The Truth About the Federal Tax Burden

You wouldn’t be at fault if you thought President Barack Obama could make a rainbow sound defeatist if you listened to his State of the Union address last night. He once again pushed for higher taxes on the pot at the end of that rainbow as a way to solve the country’s problems, in a bid to win re-election.

"You can call this class warfare all you want," President Obama said. "But asking a billionaire to pay at least as much as his secretary in taxes? Most Americans would call that common sense."

Most Americans would also call common sense not letting the government borrow $4.6 trillion — equal to Germany and South Korea — on the President’s watch to spend on failed companies like Solyndra or on the Chevy Volt or on bailing out of failed companies like Fannie Mae, Freddie Mac, General Motors (NYSE:GM), Chrysler, GMAC, or the multiple bailouts of AIG (NYSE:AIG), Bank of America (NYSE:BAC), Citigroup (NYSE:C) and numerous faulty banks..

Not to mention the trillions of dollars in bailout help from the Federal Reserve, which is adding to the monetary base.

All taxpayers face higher taxes in order to pay the annual $450 billion interest on the  government’s $15 trillion debt, or else another downgrade to the U.S. debt looms.

But what the president failed to tell you is that taxpayers in the lower brackets, including secretaries, do not pay more federal income taxes than the upper brackets, including millionaires or billionaires. Their effective rates may be the same, but their portion of the federal tax revenue pie is much smaller.

The federal tax burden in this country disproportionately falls on the upper bracket, including small businesses who create most of the jobs, which pay wages to taxpayers who pay federal income taxes the government overspends.

The top 5% of earners in this country pay 58.72% of all federal income taxes, according to the National Taxpayers Union. The top 10% pays 70%. The top 1% pays 38.02%. The bottom 50% pay 2.7%.

That means about half the country currently pays no taxes at all. That likely includes some secretaries, unless they are very well paid.

What you didn’t hear is this: taxpayers in the lower brackets are not always stuck there, and many in the upper brackets don’t stay there for the rest of their lives.

A 2007 Treasury Department study says almost 58% of U.S. households in the lowest-income quintile in 1996 achieved success and moved to a higher level by 2005. And more than 57% of households in the top 1% in income dropped to a lower-income group by 2005.

Every day in America, the poor achieve success and join the upper brackets, while the rich don't stay rich.

The recession increased the ranks of these “no federal tax” taxpayers, as wages plunged and as the Administration gave temporary tax breaks to the lower brackets.

In a typical year, 35% to 40% of households owe no federal income tax, says the Center on Budget and Policy Priorities, a nonpartisan research group.

Many of these households are senior citizens, the disabled or students. And they do fork over payroll, state and local taxes. About 14% of households paid neither federal income tax nor payroll tax in 2009, according to data from the Urban Institute-Brookings Tax Policy Center.

The poorest fifth of households paid 12.3% of their incomes in state and local taxes in 2010, says the Institute on Taxation and Economic Policy.

Factor in all federal, state, and local taxes, the bottom fifth of households paid 16.3% of their incomes in taxes, on average, in 2010, according to the Tax Policy Center. The second-poorest fifth paid 20.7%, says the Tax Policy Center.

But who shoulders the tax burden obscures a much more important point. The president linked tax cuts for the upper bracket as unfair to college students, seniors or families. But that’s misleading.

Again, the president added $4.6 trillion in spending on his watch to the nation’s $15 trillion debt burden, and the nation still lost a net 1.9 million jobs.

What’s really at stake is how the government has wasted your tax money, and how the government needs more of your money just to pay the interest costs on the U.S. debt, which the president has worsened, so as to avoid the bond markets enacting fiscal austerity on the U.S. via demanding higher interest rates on U.S. bonds.

There was little mention of this in the State of the Union address, or of the country’s poor economic growth, the country’s $15 trillion in debt, or that tax hikes on the upper bracket would barely pay a fraction of the $450 billion in annual interest costs on the U.S. debt.

The president’s policies have created the worst economic recovery since government officials first made a serious crack at tracking this data beginning in the Great Depression.

Despite spending all that money, the U.S. is in the ultimate jobless recovery, with a net 1.9 million jobs lost. The labor force is now smaller than before the President took office.

Companies are sitting on $2.9 trillion in cash and are moving operations overseas at a faster rate, before a flood of new, costly rules from health reform, Dodd Frank and other reform measures kick in. (Bills that many in Congress have not read.)

And that’s only federal rules; state and local rules on businesses are increasing, too.

So the president’s "Buffett Rule", a capital gains tax hike on the upper bracket, would hardly pay for his deficit spending either.

The president also failed to mention in his address that firms that pay their executives in the form of capital gains from the firms' investments have first paid corporate taxes at a 35% rate on those gains, before making these payouts.

The president also didn’t mention that higher capital gains taxes would mean higher taxes on angel investors who plunk money into startups like Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG) or Facebook. Higher taxes here would mean less money from them to invest in startups, icing over economic activity.

Raising everyone’s capital gains tax rates to get more money from executives at hedge funds or private equity firms would be tricky to execute. It would involve writing new measures in an already tangled pile of a U.S. tax code.

Instead, charging income taxes on these gains for just these workers, instead of raising   everyone’s capital gains taxes, can be done.

In the U.S., partners at these firms are not taxed when they get these gains as income, because it is difficult to ascertain the present value of their percentage stake in future profits.

But it could be doable, and once those gains are shelled out to these partners as part of their salary, the company could withhold taxes at the federal income tax level, instead of capital gains. The United Kingdom assesses income taxes on such gains paid as income to directors or workers at investment shops.

A line item on taxing this “carried interest” at ordinary income rates was included in the Obama Administration's 2008 Budget Blueprint, and has been part of the Administration’s budget plans since 2010.