Economy & Budget

Democratic Myth No. 2: Those who have done well should pay their fair share

Democratic Myth No. 2: Those who have done well should pay their fair share
President Barack Obama, right, meets with Warren Buffett, the chairman of Berkshire Hathaway, in the Oval Office.

Editor’s Note: This analysis the second in a five-part series on Democrats’ mythical sound bites by Andrew Puzder, an economic adviser to Mitt Romney and CEO of CKE Restaurants, which employs about 21,000 workers. The first installment was entitled, “Democratic Myth No. 1: GOP Is to Blame for Failure of Obama’s Job Policies.”

President Obama has repeatedly attempted to frame the debate over increasing federal revenue and reducing the deficit as a simple matter: Just raise taxes on people who have been successful.  To use the President’s precise phrasing: “All I’m saying is that those who have done well, including me, should pay their fair share in taxes.”

This sound bite sounds so good that one is tempted to simply agree without ever questioning the president’s underlying assumption that the successful among us are not already paying their fair share.  Or, that increasing tax rates on the successful is the same as increasing tax revenues.  Neither assumption reflects reality.  As is the case with every Democratic sound bite, the president is counting on it being so appealing that most Americans will accept what he says rather than see it for the myth that it is.  In fact, he is counting on people believing the myth even when faced with facts to the contrary.

Dare we ask what share of federal income tax revenues “those who have done well” should pay as their “fair share” and then ask whether they are failing to do so?  Should we expect a president who claims successful Americans are failing to pay their fair share to demonstrate why he believes this before repeating it relentlessly as if it were a fact?  Perhaps not.  In the wrong hands, an oft-repeated myth can become more effective than the truth.

Higher income, greater tax burden

So, what is the reality?  We currently have a progressive tax system where those with more income pay a greater share of their income in taxes.  In 2009 (the most recent year for which we have such data), the top 1 percent of taxpayers (those earning over $344,000) earned 17 percent of adjusted gross income but paid 37 percent of all federal income taxes, more than twice their share of national income.  That seems very unfair to the 1 percent and like a very good deal for the other 99 percent.

The top 5 percent (those earning over $155,000) earned 32 percent of adjusted gross income but paid 59 percent of all federal income taxes.  In other words, the top 5 percent paid more in income taxes than the remaining 95 percent combined.  Again, hardly unfair to the other 95 percent.  The top 10 percent (those earning over $112,000) earned 43 percent of adjusted gross income but paid 71 percent of all federal income taxes.  On the other hand, the bottom 50 percent earned 13.5 percent of adjusted gross income and paid 2.5 percent of all federal income taxes.

While much depends on your definition of “fair,” the wealthy already pay substantially more than their proportional share of taxes and perhaps more than many would objectively consider their “fair share.”  Why President Obama feels that “those who have done well” are failing to pay their fair share is, shall we say, unclear.

Is he talking about tax rates?

Perhaps the president is talking about tax rates as opposed to actual dollars.  He certainly seems to focus on the rates Warren Buffett, Mr. Buffett’s secretary and Mitt Romney pay.  So what tax rates do the successful pay?  The top one percent of taxpayers pays an average rate of 24 percent.

How does this compare to the remaining 99 percent of taxpayers?  Well, the top five percent of taxpayers pay an average rate of 20 percent.  The top 10 percent of taxpayers pay an average rate of 18 percent.  Those in the top 10 to 25 percent of taxpayers pay an average rate of 8 percent.  Those in top 25 to 50 percent of taxpayers pay an average rate of 6 percent or one-quarter the rate the top one percent pay.  Those in the bottom 50 percent of taxpayers pay an average rate of 1.85 percent, which is one-tenth the rate paid by those in the top 10 percent of taxpayers.  Again, this hardly seems unfair to those in the lower income brackets.  Actually, it seems pretty progressive.

Warren Buffett’s rate

Of course, there are successful people who pay less than the average rate for their bracket such as Gov. Romney, Warren Buffett and the president.  On the other hand, there are successful people who pay more than the average for their bracket.  That’s what makes it an average.  If a successful person’s tax rate is lower than the 24 percent average cited above, it is almost certainly because they received a substantial amount of income in the form of capital gains or dividends, or made significant charitable contributions.

This is certainly the explanation for Gov. Romney’s and Mr. Buffett’s tax rates, but the investment activity and charitable giving that give rise to this apparent rate anomaly should be applauded rather than demonized.  If this is the “unfairness” that offends the president, perhaps he should drop the “fairness” language and just say he wants to raise the taxes on dividends and capital gains and eliminate the deduction for charitable contributions.  Of course, both of these actions would be extremely counterproductive.  Like many of the president’s proposals, his tax “fairness” arguments are rooted in emotion rather than an understanding of economics.

Explaining capital gains, dividends

In reality, even with capital gains and dividends, the government gets its fair share.  Like the deduction for charitable contributions, lower tax rates for capital gains and dividends are intended to encourage people to take positive action; in this case, investing their assets which generates growth and increases overall tax revenues.  Increasing tax revenues obviously should be the goal of tax policy and the best way to do so is to encourage economic growth.  The current dissatisfaction with capital gains and dividend tax rates often grows out of a general misconception concerning how those rates apply to income the government has already taxed.

