Analysis: Lower tax rates have proven dandy ... for the rich
Monday, April 17, 2006 7:06 AM PDT
By Joel Havemann, Los Angeles Times
Printable version
E-mail this articleWASHINGTON -- A decade ago, when publishing magnate Steve Forbes ran for president, he vowed to deliver a new era of prosperity with just a simple change in the federal income tax: Instead of people with more money paying higher rates, all would pay the same "flat" tax rate -- unleashing "the fantastic growth waiting to burst forth in our economy."
Forbes' "flat tax" plan was dismissed as simplistic by many mainstream economists and viewed with horror by the legions of special interests that benefit from all the deductions and loopholes that flat tax advocates would eliminate.
But this weekend, as millions of Americans faced the perennial deadline for filing their federal tax returns, most of them were operating in something very close to the world Forbes and other flat-tax visionaries proposed. Without any fanfare or philosophical debate, millionaires and middle-class Americans now pay taxes at almost the same rates.
So what about the "fantastic growth waiting to burst forth?" Has leveling out federal income tax rates produced a cornucopia of financial benefits?
The answer is probably yes -- if you're a millionaire. And probably no -- if you're almost anyone else. Flattened, and thus lower, tax rates have contributed to huge increases in the wealth of the wealthy, but so far they have not been accompanied by significant economic improvement for most people.
In fact, while most pay less in taxes than they did a few years ago, the Federal Reserve Board, in its latest three-year examination of family finances, found that average family income fell by 2 percent between 2001 and 2004 after adjusting for inflation. In the previous three-year period, average family income grew by 17 percent.
"It's as if Santa Claus dropped bags of money down everybody's chimney," said Leonard E. Burman of the private Tax Policy Center. "Only he dropped extra big bags in rich people's homes, and extra small ones in smaller homes."
Because of more credit card debt and borrowing against their homes, the 25 percent of Americans at the bottom of the wealth scale had negative net worth in 2004.
The first federal tax code specified a maximum rate of just 7 percent, but by the time the United States entered World War I in 1917, Congress had boosted the top rate to 77 percent. During World War II, the top rate hit an astonishing 94 percent. In fact, the top rate on investment income was 70 percent as recently as 1980, although wages faced a top rate of "only" 50 percent.
The tax cuts engineered by President Reagan brought the top rate for all income down to 50 percent, and the 1986 tax reform slashed the top rate to 28 percent as of 1988, its lowest level since 1931. But that lasted only two years before deficit-reduction packages gradually lifted it back to 39.6 percent.
Taxes have had an intimate and often stormy relationship with America's economy and its politics since colonial days. In response to the British Sugar Act in 1764, which put duties on a range of foreign goods brought into the colonies, patriot leader Samuel Adams wrote: "If taxes are laid upon us in any shape without our having a legal representation where they are laid, are we not reduced from the character of free subjects to the miserable state of tributory slaves?"
If Adams had lived to see the rates imposed during the two world wars, he might have tried to start another revolution.
Under Forbes' largely forgotten flat tax proposal, taxpayers would have paid 17 percent in taxes on all income beyond $36,000 a year, excluding pensions and profits from the sale of investments. The system was to be so simple, the candidate said, that most taxpayers would fill out a form the size of a postcard.
No such system was adopted or even seriously considered, but President Bush has achieved something close to the flat rate structure by cutting tax rates on earned income and particularly on dividends and investment profits.
Last year, for example, according to the Tax Policy Center, people with incomes between $500,000 and $1 million owed exactly as much in combined federal income and payroll taxes as a share of their income -- 22 percent -- as did taxpayers reporting at least $1 million in income.
Taxpayers in the $100,000 to $200,000 range paid nearly the same rate, 20.6 percent. Even those in the $30,000 to $40,000 range paid 13.6 percent.
For a solid majority of taxpayers, the bite taken by income taxes is smaller than the bite taken by the taxes that finance Social Security and Medicare. The latter are simple flat taxes and have played a significant role in flattening the overall rate structure.
Advocates of the flat tax have long argued that it would stimulate economic activity and thus ultimately benefit everyone. Bush shares that view, though he has not officially advocated a flat tax.
And in recent years lower tax rates do seem to have contributed to healthy economic growth. The economy has been producing goods and services at a rising pace since the end of the 2001 recession. Unemployment is a low 4.7 percent.
But the health of the economy as a whole has not translated into gains for most workers. Because of global competition, the decline of manufacturing, weaker labor unions, immigration and other factors, most workers have not been able to obtain higher pay.
Instead, "flatter" income tax rates have contributed to an economic landscape that David Kelly, economic adviser to Putnam Investments, likens to an hourglass. Some from the traditional middle class are rising into the top, while others are being squeezed out into the bottom.
Average family net worth has continued to grow, in large part because of rising home prices, but at a rate that sagged from 29 percent between 1998 and 2001 down to 6 percent between 2001 and 2004. And for most Americans, whatever nominal pay increases they got in the last three years were more than offset by higher costs of things such as health care.
Meantime, the disparity between the wealthiest Americans and everyone else has grown.
Last year, for example, a typical corporate chief executive officer made 279 times the average pay of a non-supervisory production worker, according to the liberal Center for American Progress.
That figure, the second highest in 40 years, was up from 229 in 2004 and 185 in 2003.
Measured another way, during the previous seven economic expansions before the current one, employee compensation rose four times faster than corporate profits, according to the labor-supported Economic Policy Institute. In the current expansion, profits have risen three times faster than compensation.
The failure of flattened tax rates to deliver greater rewards to the mass of workers helps account for why polls show Americans are so sour about the economy.
Maria Bautista of Concord, Calif., who took part in a recent Los Angeles Times/Bloomberg poll, said the national economy was performing "fairly well" but nevertheless said she paid too much in taxes.
"The rich absolutely do not pay enough in taxes," said Bautista, who as an assistant special education teacher does not rank among the rich. "There are less and less in the middle; either you make it big or you get left behind."
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