What About The Rich?
While there’s a lot of discussion around universal healt-care at the moment, there’s arguably more discussion around the super wealthy — specifically, around “the 1% vs. the 99%”. And since it’s always fun to think about the rich, I figured I’d extend my tax research to look at them as well. But to start with, of course, we have to figure out who we mean by the rich. The top one percent is a great tag line, but what does that actually mean? The top 1% by total net worth? The 1% of households with the highest income? The households that earn in the top 1%?
Let’s discount the first one. While the top 1% by total net worth is actually the best measure of the super wealthy, the reality is, the U.S. doesn’t tax on net worth. And aside from a handful of hard-line communists, very few Americans are suggesting they should. The notion that Bill Gates should be forced to sell off 6% of Microsoft every year and give the proceeds to the government is, while perhaps entertaining, not going to get us very far. So let’s just assume that when Warren Buffett says the rich aren’t paying enough taxes, he’s almost certainly talking about taxes on income, not wealth.
So which of the other two options is it going to be? In 2009, approximately 140.5 million tax returns were filed with a total adjusted gross income of just over $7.5 trillion. Do we call the 1% the group of earners that earned the last $76.3 billion (that would be somewhere under 2,000 people)? Or do we call the 1% the top 1.4 million earners (which would be somewhere around $1.2 trillion in earnings)? The former is arguably a better definition of the super wealthy (though still not a particularly good definition, since it’s not talking about wealth). But the latter seems to be a better representation of how the phrase is used in the vernacular (e.g., the top n% of the population earns x% of the money). So, for purposes of the rest of this discussion, we’ll use that as the definition of the top one percent: the 1% of income tax filers with the highest income.
Now that that’s decided, let’s take a look at the group as a whole.
Again, just a preliminary look provides some interesting results. First, as expected, the size of the one percent is growing over time. From 1997 to 2009 an extra 180,721 Americans joined the top one percent. The first interesting data point is the decline from 2007 to 2009. This is, of course, a direct result of the recession, but that’s a topic for another post. The second interesting point is their actual income. As can be seen from the trend line, not only have the number of people in the top 1% been increasing, but their average income has been increasing as well. That said, while the trend is increasing, the graph makes it obvious that there’s a tremendous amount of volatility in that income. The average person in the top one percent made $683,000 in 1997, $1.6 million in 1999, $716,000 in 2002, $1.7 million in 2007, and $890,000 in 2009. Those are some big swings.
Now let’s look at the top 1% vs the other 99%.
Strictly speaking, this is still a bit of a digression. I’ll come back and hit some of the interesting points here in other posts (e.g., while the recession has pushed everyone back, the whole country is still substantially ahead over the course of a decade; and the clear leading effect of the top 1% (their income both rises and falls before the rest of the country), and what implications that may have for the success or failure of “trickle down” economics). But while it may have been a digression, I think it’s been useful to set the stage before we actually look at the taxes. Let’s do that now.
Well, so much for my notion that we’re already on a flat tax. For lower- and middle-class families we may be approaching a flat tax, but the rich are certainly paying a whopping ton more in taxes, of course in terms of dollars, but also in terms of percentage of income. OK. Fair enough. But what about the notion that, relative to their income, they don’t pay their fair share of taxes? We already took a look at overall income above. But let’s compare the income of the top 1% as a percentage of aggregate U.S. income to the income tax of the top 1% as a percentage of aggregate U.S. income tax.
I confess to yet again being surprised by the data. While I was never really worried about it, I have to say, I had at least notionally bought into the concept that the rich weren’t paying their fair share of taxes. I mean, even Warren Buffett thinks they’re not. But looking at the data, actually, they’re paying far more than their fair share. It’s true, they certainly make a disproportionate percentage of all of the income in the country. From 1997 to 2009, the top 1% of earners made anywhere from 15% to 35% of the income in the U.S. But given the “80:20 rule”, we shouldn’t necessarily find that so surprising — after all, again, we’re not communists. What I did find surprising though was that, while they made from 15% to 35% of the income, they paid 32% to 51% of the taxes. That is to say, of all of the Federal income taxes payed by everyone in the country, the top 1% pay between a third and a half of them. I’ll just stick with, “interesting”.
