Friday, April 13, 2007

Quick Response

In regard to a friend's inquiry as to why I consider "tax cuts for the rich" a frivolous political slogan, I'll throw together my thoughts as briefly as possible.

To lament "tax cuts for the rich," you're looking at it in a statistically inaccurate gross numerical sense. To see the true ramifications of the cuts, we need to accept a methodology that properly looks at proportionate numbers and see where the tax burden has been shifted. Like Hoover Institute economist Dr. Thomas Sowell said of the "tax cuts for the rich" mantra, it, like most political slogans, is based on "slippery words and sloppy thinking."

A preface to my arguments below: Lower income households had their tax rates cut under the GOP's 2001 and 2003 cuts. I personally know families who have benefited greatly from these measures. The reforms to the marriage penalty tax and child tax credit were extremely pro-family and pro-low income families.

Harvard Economics Professor N. Gregory Mankiw, Ph.D., posted this popular story that explains it in layman's terms on his blog.

As we attempt to maximize revenue while providing the lowest possible marginal rates across the board, and imperative economic parameter deals with the elasticity of taxable income. A recent empirical work by Gruber and Saez in The Journal of Public Economics elucidated that, "We estimate that this overall elasticity is primarily due to a very elastic response of taxable income for taxpayers who have incomes above $100,000 per year, who have an elasticity of 0.57, while for those with incomes below $100,000 per year the elasticity is less than one-third as large....We then derive optimal income tax structures using these elasticities. Our estimates suggest that the optimal system for most redistributional preferences consists of a large demogrant that is rapidly taxed away for low income taxpayers, with lower marginal rates at higher income levels."

From a purely quantitative view of raw numbers, the tax cuts disproportionately alleviated total tax revenue from higher income brackets, as it lowered all brackets, yet brought the top bracket closer to equilibrium. But when we're dealing with a progressive tax rate, the higher income earners will always have their taxes effected more than the lower income earners, as a percentage modification has higher numerical ramifications to a larger sum than a smaller sum.

However, if we examine the true impact of the tax reform, we find the tax burden was shifted more toward the high income earners. What this means is the "rich" pay for more public spending now than they did before tax rate cuts, and the low income earners pay less than they did before. According to the Congressional Budget Office, in 2000 (prior to the Bush rate cuts of 2001 and 2003), the highest 20% of income earners' tax dollars accounted for 81.2% of total federal revenues collected. Post tax cuts, in 2004, the highest 20% of income earners paid 85.3% of taxes collected. The second highest twenty percent went from paying 18.5% to 18.8%, while the middle twenty percent (the mighty middle class) dropped from contributing 5.7% to 4.7% of revenue. The second lowest twenty percent of income earners had a substantial benefit, seeing their portion of revenue go negative, meaning they receive more benefits than they pay in taxes, the change being from 1.1% to -0.9%. The lowest 20% went from -1.6% to -2.9%, an impressive number.

Cumulatively, the economic consensus and rational conclusion of the 2001 and 2003 cuts are twofold. First (and foremost), the economic stimulus provided by the cuts was substantial, and a contributing factor to the rapid economic growth of the past three years. This point wasn't contested. Second, the tax rate cuts positively impacted both the rich and the poor, modifying the elasticity to achieve maximum efficiency bracket allocation, while shifting the proportional burden farther toward the rich (even though they paid a lower dollar sum).

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