“The taxpayer: that’s someone who works for the federal government
but doesn’t have to take a civil service examination.”
— President Ronald Reagan

2025 should be an “interesting” year when it comes to debate over federal taxes.

The 2017 tax cuts are set to expire, and politicians will need to wrestle with decisions about who pays what and how much.

Add already large budget deficits to the equation and conversations get even more complicated.

You just can’t keep spending more money than you take in. One constant in tax debates seems to be that “someone else” should pay more, but not me.

And cries about “the rich not paying their fair share” are popular mantas of politicians. There are even some very rich people who agree.

Warren Buffett has noted that “the wealthy are undertaxed relative to the general population.” Microsoft founder Bill Gates has declared, “I need to pay higher taxes. The government should require people in my position to pay significantly higher taxes.”

But as former Sen. Bob Packwood, R-Oregon, commented, “You can tax the rich all you want. The problem is there aren’t enough of the rich.”

So, I thought it might be interesting to offer the following facts, courtesy of the Tax Foundation’s analysis of 2022 IRS data so you can think about this as the debate begins.

Note that the 80-year-old Tax Foundation is the world’s largest leading nonpartisan tax policy 501(c)(3) nonprofit organization.

• The top 1%, which includes 1.5 million returns with adjusted gross income (AGI) above $663,000 made up 22.4% of the country’s total reported income, yet their share of income taxes paid was nearly double that at 40.4%. Their average federal tax rate was 26.1%.
• For the top 1% to 5%, there were about 6.2 million returns with AGI of $262,000 to $663,000. These people had 15.9% of total earnings, while contributing 20.6% of income tax revenue, with an average tax rate of 18.8%.
• Between the top 5% to 10%, there were 7.7 million returns with AGI of $179,000 to $262,000. Their share of earnings was 11.1%, which almost matched their share of taxes paid of 11%. Average tax rate was 14.7%.
• The next 23.1 million returns were for incomes of at least $100,000. Share of income was 20.5% with share of tax at 15.2% and an average tax rate 10.7%.
• There were 38.5 million returns for taxpayers with earnings of at least $50,000, representing the top 25% to 50%. Share of income was 18.6%, with a share of tax at 9.9% at an average tax rate of 7.7%.
• The bottom 50% equaled about 76.9 million returns with earnings under $50,000. Share of income 11.5%, share of tax just 3%, with an average tax rate of 3.7%.

Add all of this up, and the top quarter of earners reported 69.9% of all income in 2022 but paid 87.2% of all income taxes.

So, despite the 2017 reform’s modest individual tax rate cuts, the tax code continues to soak the upper middle class as well as top earners. And this doesn’t include state and local taxes.

Two other notes: First, these figures overstate the actual income tax burden shouldered by the bottom 50% because “refundable” credits paid to those with no tax liability are treated as spending and aren’t reflected in the IRS numbers.

Second, these numbers only cover income taxes and not payroll taxes paid by workers with lower earnings. But, according to the Tax Foundation, although payroll taxes somewhat modify the progressivity of the overall tax code, the basic picture doesn’t change.

Given the facts, it seems hard to pretend that the top 1% (“the rich”) are somehow getting a free ride. Yet politicians continue to cry that “the rich” aren’t paying their “fair share.”

With just 1% of taxpayers shouldering more than 40% of income taxes — and the top 5% paying more than 60% of the bill — the facts just don’t match the rhetoric.

And my personal experience serving as financial adviser to folks who were largely successful professionals (who worked very long hours) was consistent with these findings.

In fact, most paid more than one-third of their earnings to Uncle Sam, often more than 40% when including payroll taxes and more than half when adding sales and property taxes.

Despite claims of big earnings somehow paying very little tax, I didn’t see this among our clients.

Some of the most glaring exceptions seem to be with ultra-high-income individuals, in which most money is unearned (investment) and not earnings from work. The wealthy often have no work income, but rather dividends and interest from investments.

Qualified dividends are taxed at a maximum rate of 20% (versus a top rate of 37% for ordinary income) and municipal bonds are a favorite with tax-free income.

A similar (and often reported example) example is hedge fund and private equity managers. There’s a loophole called “carried interest,” also known as a “profits interest.” It allows the fund’s managers a share of fund profits, which is taxed at 20% compared to the 37% top rate for ordinary income.

That, my friends, is a big rate difference — and on lots of money.

Congress’ experts project that, over the next 10 years, taxing carried interest at ordinary rates would raise more than $14 billion. And it would certainly help eliminate claims that the rich don’t pay their fair share.

To be fair, however, many of the wealthiest Americans are huge philanthropists and give massive amounts to charity, which reduces their tax bills.

The same tax rules for charitable donations apply to all of us, but few of us can afford to make huge donations and still pay our bills.

There is also the issue of estate taxes, clearly a way to tax the rich as only estates worth more than $13.6 million (double that for married taxpayers) are taxable.

Yet it’s estimated that a little more than 7,000 estate tax returns will be filed for people who died in 2023, of which about 4,000 will be taxable with taxes due of about $23 million.

The 4,000 returns represent less than 0.2% of the 2.8 million people expected to die in the year.

The estate tax raised about $24 billion in 2001 from a little more than 50,000 taxable returns. So even with the dramatic increase in exemptions, the total tax take is almost unchanged.

When you consider the significant impact estate taxes can have on family farms, ranches and small business (which are usually very illiquid) along with the costs for legal/tax planning for high net worth families, you have to wonder if this tax is really worth the effort.

It’s worth noting that if the 2017 tax laws are allowed to expire in 2025, estate tax exemptions would be cut almost in half, with more estates subject to tax and more taxes raised.

You will note that I have not commented on corporate taxes, but rather focused on taxes you and I pay.

The federal corporate tax rate now stands at 21% compared to 35% in 2016 and an average rate of 32% from 1909 until 1924. It hit an all-time high of 52% in 1968 and a low of just 1% at its 1910 inception.

Many argue that big companies don’t pay their fair share. But I am reminded that taxes paid by companies are a cost of doing business, which almost certainly is passed on to consumers who buy their products.

So, ultimately, it can be argued that individuals wind up paying these, too.

Finding the right tax policy will be challenging. And I am reminded of the Laffer curve, a bell-shaped economic model that shows the relationship between tax rates and the amount of revenue the government collects in taxes.

The curve is based on the idea that tax rates of 0% and 100% (too low or too high) can’t yield government revenue.

By example, if a shopkeeper’s product is priced too low, the shop loses money. If the product is priced too high, no one will buy it, and the shopkeeper loses money.

The optimal price (or tax rate) is somewhere between the two extremes. Many economists argue the same for tax rates — with lower rates inspiring greater productivity and ultimately more total tax revenue, while higher taxes discourage taxable activity that decreases total tax revenue.

Again, finding the right balance will be important.

I’ll leave with a joke from Jay Leno to lighten the conversation: “Worried about an IRS audit? Avoid what’s called a red flag. That’s something the IRS always looks for. For example, say you have some money left in your bank account after paying taxes. That’s a red flag.”

I guess Reagan was right. We all do indeed work for the government.