A Little Secret About Our Tax System

Dr. Kevin Christ

By: Dr. Kevin Christ - Associate Professor of Economics, Rose-Hulman Institute of Technology

Category: Economy

Lost in the tumultuous debates over healthcare, energy policy and fiscal deficits is an interesting little secret about our federal tax system. Increasingly over the last generation, the proportion of our population that actually pays federal income taxes has been going down. As a result, that smaller portion has ended up paying an increasingly larger share of total federal taxes.

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In 2007, only 67 percent of federal income tax returns actually reported taxable income. In 1986, this percentage was 82 percent and the trend has been consistently downward since then. Such a narrowing of the tax base means that the burden of financing the federal government falls more heavily on an increasingly smaller subset of the population.

For example, in 2007, the top one percent of income earners - admittedly some very wealthy people - earned 24 percent of the nation's income, but were responsible for 40 percent of the federal government's income tax revenue. In 1986, the top one percent of income earners accounted for only 25 percent of income tax revenue. In fact, in 2007 the share of the tax burden borne by the top one percent exceeded the share paid by the bottom 95 percent of taxpayers combined.

One could look at these numbers and easily argue that such trends are the natural outcome of an economic system in which the wealthy have done exceptionally well, and that certainly is part of what has been going on. After all, some might say, those who have benefited most from our economy's expansion over the past 30 years should pay the most.

But our tax code also has seen a proliferation of adjustments to incomes, allowable deductions and new tax credits that have contributed to the narrowing of the tax base. In 2007, almost one in five returns from people with $30,000 to $50,000 income had no taxable income.

This trend toward a narrower tax base is mostly unknown because it has occurred during an era famous for the lowering of top marginal rates. This has made it easy to conclude that changes in our tax system over the past 25 years have been unambiguously good for top income earners. It also has made it easy to suggest that the answer to any financing dilemma our federal government now faces is simply to reverse course and start raising top marginal rates.

Like many economics professors, I take higher future taxes as a foregone conclusion because of our current policies and because of long-term demographic issues related to Social Security and healthcare. We've known about the looming crises in these programs for a long time, and the current recession's impact on tax revenues and expenditures only brings the days of reckoning closer.

Thus the key question will not be "will we have higher taxes?" but "how will we manage our tax system so as to solve our fiscal challenges without doing too much damage to the economy?"

One alternative is to follow up on populist campaign rhetoric, ruling out any tax increases on large segments of our population and sharply increasing the progressivity of the federal tax structure so that even more of the burden is borne by those at the top of the income distribution. This approach appeals to most voters because most are not in those top brackets. But it also would continue the trend toward a narrower tax base.

As one who takes a very long-term view on social matters, I can't believe that such a trend is healthy for our country. Democracy is a participative sport. The financing burden of the services and benefits we bestow upon ourselves should be fairly AND broadly borne.

Most people already agree that some measure of progressivity is needed to satisfy social concerns over fairness. But if we could also agree that a narrowing tax base may not be healthy for our democracy in the long run, then discussions about how to broaden it fairly could proceed in a mature manner.

Alternatives to raising taxes only on the most wealthy will be less popular with voters, but a healthy democracy needs as many of its citizens as possible to understand the costs of government.

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