Let’s take a very simple example of how this might work under current tax law.  Say that you want to invest $1,000 in a company.  If you are a high income earner, to invest $1,000 you must earn about $1,500 as your marginal rate on earned income (as opposed to capital gains or dividend income) is 35 percent.  After earning this $1,500, you have $1,000 to invest and the federal government has collected $500 in taxes.

Let’s say the company in which you invested decides to pay you a $100 dividend.  To do so, the company must earn about $150 as the tax rate on corporate income is also 35 percent.  Now you have $1,100 and the government has $550.  However, you have to pay taxes on the $100 the company paid you as a dividend even though the company already paid taxes on this income.  At the 15 percent rate the federal government currently taxes dividends, you would pay another $15 so that you now have $1,085 and the government has $565 or 34 percent of the $1,650 in income you and the corporation in which you invested earned notwithstanding that you paid only a 15 percent rate on your dividend.  This is because the federal government taxed the dividend income both when the company earned it and when you received it.  In short, dividend and capital gains income are very different than income from wages because dividends and capital gains have already been taxed before the investor receives them.  This is an inconvenient truth that the president ignores.

Government’s chain of taxes

Looking at the entire series of income-generating events and the government’s taxation or double taxation at every stage, it is hard to see how government is getting less than its fair share.  This is particularly true when you factor in payroll taxes, state income taxes, personal property taxes, real estate taxes and sales taxes.  In addition, depending on the value of your entire estate, you could end up paying a death or estate tax on this $1,085 of up to 35 percent despite the federal government having already taxed or double taxed it when earned.  If you lived in a state with a state death tax, you would end up paying even more.  In the end, the government’s share of earned income is so substantial its surprising any money is left. That hardly seems fair to those who earned the income or unfair to the government.

Perhaps this is why the president occasionally attempts to change this mythical sound bite from the successful needing to “pay their fair share” to the successful needing to be “patriotic” and “do the right thing” by paying more taxes.”  Whether he’s talking about fairness or patriotism, the president is missing the point and demonstrating yet again that he is simply unwilling to do what needs to be done to reinvigorate our economy.

More obligations than revenue

Rather than asking whether taxes are fair or patriotic, the president should be asking whether tax rates maximize tax revenues.  Our problem as a nation is that we have more obligations than we have revenue.

Simply, we can’t pay our bills. The solution isn’t increased “fairness” or “patriotism.”  The solution is increased revenue.  Percentages (rates) do not pay the bills, dollars (revenues) do.

Economic growth generates higher tax revenue. Higher tax rates on people who are successful, while emotionally appealing to those who will not have to pay them, may actually reduce rather than increase the government’s tax revenues by reducing investment and growth.

Raising taxes may help or it may hurt.  If it were as simple as raising tax rates, the government could increase tax rates to 100 percent?  However, at a 100 percent tax rate there would be no incentive to earn (or report) income and, as such, no tax revenue (see “The Laffer Curve”).  As the president once stated:   “The last thing you want to do is raise taxes in the middle of a recession because that would suck up… take more demand out of the economy and put businesses in a further hole.”  So why increase them now?

Seeking political advantage

Clearly, the president’s promotion of higher tax rates on the “rich” is not designed to address our fiscal problems.  Rather, it is misdirection intended to gain a political advantage.  It is also consistent with the president’s desire to redistribute wealth, grow government and further expand the dependency state that appears to be his ultimate vision.  Everyone would agree that our tax system should be fair (and, within reason, it is), but the more important question is whether we are raising sufficient revenue to pay our bills and reduce our debt.  Rather than arguing for “fairness” or “patriotism,” the president should be promoting private sector growth, the surest way to increase tax revenues.  Unfortunately, President Obama views taxes politically and ideologically rather than fiscally.

Two very different visions for America

If the president’s tax fairness sound bite clarifies anything, it’s the distinct difference in the Presidential candidates’ respective visions for America’s future.  Mitt Romney’s tax plan is an economic growth, revenue generating plan.  It does not lower tax revenues for the successful, as the president claims, nor does it increase taxes on the middle class, as the president also disingenuously claims.  It’s the plan we need from someone who understands that balancing our budget and paying down our debt are more important objectives for increasing our prosperity than redistributing wealth and growing government.

Clearly, the president’s “pay their fair share” sound bite is a complete myth, a wily political subterfuge rather than an attempt to promote “fairness” or “patriotism” or seriously address our debt and deficit problems.  Is it really in our nation’s best interest for the president to tell the 50 percent of people who pay 2.5 percent of all federal income taxes that the successful are paying less than their fair share when the top 5 percent of income earners pay more in income taxes than the remaining 95 percent combined?  At a time when we need serious economic policy to reduce our debt and deficits, is a political victory really worth dividing our nation along class and economic lines?  America has always been an opportunity- based society where we encourage success rather than envy and where we applaud rather than punish those who succeed.  No election result is worth changing that.

Andrew Puzder is CEO of CKE Restaurants, Inc., which employs about 21,000 people at Carl’s Jr. and Hardee’s restaurants. He is co-author of “Job Creation: How it Really Works and Why the Government doesn’t Understand it.” He is an Economic Adviser to presidential candidate Mitt Romney. 

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