One more aside, while we’re looking at wealth and tax breakdowns: if the top 1% are paying between a third and a half of the taxes in this country, what does it look like for other income groups? Is any group taxed in a particularly unfair way? Let’s take a look.
This data is for 2009 only, and keep in mind, the numbers are for total income earned in the country and total tax payed, using the “99 vs 1” model. In other words, this doesn’t apply to any (or even a typical or hypothetical) individual or family — it only applies to the distribution from the median. So, is there anything curious here? First, look at the “80:20 rule”. The top 20% of the population makes 60% of the income. I’m not sure if I would have guessed that or not. I probably wouldn’t have believed that they actually made 80% of the income, but I hadn’t really thought it through before I ran the numbers. They do, however, pay 83% of the taxes, so I guess the rule holds there. Far more interesting however is to look at the top 50%. The top 50% of the country pays 98% of the taxes. That’s the kind of thing that politicians can use to get people’s blood boiling. “Half the country isn’t paying their fair share of taxes!!!” But, of course, the thing this chart doesn’t show is where the median is. For the record, in 2009 it was $31,757. Half the country made below that number, and half above. Argue amongst yourselves as to whether the half of the country below $31,757 should be paying more than 2% of the country’s Federal income tax (and while you’re at it, argue whether half of the country should be making below $31,757 at all).
But while looking at taxation on the rich may be interesting, looking at personal, directly observable taxation as we have been so far is only one piece of the puzzle. The reality is that with all the complexity of income tax, property tax, sales tax, etc…, etc…, we still haven’t considered corporate tax. Or other tax. Other tax? Are there other taxes? On page 3 we’ll look at the total tax picture for the U.S.
Chris,
This was a great post, informative and interesting. I have a few thoughts that perhaps you or someone else could comment on:
First, regarding the taxes paid by the wealthy (i.e. “top 1%”), many people combat the notion that the wealthy are being disproportionately taxed by invoking the law of diminishing (marginal) utility. That is, while the wealthy may be paying a considerably greater percent of their incomes in taxes than the less affluent, they, the wealthy, still have a ton of money laying around and the taxes paid, despite being numerically larger, are worth about the same when adjusted for utility. Inherently, this makes some sense to me in that I may more desperately need that X percent of my income if I make $20,000 per year rather than $200,000 or $2,000,000. However, a dollar is always worth a dollar and any concept of utility seems too subjective to be helpful on this scale. What are your thoughts on this?
Second, you made an excellent point on the costs associated with complying with our über-complex tax code. The cost alone is enough to justify considering alternate systems (flat tax, fair tax, etc.). But, how do we, the US, relate to comparable countries in regards to tax complexity? A quick skim of the World Bank Ease of Doing Business Rankings is informative for some glimpse at corporate taxes, however it was relatively unhelpful in yielding information on personal tax complexity. I would be especially interested to see which tax systems have stimulated the most growth.
Third, I am curious about the connection between our total tax burden and the inference that we have the ability to tax more yet still grow our GDP per capita. It is obvious that other countries are able to tax more and maintain a higher GDP per capita than us (or, as your rightly pointed out, raise their GPD per capita faster than us despite higher taxes), but I wonder if suggesting that ‘because other countries have done it, we can too’ may be a too simple an answer. I am certainly no expert in macroeconomics, but some of the countries that managed this feat (like Luxembourg, Switzerland and the Netherlands) are working with a significantly smaller populations, which, I imagine, could be more readily affected by an influx of businesses than our much larger country – in effect growing GDP despite the “tax burden.” So, the question is how much can we learn from countries like Luxembourg and where do those analogies lose utility?
Anyway, thanks again for the great article!
Best,
Micah
Hey Micah,
Thanks for the great reply and the great questions! I’ll come back to the first and third a little later, but I wanted to just give a quick answer to your second question.
