Republicans abolished federal income taxes for 60% of wage earners. It’s time they took political credit for doing so.
The Laffer curve stands for the proposition that in some cases (not all) revenues can be increased by reducing tax rates. This generally results when tax rates are so high and discouraging so much productive activity as a result that the rates are actually generating less revenue that they would if they were lower.
This has been demonstrated in the real world with capital gains taxes in recent decades. Since the 1960s, capital gains taxes have been cut 3 times and raised 3 times. Every time they have been cut, capital gains revenues have actually increased. Every time they have been raised, capital gains revenues have fallen.
Professor Laffer often explains this effect by saying that there are two rates when the revenues raised are always zero, a 0% tax rate and a 100% tax rate. But today I am going to explain a new breakthrough for the Laffer curve. I am going to explain how we can increase total federal income tax revenues with a zero percent federal income tax rate for a majority of Americans.
To see this, let’s start with where we are today with the federal income tax. According to the latest official data from the Congressional Budget Office (CBO), the top 1% of income earners pay 39% of all federal income taxes, while earning 19% of pretax income. The top 5% of income earners pay 61% of all federal income taxes, while earning 32% of pretax income. The top 10% of income earners pay 73% of all federal income taxes, while earning 42% of pretax income.
This has been the result of Reagan Republican supply-side tax policy from 1981 to 2007 (abandoned by Bush Treasury Secretary Hank Paulson in 2008, then economic policy guru for the administration). Reagan and his supply-siders cut tax rates for these upper income workers sharply during those years. The top federal income tax rate was 70% when Reagan entered office. It was 28% when he left in 1989. Blunders led by Bush I economic policy architect Richard Darman and by President Clinton and his economic policy team raised the top rate back up to 39%. But Bush II, originally committed to supply-side economics, reduced the top rate back to 35%, amidst much howling and braying by the Left.
The data above shows an enormous Laffer curve effect among the top income earners in response to these lower tax rates over the last 30 years. The much lower rates provided powerful incentives for these upper income earners to produce more because they were allowed to keep a much higher percentage of what they produced as a result. These upper income earners produced so much more that they actually ended up paying a higher nominal amount of taxes, even though those taxes were a lower percentage of their incomes.
Now let’s look at the other end of the income scale. According to the latest official CBO data, the bottom 40% of income earners don’t pay any federal income taxes as a group on net. Because of refundable income tax credits in the tax code, they actually receive payments from the income tax code on net equal to 3.6% of all federal income taxes. “Refundable” means if you don’t have enough income tax liability to receive the full amount of a credit, the government will send you a check for the difference. For example, suppose you have 3 children and consequently are entitled to $3,000 in federal child tax credits against your income taxes. But suppose you otherwise only owe $800 in federal income taxes. Because the federal child tax credit is refundable, you not only do not have to pay the $800, you actually get a check from the federal government for $2,200.
The middle 20% of income earners, the true middle class, pay only 4.4% of all federal income taxes, while earning 13.4% of pretax income. If you combine this middle 20% with the bottom 40%, then the bottom 60% of income earners together as a group on net pay only 0.8% of all federal income taxes. (The bottom 40% receive 3.6% of all federal income taxes while the middle 20% pay 4.4%, leaving the bottom 60% altogether paying only 0.8% on net).
This was also the result of Reagan Republican tax policy. Reagan actually proposed the first major refundable income tax credit, the Earned Income Tax Credit (EITC), in his historic 1972 testimony before the Senate Finance Committee. In that testimony, Reagan was leading the eventually successful fight against President Nixon’s proposed guaranteed national income, the Family Assistance Plan (FAP), which would have been a socialist nightmare. With his enormously successful welfare reforms in California in mind, Reagan called instead for focusing welfare assistance on the lowest income truly needy. He also called for workfare, requiring work in return for welfare for the able-bodied. Reagan also proposed the EITC to offset the burden of Social Security payroll taxes on the poor. After Nixon’s FAP was defeated, Reagan’s California welfare guru, Robert Carleson, was appointed national welfare commissioner, where he spread the Reagan welfare reforms to other states across the country.
As President, Reagan cut federal income tax rates for everyone across the board, including those at the low and middle-income levels. He indexed income tax rates for inflation, so that inflation would no longer drive low and moderate-income workers into higher rate brackets. He doubled the personal exemption, which helps lower income workers the most. Subsequently, the Republican majority Congress led by former House Speaker Newt Gingrich adopted a child tax credit of $500 that President Bush later doubled and made refundable, which again helped low and moderate income workers the most. President Bush also reduced the bottom tax rate by 33% to 10%, while reducing the top tax rate by only 13%. President Clinton contributed to this by expanding the EITC in 1993.
The end result of this is that the Republicans, primarily, abolished federal income taxes for what some call the working class, and almost abolished federal income taxes for the middle class, as the numbers discussed above show.
Last year, on the campaign trail, Obama told Joe the Plumber, “We’ve cut taxes a lot for folks like me who make a lot more than 250, but we haven’t given a break to folks who make less.” Obama repeated over and over during the campaign that the Republicans cut taxes only for the rich, while jilting the middle class. This was our first indication that Obama is not living in the real world, and that he has trouble telling the truth. Dangerous for America to have a President like that.
With the reality as described by the numbers above, which are for 2006, we can now see that Obama’s campaign theme of cutting income taxes for the middle class was a cynical manipulation of voters. Reagan and the Republicans had already cut income taxes for the middle class and working people to little or nothing. You can’t cut federal income taxes more for people who are already paying little or nothing.
As President, Obama’s tax policy involves adding or expanding still more refundable tax credits to the code, shoveling still more tax revenues to favored constituencies. As a result, he is mangling the income tax code into a socialist redistribution system, rather than a revenue-raising system. Obama has already expanded the EITC still further, and adopted a new, refundable, $400 per worker income tax credit, both of which were in his February stimulus package, among still more in the process of adoption. Those additional tax credits have probably now eliminated all federal income taxes completely for the bottom 60% as a group on net.
Many conservatives are deeply troubled by this. They fear that with the bottom 60% of income earners paying nothing in federal income taxes, this majority will see no reason not to vote for limitless spending burdens. But it would be politically disastrous for conservatives to campaign on increasing taxes on the bottom 60% because that is good tax and social policy. Steve Lonegan recently demonstrated this in the New Jersey gubernatorial primary, where he campaigned on a 3% state flat tax. This would be very good tax policy, but it would have resulted in a slight increase in state income taxes, about $300 per year on average, for the bottom half of income earners in New Jersey, who essentially pay no state income taxes now. His opponent Chris Christie pounded away in advertising on that point, and won easily. And this was in a Republican primary.
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