Tax debates feature many myths
Published January 7, 2021
By John Hood
With Democrats in charge of the White House, and U.S. House, and (possibly as of this writing) the U.S. Senate, you can expect a push by left-wing activists and politicians to repeal some federal tax cuts enacted by the previously Republican Congress and signed by President Trump.
Here in North Carolina, pandemic-related concerns about state revenue collections, combined with fiscal demands from reelected Gov. Roy Cooper and the spending lobbies who support him, will produce a push by progressives to roll back tax cuts enacted by the Republican-led legislature.
During the ensuing debates, you’ll hear strident claims about our “regressive” tax system, or about many Americans paying no taxes at all, or about “closing loopholes” as a reasonable alternative to raising taxes.
You’ll hear these claims from left-wingers, right-wingers, and centrists, respectively. You should discount them. Each claim is wrong.
Is our tax system rigged in favor of the wealthy? Hardly. America’s tax system is either modestly or moderately progressive, depending on how you define the terms. “Progressive,” in this context, means that as your household income rises, the share of that income you pay in taxes — not just dollars paid — also goes up.
A regressive tax works the opposite way. The share of income paid in taxes goes down as one’s income goes up.
At the state and local level, most tax codes do skew somewhat regressive. That’s largely because most make use of sales taxes. Income saved is not subject to sales taxation, of course. And while most goods are taxed, many large service sectors such as medical care are not. Upper-income people tend to save more of their income, and spend more of it on untaxed services.
On the other hand, our federal tax code, even after the Bush-era and Trump-era tax changes, is rather progressive. It taxes the wealthy at much higher rates than the non-wealthy. If you combine the effects of all taxes — and you should, because we all pay taxes at multiple levels and because a great deal of federal money sloshes through states and localities — the federal effect predominates.
According to the latest modeling from the Institute on Taxation and Economic Policy, the lowest-income quintile (or 20%) of American households pays about 20% of their incomes to government at all levels, either directly or indirectly (by paying higher prices for taxed goods, for example). The second-lowest quintile pays 22%. The middle quintile pays 26%. The upper-middle quintile pays 28%. And the higher-income quintile pays 31%.
Folks, that’s a progressive tax system.
By the way, notice that even the lowest-income quintile pays 20% their incomes in taxes. That should put to rest conservative claims about legions of tax slackers. Granted, most of these households have no net liability for federal income taxes. Thanks to exclusions, deductions, and child-tax credits, they end up getting back more in refunds than taxes paid.
But federal income taxes are far from the whole story. Payroll taxes still hit them hard. As do sales and excise taxes, and tariffs, and property taxes (even if you rent, you bear much of actual cost of the property tax applied to your apartment or home).
Finally, let’s consider the frequent claim that “closing loopholes” is an attractive alternative to raising taxes. While there are some true special-interest giveaways embedded in federal and state tax codes, such as credits for certain investments or energy sectors, most “loopholes” turn out to be attempts, however clumsy, to define income properly so it can be fairly and efficiently taxed.
Governments shouldn’t be taxing gross incomes. They should be taxing net incomes. (In North Carolina, in fact, that is a constitutional requirement.) If a household or business spends money on raw materials, supplies, tools, equipment, training, marketing, or other expenses, the amount must be deducted before income tax is applied. If you think this is easy, ask an accountant.
Whatever tax policy our leaders choose, it should be based on a clear understanding of the facts — not erroneous but widely repeated myths.
John Hood is chairman of the John Locke Foundation and author of the forthcoming novel Mountain Folk, a historical fantasy set during the American Revolution.