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Harris Sherline: Is the U.S. Income Tax System Fair?

Here are the facts about who actually pays the most — and the least

There has been a lot of talk lately about drastically changing the nation’s income tax system, including getting rid of the Internal Revenue Service. Many people feel this is long overdue, while others believe such a dramatic change is too extreme and favor a general overhaul of the existing tax laws. Still others like things the way they are and prefer that nothing be done at all.

Before deciding whether the income tax and the IRS should be scrapped, we should also consider whether the present tax system is “fair” and, if not, what would be more equitable. Although arguments about this subject have raged back and forth for years, generally focusing on making the “rich” pay their “fair share,” we rarely hear specific facts about who actually pays most of the income tax, or the least.

The federal income tax, currently as high as 35 percent of “taxable income,” is increased by as much as 11 percent in state and local income taxes, plus another 6.2 percent and 1.45 percent in Social Security and Medicare taxes, which makes the total tax burden for some taxpayers nearly 54 percent, not including excise, sales and property taxes, along with a host of other taxes, assessments and fees too numerous to mention. By contrast, medieval serfs were required to give only one-third of their production to the lord of the manor, and they were considered slaves.

While those who have lower incomes pay the least, with tax rates that range from zero to 15 percent, they are also subject to federal payroll taxes of 7.65 percent, in addition to various state and local payroll taxes.

Because the same income is frequently taxed more than once, the effective cumulative tax rates are often much higher than most people realize. A simple analysis illustrates the point.

If you track $1,000 of corporate profits to a shareholder, the end result might be something like the following. First, at the corporate level, the $1,000 may be taxed at about 35 percent. That leaves $650 available for dividend distribution. Those shareholders who receive a dividend and are in the top tax bracket would pay 35 percent in federal income tax on the $650 dividend income (married, filing jointly), leaving $423 to spend or save. If that money is saved and becomes part of the taxpayer’s estate, and assuming the estate is taxed at the current maximum rate of 35 percent, it would be reduced by another $148 in federal estate taxes, leaving a balance of only $275.

Thus, $1,000 in corporate earnings, after passing through three levels of taxation, could conceivably end up being whittled down to $275. The original $1,000 of corporate profit would have been assessed a total of $725 in taxes, or a whopping 72.5 percent. Is that the “fair share” that many politicians keep saying the “rich” should pay?

Facts generally don’t seem to matter much in these highly politicized arguments, but to properly frame the discussion, the following information (courtesy of IRS statistical data) should be considered: Only half of all taxpayers pay 96.54 percent of the income tax (federal). Putting it another way, almost half of all wage earners pay no income tax at all.

» The top 1 percent of wage earners (“the rich”) pay more than one-third (34.27 percent) of the total federal income taxes collected.

» The top 5 percent of wage earners (“the rich”) pay more than half (54.36 percent) of all federal income taxes.

» The top 10 percent of wage earners (“the rich”) pay nearly two-thirds (65.84 percent) of all income taxes.

» The top 25 percent of wage earners (“the rich”?) pay nearly 84 percent of the total federal income taxes received.

And what percentage of all the income in the United States is earned by these groups?

» The top 1 percent earn 16.77 percent of all income.

» The top 5 percent earn 31.18 percent of the total income.

» The top 10 percent earn 42.36 percent of the total income.

» The top 25 percent earn 64.86 percent of the total income.

So, although only 1 percent earn 16.77 percent of all the income, they also pay more than one-third (34.27 percent) of the total income taxes collected. The top 5 percent earn a little more than 31 percent of all the income but pay more than half (54.36 percent) of the nation’s total income tax bill. And, while 25 percent earn about 65 percent of all the income, they pay almost 84 percent of the total income taxes.

It’s clear that the income tax burden is heavily skewed against those with higher incomes, some would say punitive, while almost half the filers pay no income tax at all.

Is this the “fair share” that people keep talking about? Just how “fair” should it be? Should the top 5 percent or 10 percent of the wage earners pay 80 percent of the income taxes? Or 90 percent? And is it “fair” that nearly half of all wage earners pay no income tax at all?

When the 16th Amendment to the Constitution established the federal income tax in 1913, the intent was to tax only the very rich. Rates began at 1 percent and increased to 7 percent for taxpayers with income in excess of $500,000 (more than $10 million in today’s dollars). Less than 1 percent of the population paid any income tax at all, compared with nearly 50 percent of taxpayers paying as much as 35 percent of their taxable income today.

Many of those who argue that “the rich” should pay their “fair share” of the income tax burden would no doubt be shocked to realize that they are probably included in the definition of “rich,” if the adjusted gross income on their tax returns is just a little more than $57,000. So, when many politicians talk about the “rich paying their fair share,” they literally mean everyone whose income is in the $50,000 range. The last time I looked, these taxpayers were a long way from being rich.

Everyone would undoubtedly agree that taxes are necessary to operate the government, provide police protection, defend the nation, build roads, fund essential programs such as education and health care, etc., etc., so the issue is really how to do it, and this invariably comes down to the question of whose ox should be gored, not what is “fair.”

We may have reached the point where changing our system of taxation is so long overdue that something more than tinkering is necessary. Three alternatives have been proposed: the flat tax, a national sales tax and ad valorem taxes. Politics aside (if that’s possible), perhaps we should examine these options more closely before voting to scrap or not to scrap the income tax and the IRS along with it.

— Harris R. Sherline is a retired CPA and former chairman and CEO of Santa Ynez Valley Hospital who as lived in Santa Barbara County for more than 30 years. He stays active writing opinion columns and his blog, Opinionfest.com.

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