President and Media Say Tax Rates Too Low

June 4th, 2011 by Lee Eldridge

President Obama“I say that, at a time when the tax burden on the wealthy is at its lowest level in half a century, the most fortunate among us can afford to pay a little more.” — President Obama, April 13, 2011

A few weeks ago I posted an article about tax revenues as a percentage of GDP. My point at the time was to explain how tax rates have had little effect on tax revenues generated. Whether tax rates have been high or low, we have typically generated about the same tax revenues as a proportion of GDP. The great truth is that it’s the economy that drives tax revenues, NOT tax rates. The higher the GDP, the higher the tax revenues.

The President and his partners in the media are making the claim that, as Jake Tapper from ABC News puts it, “the U.S. has the lowest tax rate as a percentage of GDP since the 1950s.” This claim in not only inaccurate, it’s intentionally misleading. The message is that our tax rates are too low, and that’s why we are now collecting less tax revenue as a percentage of GDP.

The accurate statement would be that “tax revenues” as a percentage of GDP are at their lowest since 1950. This statement carries a different meaning than saying “tax rates”. But the truthful statement doesn’t fit the President’s agenda, or the media’s agenda, of raising taxes on the “rich”.

So let’s look at the facts.

The post-World War II average of tax revenues as a percentage of GDP is 17.8%. So given the comments made by the media and the President, you would expect during the Bush years that we must have been collecting less than this. Here are the numbers:

2001: 19.5%
2002: 17.6%
2003: 16.2%
2004: 16.1%
2005: 17.3%
2006: 18.2%
2007: 18.5%
2008: 17.5%
2009: 14.9%
2010: 14.9%

From 2001-08 (the Bush years), that’s an average of 17.6% of GDP, roughly equivalent to the 60 year average of 17.8%.

So what do these numbers show us? That during a time of lower tax rates compared to our historical average, we have still been collecting the same percentage of tax revenues compared to GDP that we have collected for the past 60 years.

Also, when you look at these numbers, you see how the numbers decline during and following the last recession (the one that Bush inherited in the early 2000s), and then grow as our economy continues to recover and expand. By 2007 under the Bush tax rates, we were well above the post-World War II average collecting 18.5% of GDP in tax revenues. Then as we head into this latest recession, the numbers begin to decline again. But this time they fall more dramatically. Why? Because the economy fell more dramatically.

The changing tax revenues over time are the result of fluctuations in the economy, not tax rates. Raising or lowering the tax rates will not have a substantial effect on tax revenues generated as a percentage of GDP. Want to increase tax revenues? Fix the economy.

Taxing the Rich Makes Tax Revenues More Volatile
I had already been thinking about writing this post (I have a long list of potential posts rattling around in my brain that I never get around to writing), but this morning I read an interesting article on IBD about this very subject. (Read the article here.) They expand on these facts, and explain how shifting more of the tax burden to the rich and to business only makes tax revenues more volatile during a recession. Here’s what I found most interesting in the article:

It’s not that we’re taxed too little, but that the tax burden is heavily skewed toward an increasingly narrow, volatile tax base — businesses and the “rich.”

Together, income taxes paid by corporations and the wealthiest 5% of Americans account for a stunning 41% of all federal revenues. At the other end of the spectrum, almost half of Americans pay no federal income tax at all.

As a result, federal revenues now swing more wildly between boom and bust. Here’s why:

Although liberals will never admit it, the rich typically suffer big income losses during recessions.

An IBD analysis of Internal Revenue Service data shows that the total adjusted gross income of the top 5% of taxpayers fell 11% from 2007 to 2008 (the most recent year for which the IRS has data), while the bottom half of taxpayers saw their AGI decline just 0.3%.

As a result, tax payments from the top 5% plunged $70.6 billion — accounting for 84% of the revenue loss over those two years, the IRS data show.

And as corporate profits dry up in a downturn, so do corporate tax payments.

Broadening the tax base would minimize this whipsaw effect, as evidenced by the fact that even as income tax revenues plunged, the far more broad-based payroll taxes — paid by every worker — climbed slightly.

If Democrats have their way, the federal tax burden will be even more skewed toward the “rich,” which will, in turn, make federal revenues still more volatile.

The moral of the story? We badly need tax reform, not increases in tax rates on the wealthy and on business. Both the Obama debt commission and Paul Ryan have suggested lowering the tax rates and eliminating deductions in order to broaden the base of tax payers. Personally, I don’t think that goes nearly far enough. Our tax system needs to be completely overhauled. But don’t hold your breath.

Note: Tax facts found here.

4 Responses to “President and Media Say Tax Rates Too Low”

  1. Lee Eldridge Says:

    BTW — I think the use of the word “burden” is interesting. And I suppose it’s how you define “burden”. With every significant tax cut (Kennedy / Reagan / GWB), we have actually shifted a greater percentage of the tax burden to the rich. While the tax rate may have gone down on the rich, they have been responsible for a larger percentage of the total tax revenue paid.

    Here’s an example of how it breaks down:

    20 people go out for a nice dinner — a steak and a couple drinks. The bill comes and it’s $1000. If you split it up evenly, that’s $50 each. But instead they take a vote, and decide that everyone should pay according to their ability to pay.

    One person pays $410.

    Nine people pay the remaining $590 (averages out to about $65 each).

    The remaining ten pay nothing.

    That’s how our tax code works.

    I do think we have to have a progressive tax code where the rich pay a higher rate than the middle class. But at what point does this become self defeating? I think we’ve gone well past that point already.

  2. Bruce Grobman Says:

    The statistics do seem compelling. Raising tax rates does not increase revenue!
    Also, the tax code is a labyrinthine collection of documents designed by those able to afford the best tax lawyers and accountants. It has become an industry in and of itself!
    Let’s throw it out and replace it with a single paragraph: Individuals and corporations pay a flat 20% of their earnings above $25,000. Period. No exceptions and no deductions.
    This would result in,for example, my wife and I paying approximately what we do at present, with our $50,000 2person exclusion and nothing else!

  3. Lee Eldridge Says:

    Bruce, I like the way you think. Taxes shouldn’t be rocket science. I have some thoughts on a new tax system I hope to find the time to write about soon. Thanks for reading!

  4. Frank Says:

    I’m with Bruce.