Should President Obama Break His Pledge and Raise Taxes on the Upper-Middle Class?

Because so much of what passes for political debate in this country takes place in a faux-fact zone, it is a welcome change to read Reihan Salam’s latest essay in the National Review. During the 2008 campaign, Barack Obama famously promised that taxes would either stay the same or go down for households making less than $250,000 a year. But Salam points out that there’s no way of reducing the budget deficit to acceptable levels, let alone financing the kind of federal government Obama favors, while relying solely on income and payroll tax increases for households making more than that figure. Of course, there’s not much that can be squeezed out of the bottom four income quintiles (households making less than $100,000 per year). On the other hand, relying solely on the rich for added revenues would imply tax rates in excess of 75 percent. But what about the well-off but not rich—those in the fifth quintile who earn between $100,000 and $250,000 a year? Can they really be held harmless?

To dramatize the problem we’re facing, let’s consider the analysis the Urban Institute’s Eugene Steuerle and Stephanie Rennane published in January, which looked at taxes and benefits for households in different income brackets. The average couple earning $112,000 and retiring in 2010 will have paid $140,000 in lifetime Medicare taxes, but is expected to receive lifetime Medicare benefits totaling $343,000. Twenty years from now, the same couple would have paid $171,000 in lifetime Medicare taxes and would receive $530,000 in benefits. (Technical note: These amounts are in constant 2010 dollars, adjusted to present value using a 2 percent real interest rate. In calculating net benefits, the authors have taken into account premiums as well as payroll taxes.)

Or consider the analysis USA Today published last week, which found that Americans are paying the smallest share of their income for taxes since 1958—23.6 percent, versus about 27 percent in the 1970s, 1980s, and 1990s. On average, a person making $100,000 this year will pay $23,600 in combined taxes—federal, state, and local, income, payroll, and sales—versus $28,700 in 2000 and $27,300 in 1990. Even when the one-year Social Security tax cut ends, the tax gap between now and a decade ago for individuals making $100,000 will still be more than $3,000.

Of course, you might argue we’re short on revenues because the tax code has let the very wealthy off the hook in recent decades. Maybe so, but it’s hard to see that in the data. According to the Urban-Brookings Tax Policy Center, the effective tax rate for all federal taxes in 2009 was 18.2 percent. The effective rates by quintile were:

 Lowest  -0.9
 Second  6.6
 Third  13.4
 Fourth  17.2
 Top  22.9

But maybe the real action is within the top quintile of income-earners, with the super-rich making out like bandits. Again, the Urban-Brookings numbers don’t support that story:

 80-90  19.4
 90-95  22.0
 95-99  23.5
 Top 1 percent  26.1
 Top 0.1 percent  27.9

This is just a one-year snapshot, of course. What about trends over time? We know that the distribution of income has become less equal in recent decades, with those at the top commanding a larger share. You might think that the share of taxes paid by high earners has declined during this period, shifting the burden to those below. But according to the CBO, that hasn’t happened either. While the share of national income for the top quintile and the top 1 percent has risen considerably since the mid-1980s, their share of total federal taxes has risen even more.

You might still argue, however, that the right comparison is not across time but across national boundaries. Surely the rich pay more of the total tax burden in other advanced democracies, and we need to become more like them. Wrong again. Using 2005 OECD data, The Wall Street Journal recently reported that the share of taxes paid by the top 10 percent in the United States is 1.35 times larger than their share of income. The comparable number for France was 1.10 times; for Germany, 1.07 times; for the OECD as a whole, 1.11. And this is what we should expect, given that most other democracies rely less on income taxes and more on alternatives such as the VAT, which is less progressive.  

Finally, you might be curious about the numbers lurking behind the abstractions of quintiles. I was too, so I checked. According to the Census Bureau, the top 5 percent of household incomes began at $180,001. The Obama campaign pledge has the effect of exempting all but the top 2 percent of households from even the possibility of higher taxes.

How realistic is this? It’s widely agreed (even across party lines) that if increased tax revenues are to be part of a long-term fiscal stabilization plan, they should come via a version of the 1986 reform, which broadened the tax base by reducing tax expenditures—i.e. special tax credits, deductions, exemptions, deferrals, and preferential rates. But as a recent note from Roberton Williams of the Tax Policy Center makes clear, it’s the well-off but not rich (i.e. the top quintile excluding the very rich) that benefits massively and disproportionately from itemized deductions and exclusions from taxable income. In other words, while it may make political sense to shield households that fall between the 80th and the 98th income percentiles (i.e. those making between $100,000 and $250,000 per year) from tax increases, we won’t raise much revenue if we do.

This prospect won’t trouble the conservatives, who don’t want to raise taxes on anyone and are prepared to gut the federal government in the process. But it should alarm moderates and liberals who believe in public investments and the social safety net. Unless Obama is prepared to tolerate huge deficits indefinitely, or to emulate arch-conservatives and curb the budget deficit with spending cuts only, he will have to break his unsustainable tax pledge at some point. The only question is when.