Friday, November 19, 2010

Libertarian Nonsense on Tax Policy

The article that I linked to above was published in a blog operated by a libertarian who is both a Senior Fellow at the libertarian Cato Institute and the Director of Undergraduate Instruction at Harvard. I thought that it would be interesting to get a libertarian perspective on tax policy from someone whose views were considered publishable by a distinguished libertarian who works in one of our elite universities.

I was really disappointed by the article. The rationale used to argue against a progressive tax system is typical of the arguments used by those without the benefit of an expensive education.

The article begins by telling us that the battle between the rich and poor has been going on for thousands of years and there is nothing new about the current battle. The poor will always be envious of the rich, and the poor will always be with us, so the battle over tax policy is boring and useless. He then provides us with an analysis of the issues which demonstrates either ignorance or duplicity. One of his tactics is to show that the rich pay a greater share of the federal income tax than the poor. This would be expected since those with more income are bound to pay more income taxes than those with less income. He also provides data to show that the share of taxes paid by the top income earners is larger than their share of income. This demonstrates only the obvious point that the federal income tax is progressive. Critics of the current income tax argue that it has become less progressive even as income inequality has increased. Nobody needs to be told that the income tax is progressive; critics want it to be more progressive.

Another problem with his analysis is that the income tax is not our only tax on income. Everyone with income under $105,000 pays 15.6% of their income to the payroll tax. Half of this is paid for by the employer, who deducts this cost from the wages that would otherwise be paid, and the remainder is paid by the individual. Since the tax is only applied to the first $105,000 it is very regressive. For example, the tax rate for someone who earns $210,000 is only 7.8%, and the tax rate get progressively lower as income increases. The payroll tax is just another income tax. The revenue goes into the same pot as income tax revenue, and it is spent on anything that government wants to use it for. Since payroll tax revenues exceed payouts to social security beneficiaries, the Treasury puts an IOU into the social security trust fund to cover the money that it has "borrowed" from the surplus payroll tax revenues. When the regressive payroll tax is combined with other regressive taxes, such as the sales tax, the total US tax system is only slightly progressive. It is very close to the flat tax system that many conservatives seem to like.

To make matters worse, we are told that we should not be punishing success with a progressive income tax that discourages wealth creation and hard work which has made us a great nation. A quick look at the history of the income tax will show that it was substantially more progressive prior to the Reagan tax cuts in the 80's and our economy did quite well compared to its growth rate in the last 30 years. In other words, there is no reason to believe that there is negative relationship between income tax progressiveness and wealth creation. If it were not for the progressive income tax, the combined tax rate for high income earners would be less than that of lower income earners.

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