This being a presidential election year, taxes are topical all over again. As an added incentive for chattering about fiscal matters generally, there's a vigorously rising price tag for government programs--notably Medicare and Social Security--and questions about how to pay for the bills going forward. Indeed, the government budget is firmly in the red. As if that combination wasn't sufficiently provocative and challenging, the Bush tax cuts enacted a few years back are set to expire in 2010 unless Congress intervenes.
Tax policy, as always, will remain a widely discussed and passionately debated subject. Yet legislative changes of any substance are likely to be on hold until next year, once the new President and Congress have had a chance to settle in. But that doesn't alter the expectation that the tax code will be tweaked in 2009--perhaps dramatically.
Whatever comes, it's hard to imagine that the status quo will triumph. One example of the mounting political forces pushing for change came last November, when House Ways & Means Chairman Charles B. Rangel (D-NY) announced an ambitious bill that would, among other things, lower the corporate tax rate, eliminate the alternative minimum tax, provide new breaks for lower- and middle-income workers and raise rates on wealthy individuals. Even though Washington pundits claimed that the legislation had no chance of becoming law before the election, political opponents wasted no time attacking the details. One partisan columnist charged that Rangel's bill amounted to a "tax war" declaration.
But it's not about tax increases versus tax cuts, opined Gene Sperling when economic advisors to the presidential candidates convened a forum recently. "It's about smart tax policy," explained the former Clinton administration official who's currently working for Sen. Clinton's campaign.
An admirable view, although much depends on the details. On that point there was some dispute at the economic debate last November at the National Press Club in Washington. With most of the economic advisors to the leading presidential candidates in attendance, the conversation was as much about numbers and policy as it was about political posturing. In fact, no subject stirred more passion on the dais than taxes. Predictably, the panelists explored a range of priorities that generally tracked party lines. Sperling, for instance, made a case for letting the Bush tax cuts fade away in 2010. As he put it: "Should we be giving an extra $120 billion to people in the top 1 percent?"
Meanwhile, Rudolph Giuliani's advisor, Michael Boskin, a veteran of the Reagan and Bush I administrations, insisted that the economic notions favored by the Democratic candidates would only bring higher tax rates and "a European-style social welfare state."
All of which raises the question: What is the state of America's taxes? In particular, the just-give-me-the-facts-and-leave-the-politics-aside state of taxes? Although there can never be absolute clarity--much less agreement--on such a politically loaded matter, at least we can quote the historical facts. And as we head into the elections, a bit of perspective may be just the thing to counter some of the political spin that's sure to go into overdrive in the months ahead.
Let's start with the size of the tax bite relative to the U.S. economy. In 2006, the government collected tax revenues worth 18.4 percent of the $13 trillion-plus U.S. gross domestic product (GDP), according to the Congressional Budget Office (CBO). Depending on which candidate is giving the stump speech du jour, 18 percent may be labeled "excessive," "inadequate" or "just right." Statistically speaking, the figure looks middling, based on the past 45 years, as Chart 1 on page 57 shows.
An obvious follow-up question: What are the major sources for the tax revenue? The single-largest font of payments to the IRS comes from individuals, who collectively accounted for about 43 percent of the total revenues in 2006. That's about average since the early 1960s, as Chart No. 2 on this page illustrates.
The second-largest revenue source comes from social insurance taxes, which include paycheck deductions for Social Security and Medicare. In fact, these taxes have been rising as a share of total revenues. In 1962, social insurance taxes represented 17 percent of payments to the IRS; in 2006, the share had surged to almost 35 percent. In a not unrelated trend, corporate taxes over that span have fallen, from around 21 percent of the revenue pie in 1962 to just under 15 percent by 2006.
Collecting taxes is, of course, only a prelude to spending, which falls into two broad categories. On one side is what's known as discretionary spending, a domain that exists at the mercy of Congress by way of its annual budget negotiations. Everything from funding the defense department to launching a new government study on the sex life of the bald eagle is subject to approval each year.
Then there's mandatory spending, which comprises the other major chunk of government expenditures. As the name implies, this is recurring spending that's outside the usual budgetary review. Spending on Social Security and Medicare, for example, are mandatory programs. Although Congress ultimately decides the fate of mandatory spending, it tends to be enduring, in part because of politics and the fact that this slice of government largesse isn't subject to the whims of the annual appropriations process that dictate discretionary spending.
Comparing the two categories in terms of their respective shares of the economy reveals that discretionary has been losing ground to mandatory, as our third Chart No. 3 on page 59 shows. Mandatory programs have slowly but relentlessly come to dominate federal government spending. As a result, to the extent that Social Security, Medicare and other mandatory programs require more funding due to inflation and other causes, higher government spending is predestined.
Finally, there's the ever-contentious subject of tax rates for household incomes. We offer three perspectives: First up is the big picture as defined by the highest marginal income tax rates through time. As the fourth chart on page 59 depicts, the highest rate for households has wandered over the years. Back in the 1950s and 1960s, the wealthiest Americans were hit with rates as high as 91 percent. By that standard, the top rate of 35 percent for 2006 looked like a bargain.
Chart No. 5 on this page considers the total effective Federal tax rates for households in the upper levels in recent history. (Effective tax rates are calculated by dividing taxes by comprehensive household income.) The effective Federal tax rate for households in the top 1 percent, for example, was 31.1 percent in 2004--just barely below its average since 1979, according to the Tax Policy Center, a Washington think tank.
Finally, to round out our statistical tour of taxes, consider households at the bottom income levels. The effective Federal tax rates for the lowest quintile in 2004 was at its nadir for recent history, as you can see from Chart No. 6 on this page. The same is true for the middle quintile.
All of which leads to the question of what's in store for tax rates in 2009 and beyond? This much, at least, seems clear: Individuals will surely continue suffering the heavy lifting in terms of sending checks to the IRS. The great debate, once again, centers on the case for changing, if at all, the burden among the various income brackets. How progressive, in other words, should America's tax system be? We predict a tidal wave of politically motivated responses coming over the next nine months.
James Picerno (email@example.com) is senior writer at Wealth Manager.