The Facts About Taxes and Spending

Separating economic myths from economic truths

Editor's Note: Reason columnist and Mercatus Center economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.

Myth 1: Millionaires who favor of an income tax increase are fiscal heroes.

Fact 1: No, they're not. Many of the rich get the majority of their income in the form of capital gains and dividends rather than ordinary income. They are essentially advocating a tax increase on those making much less money than they do.

On its face, raising the top income tax rate seems like an effective way to make our (already progressive) federal tax system more progressive. Yet the rationale underlying this policy recommendation ignores the complexities of the United States federal tax system. As you can see from the chart above:

• As income increases, the proportion of Americans' earnings coming from wages and salary decreases (red). Meanwhile, wealthy Americans draw much of their income from dividends, interest payments, and capital gains (blue).

• Federal income tax rates are progressive, but they are not shared equally among high earners. Federal income taxes fall disproportionately on those wealthy enough to face the highest income tax rates, yet not wealthy enough to draw a large proportion of their income from non-wage sources—those filers making $100,000 to $200,000. 

So when Facebook's Mark Zuckerberg—following in the footsteps of billionaires like Bill Gates, Warren Buffett, and Ted Turner—declared that he was "cool" with the idea of paying more income tax, it doesn't really mean he's personally going to be paying more money.

Indeed, if Zuckerberg really wants to pay more taxes he can simply send a check to the Treasury Department instead of asking for a tax increase on other people's incomes.

Jakina Debnam of the Mercatus Center calculated the average tax rate on the non-wage and salary earnings of the wealthy using SOI data from the Internal Revenue Service. As she writes: "There is some rounding error incorporated from the SOI data. However, if you assume that all high income earners face the highest tax bracket on their income (that they make more than $373,651 in wage and salary income), then you get the tax rates illustrated below.

As you can see, these rates are all lower than the individual tax rate on income for single earners making more than $34,500 but less than $83,600, which is 25 percent.

Myth 2: Big government means more redistribution to the poor.

Fact 2: Large governments tend to have less progressive taxation than smaller ones.

This chart by University of Chicago economist Casey Mulligan shows estimates of the income shares paid by French earners and American earners in various taxes by different income deciles.

Two things are immediately apparent from the chart: 1) French workers pay higher proportions of their income in taxes than their American counterparts at every earnings level and 2) counterintuitively, the American tax system is more progressive than the French system.

According to the Organization for Economic Cooperation and Development, most taxpayers in Western European countries—countries known for their relatively generous welfare states—pay a smaller fraction of their income in individual income tax than Americans do.

France's individual income taxes, which are progressive like ours, bring in less than 4 percent of the country's gross domestic product (GDP) to public treasuries, compared with 10 percent for individual income taxes in the United States.

The regressive payroll tax is France's biggest tax, bringing in more than 17 percent of GDP (plus another 4 percent from its flat-rate contribution sociale généralisée), compared with the 6 percent of GDP the United States gets from its payroll tax. Customs, excise, and sales taxes amount to 11 percent of GDP in France, but only 4 percent in the United States.

Myth 3: The doomsday projections about unfunded Social Security and Medicare obligations are overstated.

Fact 3: The unfunded liabilities for Social Security and Medicare exceed one full year of the United States' gross domestic product. That's on top of the spending that's supposedly funded.

The net present value of the long term cost of Social Security is $17.9 trillion. The figure for Medicare is $3 trillion. (These are very conservative figures.) Together, that's $20.9 trillion for which we need to cover the difference between the payroll tax and other taxes dedicated to funding the programs and benefits that have been promised. The total size of the U.S. economy is roughly $15 trillion.

The above chart shows the size of the unfunded liabilities for Social Security and Medicare and contrasts that number with the size of the economy today. As you can also see, if we were to put 100 percent of the yearly production of every stock, building, and company in America in a bank account or trust fund, that figure would still not be enough to pay off all of the benefits that have been promised.

Contributing Editor Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.