The bottom line is that the U.S. doesn’t have any peers of comparable tax complexity. The closest is the U.K., at 11,500-ish pages is closest. But even there, that’s the entirety of their tax code. The over 16,000 pages I quotes for the U.S. was income tax only, and Federal only. After the U.K., other countries drop off quickly. Canada’s income tax act is over 2,000 pages — but it’s written in two languages at that length! The French weigh in at 1,900 pages. After that, it falls off steeply. Of the countries in which I’ve lived, Germany is pretty big at 141 pages, but that’s for the entire Abgabenordnung (or fiscal code, not just the taxes). The Czech Republic, Russia, and Singapore all have flat(-ish) tax structures these days. Really, it’s almost impossible to compare.
As somewhat of an aside, I suspect part of our tax complexity is due to our age. In Europe (and even in the U.S.), people think of the U.S as a young country. However, the reality is that we’re one of the oldest countries in the world. There are only 3 countries in Africa that predate the 20th Century, and none that predate the 19th. In the Americas, a few date from the 19th Century, but we’re the only one to date from the 18th. In Asia, Thailand dates to 1776, but it’s the only 18th Century country, and the vast majority are 20th Century. In Europe, San Marino dates to 1600, the U.K. dates to 1707, and … that’s it. The U.S. is the fourth oldest country in the world. That gave us a lot more time than anyone else to mess up our tax code.
Once again, thanks for the reply, and I’ll get back to your other two questions as soon as I have a few moments.
Hi Micah,
Coming back to your other questions, regarding the first, I’m not sure I completely buy into the marginal utility argument, at least not from that direction. It depends on what one means by “worth”. Money is an abstraction of saved societal free-time, and the rich (who by definition have acquired large quantities) are capable of doing large things (witness Bill Gates philanthropic efforts, or Sir Richard Brandson’s X Prize). One can argue that these have greater worth to society and are a natural outcome of accumulation of wealth. I would say those dollars are worth more to society, not less. That said, they are certainly worth less to the individual (i.e., you’re correct, those saved dollars are more meaningful to the poor than they are to the rich).
The question ultimately comes down to what a “fair” tax is. As I mentioned, the top 1/2 of Americans pay 98% of the Federal income tax. Digging further into this, the top 10% of Americans pay 45.1% of total taxes. This is higher than any other OECD country (for Germany, the number is 31%; for France the number is 28%). This is true even though France and Germany have much higher marginal tax rates because they also have much higher consumption taxes — and consumption taxes (e.g., sales tax) are regressive.
Regarding your third question, yes, it’s hard if not impossible to compare the U.S. to any other country. There are serious issues with scale, which is why I selected the per capita number. Two other ways we could have compared would have been to look at countries with similar populations, and to look at countries with similar total GDPs. Looking at pure GDP, there’s really no one comparable. At $13.8 trillion in 2009, the U.S. was slightly smaller than the entire E.U., but slightly larger than the 17 country Euro zone, 35% bigger than China, and more than triple the next closest economy (Japan). So, I suppose we could compare to China, but I think even more than in the per capita measures, country specific items other than taxation policy would drive the conclusion. Going back to similar population, it’s slightly better than similar GDP, but not much. In 2009 there were 5 other countries which had the same order of magnitude population as the U.S. (which is to say, in the hundreds of millions): Indonesia, Brazil, the Russian Federation, Japan, and Mexico. I would argue that the only one of those worth comparing is Japan. As it happens, the data isn’t even available for Indonesia, Brazil, or Russia. I’ve put together another chart for Mexico, Japan, and the U.S. here: https://www.cwrichardson.com/images/TaxVPopChart.png and I think you’ll find it no more illuminating than the per capita data.
But again, you’re correct. It takes miles to turn a tanker. Thinking that the sort of economic change that caused the success of Switzerland or Ireland could be effected in the U.S. would indeed be naive. I’ll write a separate post on what I think the policy implications of this data should be; for the moment, my only point was that changing tax policy is not going to have a meaningful economic impact.
Cheers,
Chris
Chris,
For the sake of simplicity, I’m going to respond to both of your replies here.
First, I have to admit that I was one of those people that assumed the US was a fairly newcomer on the country-founding scene, at least in comparison to Europe and parts of Asia as I’m fairly familiar with Sub-Saharan Africa and Latin America. I know that I visited a few bars in Prague that are older than the US, so to learn that we are the fourth oldest country in the world came as a shock.
