Thursday, July 16, 2009

The 0% Tax Rate Solution

The federal income tax code is now so mangled that we can probably increase federal revenues with a 0% income tax rate for a majority of Americans.

Long before President Barack Obama took office, the bottom 40% of income earners paid no federal income taxes. Because of refundable income tax credits like the Earned Income Tax Credit (EITC), in 2006 these bottom 40% as a group actually received net payments equal to 3.6% of total income tax revenues, according to the latest Congressional Budget Office data. The actual middle class, the middle 20% of income earners, pay only 4.4% of total federal income tax revenues. That means the bottom 60% together pay less than 1% of income tax revenues.

This actually resulted from Republican tax policy going all the way back to the EITC, which was first proposed by Ronald Reagan in his historic 1972 testimony before the Senate Finance Committee on the success of his welfare reforms as governor of California. Besides calling for workfare, Reagan proposed the EITC to offset the burden of Social Security payroll taxes on the poor. As president, Reagan cut and indexed income tax rates across the board and doubled the personal exemption. The Republican majority Congress, led by former House Speaker Newt Gingrich, adopted a child tax credit that President George W. Bush later expanded and made refundable, while also reducing the bottom tax rate by 33% to 10%.

President Bill Clinton expanded the EITC in 1993. But it was primarily Republicans who abolished federal income taxes for the working class and almost abolished them for the middle class. Now Mr. Obama has led enactment of a refundable $400 per worker income tax credit and other refundable credits, which probably leaves the bottom 60% paying nothing as a group on net.

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I find this hard to believe since everybody I know pays income tax. Since I actually pay income tax, does that mean I make more than 40% of Americans? Or more like I have less exemptions than they.

[Just supposing] I'm trying to look at it as a closed system where money is circulating from producers to consumers back to producers etc. The minority rich become rich because in general they're getting money from the majority poor (or middle-class). In other words, the poor are consuming the products of the rich. That's the way a capitalist society works (in my mind anyway).

But you don't want the poor to become too poor, otherwise they become a burden to society. You want them to be functional so they can continue to circulate money to keep the system running.

The problem is how to do this. How? By taking (taxing) the rich to supplement the poor. Like welfare? Which doesn't seem to be working too well. Or buy lowering taxes on the rich so that they can expand their business and provide jobs to the poor.

But one might ask how making the rich richer can make the poor richer too, when there's only so much money to go around. I think the idea is that it'll increase the velocity of money so it'll circulate better.

I don't know (obviously). But I think most people think of these things on one level and not as a system. If they think about it at all.

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