Tuesday, March 10, 2009

Our Immoral Tax Laws

I have previously posted an essay (link) opposing the so-called fair tax. I wrote mostly about how this proposed change of tax policy would negatively affect me and folks like me. I intend to post more against the "fair tax" in the future, but this posting is about another unfair area of tax policy: the fact that non-labor income (e.g., capital gains) is taxed at a lower rate than earned income (e.g., W-2 pay).
There are effectively two tax systems in America: one for the very rich and one for the rest of us. Income from stock dividends and capital gains, which makes up a disproportionate amount of the earnings of the very rich, is taxed at 15 percent. But the bulk of what the rest of us earn — wages and interest from savings accounts — is taxed at up to 35 percent. Though President Obama’s recent tax proposals are progressive and comprehensive, his reforms don’t do nearly enough to address this significant disparity. [NY Times]
When Congress enacted an income tax law after the 16th Amendment was ratified, the law was written to primarily tax income from wealth (non-labor income). The very simple original 1913 IRS 1040 Form was only four pages, including the instructions. There was a deduction of $3000 for a single or non-joint return and $4000 for a joint return. Then income after exemptions was taxed at 1% up to $50,000.

The income tax was progressive up to the top rate of 6% for income over $500,000. The median income in the United States in 1913 was less than $15,000 (source). The average laborer in 1913 made about $2 a day (source) or about $500 a year. Since the tax deduction of $3000 or $4000 would apply, a laborer in 1913 would not pay any income tax. This supports my claim that Congress intended the income tax originally to tax profit on wealth (capital gains, dividends, etc.).

Until 1921, the income tax code was relatively fair.
The gap between the tax rates for the rich and the rest of us is relatively recent. Until 1921, capital gains were taxed at the same rate as ordinary income. Then Congress enacted a law that taxed capital gains at 12.5 percent while ordinary income was taxed at as much as 58 percent. [NY Times]
Currently the tax rates for ordinary income are 10%, 15%, 25%, 28%, 33%, and 35% (source) and approximately 15% for capital gains (source). Thus our current income tax laws favor the rich, because the rich are the ones who earn the bulk per capita of capital gains income earned in America.
Warren Buffett knows there’s something very unfair about the American tax system. He’s often complained that while his 2006 tax rate (for federal income taxes and Social Security withholding) on $46 million of income was 17.7 percent, his secretary’s combined tax rate was 30 percent. [NY Times]
What I propose is that all income should be taxed the same, regardless of its source. Why should capital gains get a lower tax rate than the income people earn by the "sweat of their brow?" I strongly believe it is immoral to do so. I'm not very religious, but I do believe in helping the poor among us.
“Our tax policies should be redesigned through the prism that wealth is being increasingly skewed,” Mr. [Mark A.] Zandi said, arguing that higher taxes on the rich could help restore a sense of fairness to the system and blunt a backlash from a middle class that feels increasingly squeezed by the costs of health care, higher education, and a secure retirement. [NY Times]
No tax system is ever fair to everyone, but by taxing all income the same, we can move to a fairer and simpler system similar to the 1913 income tax. (The propagandists behind the so-called "fair tax" have tried to preempt the obvious by falsely proclaiming that their tax system is "fair." But this is another post.)
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