Because that's where the money is

So, the US Congress is talking about taxes again, and as always, everybody's trying to cut taxes for their donors without pissing off everyone else too much. I was curious about the effects on the bottom line of a tax increase, so I went looking for some data.

I should be clear here. I'm not an expert in any of the relevant subjects: economics, statistics, policy, etc. I just wanted to understand what it means when they talk about cutting taxes for one group by a few percent. How much does that affect everyone else.

We know that poor people don't have money to spare. Rich people do. On the other hand, there are a lot more poor people than there are rich people. Put another way, 1% of Bill Gates' income could pay off a lot of debt, but there's only one of him. 1% of an ordinary person's income wouldn't pay off much debt, but there are lots more normal people. So, how does it balance out?

I found this really useful Wikipedia link showing the number of households and mean income for households in the US in blocks of $5000.

I wanted to see how much money the government would get from a 1% tax increase, so I put together the following table. Take a look at column H.


Since that small window is a bit hard to work with, you can see the full spreadsheet here.

One thing that's important to remember: for very poor people, every dollar matters A LOT. If you take away even a small percentage of their income, they're going to apply for aid (offsetting any money gained from taxes), or they'll have to go without food, electricity, or other necessities. What I thought was interesting about this table is that, even though there are quite a few very poor households, they're so poor that 1% of their income just isn't very much money. There's just not much point in taxing poor people.

Once you get beyond the extremely poor, the numbers are roughly equal for a long time. There are fewer and fewer people in each block, but that's offset by income increases pretty well. Each $5000 block produces around $2 billion USD per 1% of income. The numbers start to look strange at $200,000 because there are so few people that they change the block sizes.

There are some complicated (and widely disputed) effects that kick in with higher taxes. Reported total income does seem to go down slightly as tax rates go up. But, nobody can agree on how great the effect is, where it kicks in, or where it stops. "Hauser's Law" is a good search term if you want more information. Despite that, it does seem that the marginal tax rate curve affects where the money comes from.

But, one thing is clear: The top 3% (people making above $250k/year) have roughly 15% of the total income in the US. And, they're the people who can most afford a tax increase. People have looked at how much the top few percent could afford to pay, and while the 90% marginal rate from the 1950s is probably too high, at the very top, a 70% marginal tax rate is not unreasonable. (For reference, the current top marginal tax rate is around 40%, though very few people with that income pay that much.)

So, how much money do we need?

Each year, the US government takes in a bit more than 2 trillion dollars in taxes and other income, and spends a bit more than 3 trillion dollars (close enough -- what's a few tens of billions between friends?). So, just to pay the bills (never mind paying down the deficit), the government should be taking in another trillion dollars per year.

But... what about waste? What about reducing spending? People have looked at that, and it turns out that the ratio that hurts least is roughly 1:1 to 2:1 tax increases to spending cuts. So, what we should do is cut $300 million to $500 million, and increase taxes by $500 million to $700 million. I'm not going to get into where to best cut, but I will point out that the US has far, far more military spending than anyone else in the world.

Let's use half a billion because it's a nice round number, and it's the easier one to achieve. If we tax EVERYONE 1%, that only brings in $94 billion, and we need 5x that. So, we could hit everyone with a 5% tax, but that means taxing people who absolutely can't spare that much money.

What about a 10% tax, starting with the richest people and stopping when we hit half a trillion? That's what I looked at in column I. With a 10% tax, you'd raise half a trillion dollars if you taxed everyone who made at least $100k/year.

How about 20%? That's column J. It turns out that if you're willing to increase marginal tax rates by 20%, you only have to do it for people making over $185k.

There is another variable, and it's a big one: tax deductions. The tax code is big and complicated, and there are lots of deductions for very strange things. Getting rid of most (or all) of these deductions would massively expand the tax base while mostly only harming people playing tax games. Of course, most of the people playing those games have also bought pet lobbyists or congressmen, and they won't go down without a fight. But, if we could do it, this might well be the best way to bring in the money.

What's the right approach, then? I don't know. I'm not an economist or a tax policy expert. But, it seems pretty obvious to me that you can't make up a budget shortfall by cutting taxes on the people who are most able to pay without increasing the tax burden on other groups.