Tom Fixes the Tax System!

by Tom

Nathaniel’s snark below aside, I am technically a co-contributor to this site and will keep blogging occasionally until Nathaniel removes my access.

The issue that I really wanted to get into was an issue of marginal tax rates.  This may seem like a bit of an esoteric topic, but I wanted to talk about it in the context of the income inequality that we see in America today.  My question then is at what rate should the marginal tax rates be set to insure that each income group is paying its proper share of federal income tax.  My guiding principle in doing this is that the percentage of total annual income earned by each quintile should be equal to the percentage of total tax paid by each group.  I know that I’m ignoring local and state tax rates, earned income tax rates, tax expenditures, every tax deduction out there, and using gross generalizations, but this is my thought experiment and I’m going to do it how I want.

Click image to make big… and see Tom’s genius.

If we then assume everybody in each grouping has the average income, the marginal tax rates for each quintile would be below:

Lowest fifth Second fifth Third fifth Fourth fifth Highest fifth Top 5 percent
29.51% 29.21% 29.60% 29.29% 12.22% 41.37%
4.33% 5.27% 6.18% 16.56% 18.74% 27.97%
173.13% 158.61% 79.01% 10.64% -13.26% -3.18%

There are three different scenarios above.

The top one is what happens if we assign tax rates based on percentage of income earned by each quintile.  I was frankly surprised at how much needed to be paid by those in the bottom quintile to pay for their share of the national income.  It was also interesting how the data separated out the top 5% from the other 15% in the top quintile.  It shows that those at the very top are pulling away from the upper middle class and that those below them are frankly not doing quite as well.

The second row is the place where I would like rates to be in my hypothetical magical world that I’m painting in this post.  I call this the progressive scenario where marginal tax rates rise with each dollar earned.  Under this scenario, the top 20% of the country would have about  50% of the nation’s wealth and would be paying 60% of the nation’s wealth.  This is a great scenario to me and provides a workable system of marginal tax rates that does a great job of incentivizing work, while still raising the necessary degree of revenue.

The third scenario is the flat fee world.  This assumes that each person pays a flat fee.  The effects are ludicrous and would involve those in the lowest fifth paying 173% of their annual yearly income, meaning that the government would take all of their income and then they would still have to pay 75% of the income they made.  There would be a negative tax rate on the most wealthy on those last dollars earned, meaning that they would get money back in addition to not paying taxes on that money.

The fourth scenario which is not included in this table is the flat tax, which would be a rate of 26.95% on all income.  Compared to our progressive rate scenario, it’s an increase on all groupings except for the most rich.  Compared to our first tax scenario, basically every group would pay a little less, but the richest would pay a lot less.

So what does this all mean?  What is the point of this exercise?  Did anybody actually make it all the way down to this part of the post?  There are three main takeaways to me:

1. The flat tax is a scam.  It sounds like a beautiful and equitable idea, but really is just a smokescreen for ensuring lower marginal tax rates on the rich.

2. Income is really unequal in America today and higher marginal tax rates are needed to combat this.

3. Chart blogging is fun and I’m going to do more of it.

Let me know what you all thought of this and if anybody is interested in the data to go over it on their own, let me know.


One response to “Tom Fixes the Tax System!

  1. Tom, this is really interesting. If you have some more time, I would be interested in seeing what happens when you factor in the things that you didn’t include: deductions, state/local taxes, etc. I imagine, but I could be wrong, that the effects you saw here would only be magnified when factoring those in. Regardless, great post.

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