The question is often asked: Do the rich pay their “fair share” in taxes? It’s never particularly clear what the rich currently pay, nor is it clear what share of taxes is fair for them to pay. A good place to start would be to determine exactly what high-income earners currently pay. Estimates from Congress’s Joint Committee on Taxation and recently highlighted in the Wall Street Journal make it abundantly clear that high-income earners to pay a disproportion share of taxes in relation to their income in the U.S. According to the Journal, taxpayers with income over $100,000 a year earn 60 percent of the nation’s income and pay 95.2 percent of the income taxes in the United States. If we consider all federal taxes paid (income, payroll, and excise taxes), those making over $100,000 (a little over 20 percent of taxpayers) pay for 75.7 percent of total federal taxes (this excludes the burden on corporate and investment taxes). If we break this down further (as in the chart below), the level of progressivity in the tax code becomes even clearer. Those making over $200,000 comprise just over 5 percent of the nation’s taxpayers, earn 32.3 percent of the income, but pay 46.7 percent of total federal taxes and 70 percent of federal income taxes. As we move down the income scale the ratio of taxes to income decreases. Those making between $100,000 and $200,000 a year make up 15.6 percent of all taxpayers, earn 27.7 percent of income, pay 29 percent of total federal taxes and 25.2 percent of federal income taxes. Those between $50,000 and $100,000 make up about a quarter of the country, earn 23.6 percent of all income, pay 18.6 percent of federal taxes and 11.3 percent of federal income taxes. Finally, taxpayers making less than $50,000 a year represent about half of the country, earn 16.4 percent of the nation’s income, pay 5.6 percent of taxes and have a negative share of income taxes because they receive more back then they pay out ( largely due to refundable tax credit programs ). So, there is the information on who pays what. Now a question for you: do the rich pay their fair share?
We recently outlined a bill introduced by Senator Patty Murray (D-WA), which would expand the EITC and pay for it in part by further limiting the deduction for executive compensation. The Senator believes that the ability for corporations to fully deduct performance-based compensation represents a massive loophole, and should be limited, much like the tax code currently limits the deductibility of cash-based compensation as a way to tax corporations more. Not only is this bad tax policy, but it is misleading to call the current tax treatment of performance-based compensation a loophole. In fact, current treatment of cash-based compensation is more of an anti-loophole that overly restricts how much a corporation can deduct in business expenses. A neutral tax code that properly defines business income would place no restriction on how much a business can deduct in compensation. Down to the basics, the federal corporate income tax is meant to tax corporate profits in order to raise revenue for the federal government. Corporate profits are defined as revenues minus costs such as compensation (executive or otherwise), raw materials, and state and local taxes. Any tax system that does not allow businesses to fully deduct their business expenses for the calculation of their taxable income, overstates income, taxes businesses on losses and artificially inflates their tax bill. There are many places in which our tax code does not allow corporations to fully deduct their business costs. One of these places is in regard to executive compensation. In 1993, a law was passed as part of President Clinton’s first budget that limited the amount corporations can deduct in cash-based compensation to $1 million. In other words, the IRS only considers the first $1 million in executive pay to be a business expense, while to the corporation every dollar of compensation is an expense. However, the limitation in current law does not apply to what is called “performance-based” pay. This pay usually means compensation in stock options, which is tied to how well a company and thereby the CEO is doing. By design, the bill created an incentive for corporations to shift from paying its executives in cash to stock options due to the fact that they could recover the full cost of that compensation as a business expense. The remaining ability for corporations to deduct the full cost of compensation in stock options has been characterized as a large “loophole.” The latest such characterization comes from Vox.com’s Danielle Kurtzleben, who argues that this is the “biggest loophole ever,” and it cost the government $7.5 billion in revenue in 2012. This characterization is extremely misleading and is a misunderstanding of what the corporate income tax is: a tax on corporate profits. The limitation created in 1993 can be thought of as an “anti-loophole:” a provision that overly restricts the amount businesses can deduct in expenses. The ability for corporations to deduct the full cost of performance-based compensation is where the law treats business expenses properly. Tax treatment of cash-based compensation should be brought back in line with the treatment of performance-based compensation. This would correct a major flaw in the corporate tax code and move it closer to properly defining profits. It is also important to remember that the full deduction for compensation—performance-based or otherwise—is in no way a tax shelter for this money. Although the corporation deducts the compensation from its taxable income, the CEO still has to pay income taxes on it. Someone is still getting taxed. We do not all have to agree on whether executives are being paid too much, or are being taxed too little. However, everyone should understand that trying to limit their pay through the corporate tax code is bad policy. The corporate income tax is meant to raise revenue for the U.S. government, not to dictate who is paid what.
Yesterday was Tax Day, and former Defense Secretary Donald Rumsfeld shared a letter he sent to the IRS with his Twitter followers . Rumsfeld said he did his best to fill out his taxes but says he’s not sure he got it right, due to the complexity of the tax code: The tax code is so complex and the forms are so complicated, that I know I cannot have any confidence that I know what is being requested and therefore I cannot and do not know, and I suspect a great many Americans cannot know, whether or not their tax returns are accurate. Rumsfeld says that he hopes that “the U.S. government will simplify the U.S. tax code so that those citizens who sincerely want to pay what they should, are able to do it right, and know that they have done it right.” Amen. Apparently Rumsfeld sends a similar letter each year . It reminded me of a similar letter President Franklin Roosevelt sent then-Internal Revenue Commissioner Guy Helvering on March 15, 1938 (taxes were due March 15 each year until 1955, when it was moved to April 15). FDR gave up trying to calculate his income tax himself and instead sent the figures to Helvering asking him to calculate it for him and let him know how much was due: As this is a problem in higher mathematics, may I ask that the Bureau let me know the amount of the balance due? Helvering’s reply, if he gave one, has not been kept. I imagine an IRS response today to such a request would not be very obliging.