Tuesday, April 17, 2018

Some Economics for Tax Filing Day

U.S. tax returns and taxes owed for 2017 are due today, April 17. To commemorate, I offer some connections to five posts about federal income taxes from the last few years. Click on the links if you'd like additional discussion and sources for of any of these topics.

1) Should Individual Income Tax Returns be Public Information? (March 30, 2015)
"My guess is that if you asked Americans if their income taxes should be public information, the answers would mostly run the spectrum from "absolutely not" to "hell, no." But the idea that tax returns should be confidential and not subject to disclosure was not a specific part of US law until 1976. At earlier periods of US history, tax returns were sometimes published in newspapers or posted in public places. Today, Sweden, Finland, Iceland and Norway have at least some disclosure of tax returns--and since 2001 in Norway, you can obtain information on income and taxes paid through public records available online."

2) How much does the federal tax code reduce income inequality, in comparison with  social insurance spending and means-tested transfers? 

"The Distribution and Redistribution of US Income" (March 20, 2018) is based on a report from the Congressional Budget Office, "The Distribution of Household Income, 2014" (March 2018).

From the post: "The vertical axis of the figure is a Gini coefficient, which is a common way of summarizing the extent of inequality in a single number. A coefficient of 1 would mean that one person owned everything. A coefficient of zero would mean complete equality of incomes.

"In this figure, the top line shows the Gini coefficient based on market income, rising over time.

"The green line shows the Gini coefficient when social insurance benefits are included: Social Security, the value of Medicare benefits, unemployment insurance, and worker's compensation. Inequality is lower with such benefits taken into account, but still rising. It's worth remembering that almost all of this change is due to Social Security and Medicare, which is to say that it is a reduction in inequality because of benefits aimed at the elderly.

"The dashed line then adds a reduction in inequality due to means-tested transfers. As the report notes, the largest of these programs are "Medicaid and the Children’s Health Insurance Program (measured as the average cost to the government of providing those benefits); the Supplemental Nutrition Assistance Program (formerly known as the Food Stamp program); and Supplemental Security Income." What many people think of as "welfare," which used to be called Aid to Families with Dependent Children (AFDC) but for some years now has been called Temporary Assistance to Needy Families (TANF), is included here, but it's smaller than the programs just named.

"Finally, the bottom purple line also includes the reduction in inequality due to federal taxes, which here includes not just income taxes, but also payroll taxes, corporate taxes, and excise taxes."

3) "How Raising the Top Tax Rate Won't Much Alter Inequality" (October 23, 2015)

"Would a significant increase in the top income tax rate substantially alter income inequality?" William G. Gale, Melissa S. Kearney, and Peter R. Orszag ask the question in a very short paper of this title published by the Economic Studies Group at the Brookings Institution. Their perhaps surprising answer is "no."

The Gale, Kearney, Orszag paper is really just a set of illustrative calculations, based on the well-respected microsimulation model of the tax code used by the Tax Policy Center. Here's one of the calculations. Say that we raised the top income tax bracket (that is, the statutory income tax rate paid on a marginal dollar of income earned by those at the highest levels of income) from the current level of 39.6% up to 50%. Such a tax increase also looks substantial when expressed in absoluted dollars. By their calculations, "A larger hike in the top income tax rate to 50 percent would result, not surprisingly, in larger tax increases for the highest income households: an additional $6,464, on average, for households in the 95-99th percentiles of income and an additional $110,968, on average, for households in the top 1 percent. Households in the top 0.1 percent would experience an average income tax increase of $568,617."

In political terms, at least, this would be a very large boost. How much would it affect inequality of incomes? To answer this question, we need a shorthand way to measure inequality, and a standard tool for this purpose is the Gini coefficient. This measure runs from 0 in an economy where all incomes are equal to 1 in an economy where one person receives all income (a more detailed explanation is available here). For some context, the US distribution of income based on pre-tax income is .610. After current tax rates are applied, the after-tax distribution of income is .575.

If the top tax bracket rose to 50%, then according to the first round of Gale, Kearney, Orszag calculations, the Gini coefficient for after-tax income barely fall, dropping to .571. For comparison, the Gini coefficient for inequality of earnings back in 1979, before inequality had started rising, was .435. ... 

Raising the top income tax rate to 50% brings in less than $100 billion per year. Total federal spending in 2015 seems likely to run around $3.8 trillion. So it would be fair to say that raising the top income tax rate to 50% might increase total federal revenues by about 2%.

4) The top marginal income tax rates used to be a lot higher, but what share of taxpayers actually faced those high rates,, and much revenue did those higher rates actually collect?

Compare "Top Marginal Tax Rates: 1958 vs. 2009" (March 16, 2012), which is based on a short report by Daniel Baneman and Jim Nunns,"Income Tax Paid at Each Tax Rate, 1958-2009," published by the Tax Policy Center. The top statutory tax rate in 2009 was 35%; back in 1958, it was about 90%. What share of taxpayer returns paid these high rates? Across this time period, roughly 20% of all tax returns owed no tax, and so faced a marginal tax rate of zero percent. Back in 1958, the most common marginal tax brackets faced by taxpayers were in the 16-28% category; since the mid-1980s, the most common marginal tax rate faced by taxpayers has been the 1-16% category. Clearly, a very small proportion of taxpayers actually faced the very highest marginal tax rates.

How much revenue was raised by the highest marginal tax rates? Although the highest marginal tax rates applied to a tiny share of taxpayers, marginal tax rates above 39.7% collected more than 10% of income tax revenue back in the late 1950s. It's interesting to note that the share of income tax revenue collected by those in the top brackets for 2009--that is, the 29-35% category, is larger than the rate collected by all marginal tax brackets above 29% back in the 1960s.

5) Did you know "How Milton Friedman Helped to Invent Tax Withholding" (April 12, 2014)?

The great economist Milton Friedman--known for his pro-market, limited government views--helped to invent government withholding of income tax. It happened early in his career, when he was working for the U.S. government during World War II, and the top priority was to raise government revenues to support the war effort. Of course, the IRS opposed the idea at the time as impractical.