Sunday, January 1, 2012

Income Tax

There has been a lot written about income inequality in America with the common refrain that it the gap keeps widening towards more inequality. If you want to read up upon it a little more here is a report from the Congressional Budget Office - Trends in the Distribution of Household Income in the United States. One quote from the report:

"As a result of that uneven income growth, the distribution of after-tax household income in the United States was substantially more unequal in 2007 than in 1979."

There is a lot of good information and graphs in the report if you were so interested, but the basic summary is that the people at the top are doing much better than the people at the bottom. Reading the quote above I would like to focus in on the "after-tax" part of the statement. The reasons why someone makes a certain income can be complicated and difficult to analyze. Do they make the money because of hard work, luck, some combination or something else more negative like corruption? Do you believe that free-market capitlism works without any flaws or do you tend to disagree with such an approach? Those are all valid questions, but they aren't ones I want to try and address.

What I would like to write about is the role the government plays in shaping the income inequality gap in the US. It should seem obvious, but ff the US government decided to institute a flat tax of 9% as opposed to the current top marginal tax rate of 35% then people making a lot of money would have a much lower tax bill.

What is amazing about the history of marginal tax rate have been the amazing swings in %s and brackets. I've written and talked about this before, but back in WWII the top tax rate was 94%. Now it is down to 35%. As recently as 1981 the top tax rate was 70%. Also, the top tax bracket has gone from $80,700,000 (adjusted 2011 $$$) in 1936 down to $56,000 in 1988. It now currently sets at $379,150.

Anyway, a lot of the big changes happened during the 1980s. President Reagen was able to reduce the tax rate from 70% to 28% in 1988. That is amazing, and something that makes it easier to understand why a lot of Republicans deify Reagen. Could you imagine a Democrat trying to increase the top tax rate by even 4% much less the 42% swing Reagen was able to accomplish?

What does this mean in terms of the math? For someone who made a million dollars in 1980 they would have to pay $646K in taxes. However, if that person was lucky enough to make his or her million dollars now they would only have to pay $310K. Should we really be surprised that such a large change in tax code wouldn't also result in a large change in income inequality? It seems like simple math to me. By cutting the top marginal tax rate in half, the US government has made it much easier for very rich people to keep their own money. I will let others debate whether or not that is a good thing.

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