“The rich aren’t paying their fair share!” is an oft-heard cri de coeur, and not just among progressives. Countless Americans hold the belief that high-income earners pay too little in taxes and that the government must step in to soak the rich.
Little do they know that the rich already shoulder a vastly disproportionate tax burden. According to a recent report from the Wall Street Journal, the US tax system remains very progressive, with the top 20 percent of income earners paying 87 percent of total income-tax revenue.
How did the US arrive at such a peculiar situation?
For slightly more than a century, the income tax has been a fixture of US fiscal policy. Channeling Progressive Era fervor, reformers in the early 20th century clamored for a tax that targeted the rich to address supposed wealth disparities that emerged during the Gilded Age.
Progressives got their wish in 1913, when the 16th Amendment was ratified, settling constitutional doubts about a national income tax. From the outset, those making under US$20,000 paid a 1 percent tax, while the super-rich making more than $500,000—a hefty sum at the time—paid a 7 percent rate.
Income-tax advocates sold the idea that it would only target the very rich, but like any other government program, it eventually expanded to cover a larger portion of the population. By 1917, the lowest tax bracket paid two percent, although the highest marginal rate had climbed to 67 percent.
After the consolidation of the welfare state throughout the New Deal and Great Society, the income tax became part and parcel of US fiscal policy. From the end of World War II to the 1980s, spendthrift politicians justified the income tax as a means to raise revenue for the massive federal bureaucracy they promoted. The political establishment tinkered around the margins, but did not commit to any substantial reform of the US tax system.
Why DC Needs to Change Its Ways
Even with Trump’s latest tax reform, which lowered corporate taxes down to 24.9 percent, the US tax system remains progressive. Many data points, even going beyond the income tax, attest that the most successful Americans foot the lion's share of the bill.
Apart from its immorality, a progressive income tax hurts the economy. In a report for the Tax Foundation, William McBride explains how income taxes reduce the incentive to work. Likewise, progressive taxation stifles investment, risk taking, and entrepreneurship, activities in which high-income earners participate in heavily.
Despite popular caricatures, the rich are not isolated from the rest of the economy. When they are able to keep more of their earnings, they can increase investment and expand business operations. In turn, humbler workers become more productive and receive higher wages.
Encouraging Signs, Tough Decisions
Albeit limited, President Trump’s tax reforms displayed why the United States must abandon her anti-rich tax crusade. The simple reduction of corporate-income tax rates has allowed numerous corporations like Southwest Airlines and Walmart to share profits with their employees. Beyond one-time bonuses, tax reform has also given companies like Apple and Fiat Chrysler the opportunity to increase investment in the United States and provide more job opportunities for American workers.
For the United States to realize the long-term fruits of low taxation, however, the federal government must keep spending levels in check to quell the temptation to raise taxes. Currently, the US national debt stands at slightly over $20 trillion. (This number does not take into account unfunded liabilities.) The true problem that drives progressive, confiscatory taxes is the massive degree of government spending, especially when it comes to entitlements.
The solution to this dilemma consists in cutting entire programs and eliminating departments—of course, a politically unpopular solution. But total federal spending made up only 3 percent of GDP during the Gilded Age, compared to the 20.5 percent level of the present day. The US economy didn’t miss a beat during that time, growing at an unprecedented pace.
All in all, DC needs to discard the primitive notion that the rich must be disproportionately taxed in order to raise funds for basic government functions. It can change its ways by reigning in government spending and gradually phasing out its unproductive income tax.