A tax tutorial for Jonathan Chait

In his characteristic way, Chait substitutes ad hominem attacks and invective for presenting relevant data:

Chait dismisses the share of taxes paid by top earners as irrelevant to the progressivity of a tax system.

Here, by the way, is the OECD data I was referring to (see page 106).

While he’s right that the share of income paid doesn’t tell you anything about top marginal rates, he is wrong to assume that the rate structure is the proper way to measure progressivity.

Here’s a crash course on progressivity:

Any system that exempts some taxpayers—the poor, for instance—or some income—personal exemption—from the income tax creates de facto progressivity independently of the rate structure.

That is true even in a flat tax system where everyone is taxed at a flat single rate. Bruce Bartlett gives a good example in his excellent new book The Benefit and the Burden: Tax Reform: Why We Need it and What it Will Take.

Bartlett writes:

The United States channels a lot of its spending to lower-income people through our tax code while European countries are more likely to do it through direct spending.  It explains why almost 50 percent of tax units in the U.S. do not pay the income tax. That alone increases the actual progressivity of the U.S. tax code.

Over the last 30 years, the progressivity of the rate structure has decreased in the United States. In the 1980s, the top marginal rate used to be 70 percent while it stands at half that today.

The U.S. is not alone in cutting its top rate. As it became clear that high marginal rates didn’t necessarily mean high tax revenue and could have negative economic effects on the economy, every major developed country flattened their rates.

However, this decline in nominal progressivity doesn’t tell you much about the actual progressivity of a tax system. That depends on the size of the exemptions, which are relatively large and frequent for U.S. taxpayers.

The OECD data shows that other countries tend to have much higher tax rates than the U.S. does but the threshold of income at which the top rate in applied is much lower.

For instance, it takes almost 3.4 times less income in France than in the U.S. to be taxed at the highest French rate. It means that other countries have higher rates but also more regressive systems.

By contrast, the United States has lower top lower rate but these lower rates kick at a much higher level—meaning that it take much more income to face the highest rates–hence the steeper progressivity.

Here’s another factor that increases the progressivity of overall taxes in the United States: Our federal government relies much more heavily on income tax than on consumption taxes such as the VAT, retail sales taxes and gasoline and tobacco taxes favored by the OECD nations.  Consumption taxes tend to be more efficient at raising revenue than income taxes but they also tend to be regressive.

I could go on but I think I’ve made my point that our federal tax system is more progressive than most other OECD countries when you factor in the proper definition of progressive, how exemptions affect effective rates, and the use of consumption versus income taxes.

As for the share of taxes paid by the top income earners in the United States compared to other Americans, the data also shows some pretty steep progressivity at the federal level.

According to the Congressional Budget Office, the top 1 percent pays roughly 30 percent of it income in taxes, while lower income earners pay a significantly smaller share.

Chait would have had a better argument if he had added state and local taxes to the overall burden paid by U.S. taxpayers. Those do flatten the progressivity somewhat but the American system still remains more progressive than most OECD countries.

On the issue of income inequality, I think the real difference between Chait and me is less analytical and more philosophical (I hesitate to use such a high-minded term in relation to Chait, who seems constitutionally incapable of disagreeing with anyone without impugning motives, professionalism, I.Q. or mental stability).

There is no doubt that the spread of income in the United States has grown over the past several decades. Yet exactly what that means or whether it is a social issue worthy of redress via the tax code or other governmental action is not clear.

If the spread in income inequality was due solely or even mostly due to corruption and cronyism, that would be one thing and it would call for some sort of intervention. But it’s not.

I think the far more-important issue is income mobility, or whether individuals possess the ability to move up the income scale based on their effort. As recent work by Julia Isaacs, Isabel Sawhill, and Ron Haskins of the Brookings Institution show persistent income mobility for most in America.

But there is lots of room for improvement. This is why I think that increasing upward mobility — in particular those who start out at the bottom — should be our primary focus. Increasing progressivity won’t achieve this goal.

I’d argue that the place to start is with the K-12 education system, which as I’ve shown elsewhere, produces generally flat results despite massive increases in spending.

Worst of all is the fact that poor Americans—those whose income mobility must be improved in today’s America—have kids who are often stuck in failing schools, with a dramatic opportunity cost of their future.

Examiner contributor Veronique de Rugy is a senior research fellow of the Mercatus Center at George Mason University.