Sign in
Become a MarketWatch member today
Brett Arends' ROI
Sept. 28, 2010, 12:01 a.m. EDT · Recommend (3) · Post:
View all Brett Arends' ROI "º
"¹ Previous Column
Don't get fooled by Ben Bernanke
First Take "º
The WaMu conspiracy gets life
By Brett Arends
BOSTON (MarketWatch) "” The collapse last week of a Congressional deal means the Bush tax cuts "” which are due to expire at the end of the year "” are likely to be a hot issue in this election.
We hear so much about taxes from both sides. But what are the facts? I decided to do a little investigating.
1.Are federal taxes high by historic standards? Not if you mean modern history. This year, according to the Office of Management and Budget, federal tax revenues will come to 15% of GDP. That's the lowest level since 1950. Under George W. Bush it averaged 18%. Under Bill Clinton, 19%. And under Ronald Reagan it was 18%. It was even higher when Dwight D. Eisenhower left office, at 18% of GDP.
For all the attention being paid on Wall Street to policy concerns, market prospects don't hinge mainly on the election and taxes, reports Barron's Michael Santoli.
2.What about federal spending? That's a different matter. Taxes are only low because we are running deficits. Federal spending is high: This year it hit 25% of GDP. Before the crisis, going back to the Eisenhower administration, it averaged about 20%. Under Reagan, it ranged from 21% to 23%. The lowest levels seen in the modern era were in 2000-2001. Then federal spending was just 18% of GDP.
3.And state and local spending? There's a perception these are also out of control. It's a myth. According to the latest data from the Census, state and local governments over the past 12 months have come to just under 9% of GDP. That's normal by the standards of recent history. Robert Ward, deputy director of the Rockefeller Institute, says state and local spending has typically been around 9% of GDP for the past three decades. If you go back to the 1970s it was often higher, at around 10%. But the big rise occurred in the 1960s. Back in the early 1960s it was only around 7%.
4.Where does federal spending go? Sixty-two percent of it goes on just three things: Retiree benefits (Social Security and Medicare), defense, and interest. Everything else -- from highways, air traffic control, the FBI, the federal judiciary, student loans, Medicaid, the Food & Drug Administration, the Environmental Protection Agency -- comes to $1.5 trillion. That's about 10% of GDP. When Eisenhower left office it was only 4%. Most of the rise took place during the 1960s and 1970s. In recent decades it hasn't changed that much. When Reagan was in office 25 years ago, it was more than 8%. Cutting all this spending could help the deficit, but, on its own, not that much. The deficit is $1.3 trillion. We'd have to cut all government functions (other than retiree benefits, defense and interest) by 87% to balance the books.
5.Is the top rate of federal income tax high? Not by the standards of modern history. At 35%, it is remarkably low. According to the Tax Policy Center, a Washington, DC think-tank that tracks these things, since the U.S. entry into World War I "” way back in 1917 "” the top federal income tax rate has only been lower than today twice: Between 1925 and 1931, and from 1988 to 1992. Reagan's big tax cut of 1981 left it at 50%. If the Bush tax cuts expire, the top rate will rise to 39.6%. But even that is very low historically. Furthermore, many of today's highest earners "” from private equity tycoons like Blackstone's Steven Schwarzman to Apple Inc. chief Steve Jobs "” aren't even paying this. They make their money from stock gains instead of ordinary income, and on that they are just paying a top federal tax rate of 15%. If the Bush cuts expire, it will rise to 20%. Bottom line: The highest-earning 10% in America pay an average federal tax rate of just 27%. And according to the Internal Revenue Service, the highest 400 earners in the country, with an average adjusted gross income of $57 million a year, paid an average tax rate of"¦ 17%.
6.Are the rich paying most of the taxes? Yes. According to data from the Congressional Budget Office, the top 5% of earners pay 44% of the federal taxes. That's a much higher share than it used to be: Twenty-five years ago, under Reagan, it was 28%. However, there is a reason for this that goes beyond mere politics. The wealthy are paying a rising share of the taxes because they are earning a rising share of the money. The top 5%, for example, make 32% of the money. Under Reagan, it was only 23%. Their taxes have risen, but their after-tax incomes have skyrocketed.
7.Will raising the top tax rates stifle growth? I used to assume that it would. And I grew up in an era when the top rates were sometimes above 70%, a level that must dissuade some from going to work. But the numbers don't stack up. During the Zeroes, when the top rates of tax were at their lowest in generations, so was the economic growth. The top rate of income tax was just 35%, and the top rate of capital gains tax was a mere 15%. But after accounting for inflation, real output per person rose by just 7.5%. By contrast, in the 1960s, when the top rate fell no lower than 77%, output soared by a third and in the 1970s, when the top rate was 70%, it rose by a quarter. In the 1950s the top rate of tax hit a ridiculous 91% "” yet the economy still grew by 18% per person.
Over the next six weeks or so you're going to hear a lot of selective statistics about taxes, and tax cuts, on both sides. The truth, as usual, is more complex.
Brett Arends is an award-winning financial columnist with many years experience writing about markets, economics and personal finance in Europe and the U.S. He has received an individual award from the Society of American Business Editors and Writers for his financial writing, and was part of the Boston Herald team that won two others. He was educated at Cambridge and Oxford Universities, and has worked as an analyst at McKinsey & Co. He is a Chartered Financial Consultant (ChFC) and Accredited Asset Management Specialist (AAMS). His latest book, "Storm Proof Your Money," has just been published by John Wiley & Co.
J.P. Morgan is firing up the wrath of former WaMu employees and shareholders who believe the deal made in the darkest hours of the financial crisis was a set-up that ultimately gave J.P. Morgan the thrift on the cheap.
11:58 a.m. Today11:58 a.m. Sept. 28, 2010 | Comments: 16
- gluesch | 6:59 a.m. Today6:59 a.m. Sept. 28, 2010
"7 myths and realities about taxes http://on.mktw.net/abM0zD" 11:27 p.m. EDT, Sept. 27, 2010 from MKTWArends
The Technical Indicator
Staking out the U.S. markets' next target
Writing on the Wall
He created the Street's biggest monster
Behavioral Economics
America on the brink of a Second Revolution
ROI
7 myths and realities about taxes
The Economist's Corner
Never mind deflation, inflation's already here
On the Markets
Advisers are skeptical, which is a good sign
Tech Tales
Could RIM's new software be its future?
Home Economics
Read Full Article »