Being an attorney by training, but not by trade, I can say that our legal system has generated similar levels of relative complexity in all areas of the law when compared to our Southern neighbors. When I’m working on projects in Latin America, it always amazes me how easy it is to maneuver in a civil law setting – most things are fairly well laid out in the code and it is reasonably static by comparison. Though, it has been interesting to watch the evolution of legal systems throughout Latin America as they slowly shift to include more of what we in the States would consider to be a common law approach. Of course, in many respects we’re moving more and more towards a codified legal system, so perhaps we’ll meet in the middle. All of this is to say that maybe “younger” countries will catch up to us in tax complexity as they age or maybe we should consider pursuing the sweeping reforms that many countries enact (seemingly without much trepidation) on a fairly regular basis.
Second, I completely agree with your comments on the marginal utility argument. I particularly like your view on the societal benefits the wealthy can generate. While some may debate whether those benefits are a natural outcome of wealth accumulation, history is filled with corporate tycoons turned philanthropists and I suspect this trend will continue.
Regarding the relative percent of taxes paid by the wealthy, I wonder what the effects of wealth distribution, or the gap between the rich and the average, have on the percent of the population paying the majority of the total taxes by country. That is, does it take a smaller percentage of the population to pay the majority of the taxes in the US because that percent of the population is so much wealthier than the average taxpayer? So, setting aside for a moment the debate on whether the wealthy are paying enough or too much in taxes, can some of the difference between the US and Germany and France, in terms of what percent of taxpayers are paying the majority of the taxes, be accounted for by disparities in the number or magnitude of the wealthy in each country? If so, how significant is this effect?
Third, thank you for your brief analysis of alternate means of comparing the US to other countries. Admittedly, I find all of the comparisons to be fairly unsatisfying though, sadly, I can’t recall enough math or economics to suggest additional means of comparison.
I’m looking forward to your policy implications/recommendations write up. I don’t know where you’re finding the time to work on all of this, but I am thoroughly enjoying it.
Cheers,
Micah
Good stuff! Maybe you should be in politics!
Great write up!
I’m skeptical of the state and local tax numbers. My CA effective tax rate is much less than my Federal effective taxe rate and CA very high state taxes.
I never understood the argument for a flat tax rate vs just eliminating exemptions. Marginal tax rates are pretty simple. People would understand the tax system better if they computed their tax from the marginal tax rate table instead of the precomputed tax tables. (IIRC this is how it was on the original federal tax form.)
I’m not sure if the rich are paying their fair share, at least not rich investors. 15% on long term capital gains is a steal.
Hey David,
Thanks! I’m definitely glad you enjoyed it.
It’s true, I would imagine your effective tax rate in CA is much lower than your effective Federal tax rate (see the first chart on page 1). However, your local and state taxes are still almost certainly higher than your Federal taxes (particularly in CA). When you add your property tax, auto tax, your CA SDI, and most significantly your sales tax, I suspect you would find those add to more than your Federal tax. That said, it’s possible they may not, as the analysis here was for hypothetical families of four, not for any specific individual. Also, the analysis was based on the largest city in each state, and living in LA could be very different than living in San Bernardino.
Regarding the rich paying their fair share, see my reply to Micah — maybe, maybe not. But as to tax policy, I agree. I’m not advocating a flat tax (even if we wanted one, we probably couldn’t implement one, because of state and municipal differences — I may have a flat tax in the Czech Republic, but that’s in part because I don’t pay separate taxes to the state of Bohemia or the city of Prague).
Now that I have excavated all this data, I do intend to come forward with some proper suggestions. In the meantime, I just wanted to point out some immediate things that jumped out of the data: that we have a preposterously complex tax system, given that for the middle class we’re effectively extracting a flat tax; and the rich are paying more than most people probably think they are.
With respect to the specific point of the 15% long term capital gains, I’m not sure. I don’t know if I can extract from anywhere the distribution of sources of income for the wealthy. But capital gains would imply they’ve sold some capital. I imagine that the majority of their income in most years comes from interest and dividends, which would be taxed as income. And in fact, capital gains and capital gains taxes are part of AGI, so both are included (though buried) in the above analysis.
Thanks again for reading and commenting!
Chris