three levels, but we did not account for state, local taxes or medical.

Other Tax Info

Two Decade Comparison

Some have claimed that the share of taxes paid by the rich has gone up in the last 20 years. They say this is the result of a "soak the rich" mentality (see Newsweek 1/27/03 p57). So, lets see if they're right. Lets compare some numbers.

Tax revenues from the top 1% increased, and from the bottom half decreased. But a closer look should raise some questions. Notice the share of the income for the top 1% doubled (from 9% to 18%) but the tax burden for the top 1% did not (16% to 25%)

This implies that the relative share of taxes paid by the poor and lower middle class went up significantly, and the relative share paid by the rich went down significantly.

To examine this implication, let's compare this to another set of data. Income tax records for 1968 and 1999 (These numbers were picked due to their availability, but they will show us only the change in income and income taxes.)

Examine the share of wages and taxes, we see a very disturbing trend. The poorest third of our population saw their share of the wages decrease to about a quarter of what they had been, while their share of the income taxes only dropped by half. In contrast the top 1/2% saw their share of the wages nearly triple, but their share of the income taxes only increased half this amount.

Comparing the change in the Standard of Living to the change in the Income Tax Rate we see the same disturbing trend a different way. The bottom half saw about a 20% drop in their standard of living, but only about a 3% decrease in their tax rate. The rich saw better than a 100% increase in their standard of living, but a tax rate 17% rate drop in their income taxes.

Both graphs show the rich getting richer, and getting the largest tax break, and the poor getting poorer.

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