Fratto: That 47 Percent No Taxes—Another Closer Look

I’m a regular reader of David Leonhardt, the New York Times’ Economic Scene columnist. He frequently combats a lot of ignorance about economics generally, and the impact of economic policy, specifically. So I was anxious to read his column this week --Yes, 47% of Households Owe No Taxes. Look Closer.

I was disappointed.

In trying to put the 47% figure into context, Leonhardt instead took us further away from fully understanding the meaning and consequences of a U.S. system that disproportionately distributes the U.S. federal income tax burden.

In fact, Leonhardt is categorically wrong on the two “ideas” he attempts to debunk. Here’s what he wrote:

With Tax Day coming on Thursday, 47 percent has become shorthand for the notion that the wealthy face a much higher tax burden than they once did while growing numbers of Americans are effectively on the dole.

Neither one of those ideas is true. They rely on a cleverly selective reading of the facts. So does the 47 percent number.

Well, not quite. If we’re referring to the top 5% of incomes as “the wealthy” Leonhardt is demonstrably wrong. And while I won’t use his “on the dole” or “free rider” language, if Leonhardt is trying to knock down the “idea” that the top 50% is subsidizes (in part) the bottom 50%, he’s wrong again. And it doesn’t require any clever selection or reading of the facts. Let’s take them one-by-one.

“Wealthy face a much higher tax burden than they once did”. Leonhardt writes: “Over the last 30 years, rates have fallen more for the wealthy, and especially the very wealthy, than for any other group In fact.” This is undoubtedly true. It’s also misleading and without meaning. President Kennedy lowered the top rate from 90% to 71%.

Did high income earners actually fork over 90% of their income to Uncle Sam? No. In fact, over the decades the income tax rate has come down substantially as the federal government removed significant offsets used to shield certain types of income and expenditures from taxation. The lowered rate was a trade-off for exposing more income to taxation. That’s what the 1986 tax reform effort was all about.

At any rate, Leonhardt also appropriately refers to the tax burden, and in tax policy when we refer to the tax burden, we mean the relative share of taxes paid by certain income groups. By this measure, “the wealthy” clearly pay a substantially larger share of the income tax burden than they have in the past.

According to IRS data, in 1987 the top 5% of earners paid 43.26% of all federal income taxes; today, that group pays more than 60% of the tax burden. By contrast, the share of taxes paid by the bottom 50% of taxpayers has continually fallen to now be well under 3% of all income tax revenue today.

Percentages can be mind-numbing, so for reference, let’s talk cash: using round numbers, the top 50% of earners pay more than a $1 trillion dollars in federal income taxes; the bottom 50% pay about $35 billion.

If “wealthy” means the top 5% of incomes, what is “fair” for that group? Should they pay 70%? 80%? As Leonhardt concludes that taxes paid by this group should increase, their share of taxes will also increase. A progressive tax system is a tradition in the United States, but is a system this steeply progressive fair? Fair or not, it’s neither effective nor efficient -- and, at any rate, it’s not sustainable. After a while you simply run out of wealthy people to tax.

What about Leonhardt’s attempt to debunk the idea that “growing numbers of Americans are effectively on the dole”?

I’m not interested in making qualitative judgments about the Americans in the bottom income brackets – I don’t blame lower income people from receiving the benefits government directs to them. Whether our system of transfer payments, tax benefits, and other social spending programs is good or bad is a discussion for another day.

But there can be no doubt, the bottom 50% of Americans benefit from the taxes paid by the top 50%. Spending programs directed to the bottom 50% of Americans include cash assistance like Temporary Assistance to Needy Families (TANF), Medicaid, various food and nutrition programs, the earned income tax credit (EITC), subsidized housing, and numerous education subsidies.

It also includes the Supplemental Security Income program and the Medicare Part D prescription drugs – programs funded not from Social Security or Medicare payroll taxes, but rather from general revenues.

In total, the cost of these programs is measured in the hundreds of billions of dollars. In 2009, Medicaid alone totaled more than $250 billion; food and nutrition assistance, more than $70 billion; Section 8 rental assistance, more than $25 billion; EITC and the Child Tax Credit combine for about $65 billion, etc.

When you subtract the roughly $35 billion in taxes paid by the bottom 50%, where do all the other funds come from? Well a lot from the top 50%, some tariff revenue, corporate taxes (which are, of course, paid indirectly by people), and about a trillion and a half dollars in borrowing (on which we pay interest).

Everyone in the bottom 50% would rather find themselves in the top 50%, and with the usual labor mobility in America, a large proportion of them will get there. Nonetheless, on a pure cash basis, it’s hard to make a case that people in the bottom 50% are somehow being cheated by the tax code.

And this group is, in fact, growing. The number tax filers with no net tax liability has grown steadily, and the benefits extended to this group are also increasing – most recently by the huge expansion of Medicaid and health subsidies in the health reform bill.

But Leonhardt eventually settles into his main point: the bottom 50% actually do pay taxes – payroll taxes. True enough. Lower incomes do in fact pay payroll taxes, and Leonhardt notes and then attempts to dismiss the argument why this metric should be discarded:

I realize that it’s possible to argue that payroll taxes should be excluded from the discussion because they pay for benefits — Social Security and Medicare — that people receive on the back end. But that argument doesn’t seem very persuasive.

Why, he asks and answers?

People do not receive benefits equal to the payroll taxes they paid. Those who die at age 70 will receive much less in Social Security and Medicare than they paid in taxes. Those who die at 95 will probably get much more.

First, it doesn’t take a genius to see that the second two sentences, taken together, contradict the first. Some people don’t live long enough to recoup their investment in Social Security, while others collect more than their share.

On average, it balances out, and people do receive benefits about equal to their Social Security payroll taxes. (I’ll be the first to note that that’s an awful return on a lifetime of savings, but we’ll also save Social Security reform for another day as well.) Furthermore, half the Social Security tax -- at least for the workers Leonhardt singles out – are paid by the employer.

Second, Medicare, it should be remembered, is an insurance program, and the hope of any insurance program is that you avoid recouping your investment – at least in dollar terms. To recoup your Medicare “investment” you probably have to get sick. But what you do get is peace of mind, and that’s an incredibly valuable benefit to those with less means than it is to the wealthy.

Finally, Leonhardt takes a swipe at commentators on this subject (“radio hosts”) – that their views are biased because they may be wealthy. Kind of a cheap shot, I think. But for the record, I am firmly in the upper portion of the income distribution. I wasn’t always in this group – I had to work up to it. And if I work really hard, I may even earn as much as a New York Times columnist. But I promise not hold Leonhardt’s income against him.

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Tony Fratto is a CNBC on-air contributor and most recently served as Deputy Assistant to the President and Deputy Press Secretary for the Bush Administration.