Eric T. Thoele Income Tax Inequalities Intermediate Macroeconomics EC3100 Rockhurst University Dr. Gerald Miller 03/31/05
Executive Summary 1) The Origin and History - This gives the basic background of the income tax system in America. It explains issues that will enable the reader to understand the drastic changes over the decades in the tax system. This in regards to the drastic inequalities in the tax schedule, the change in the percentage of Americans affected by income tax, and the policy changes in order to support the governmental budget. 2) The Filing Day - This is a brief history of the reason the income tax filing day is actually on April 15 th. This is merely a side piece of interesting information for the reader. 3) The Current Taxing Schedule - This is an explanation of the way that the current income tax system is setup. It explains the different classifications that people can label themselves under and also at which level of income to which they belong. With these two characteristics set, an appropriate, but unequal amount of money can be established as the amount of taxes the individual owes. 4) The Tax Inequality - This is the beginning of the focus of the paper where the true inequalities of the paper come to the surface. The progressive tax is not the fairest tax to all citizens no matter their financial situation. A flat tax would be more equal to all. 5) My Thoughts - This section lays out my proposed plan to make the income tax system free of inequalities, but still able to look out for the well being of its fellow man or woman.
The U.S. tax system contains many variations with regard to the amount an individual must pay to the Internal Revenue Service (IRS). It is actually possible for someone in a higher tax bracket to pay out less money than someone in a lower tax bracket, which in reality should not be the case. There are so many loop holes and different types of write-offs that individuals can use. And in some instances it is completely unfair, but at the same time legal. The tax system is also setup were the lower parts of the tax bracket actually pay out a lower percentage of earnings than someone in a higher the higher tax brackets. Thus one can see the inequalities in the tax system. It is An inequality is defined as social disparity or the disparity of distribution or opportunity. clear that some individuals are not getting the same opportunity on a percentage scale, but on the other hand individuals in the higher tax brackets have more money and are what we call today, welloff. The Origin and History In order to fully understand these tax inequalities one must begin to look at the beginning of the idea of taxing to raise money to fund the governmental budget. The IRS is the government entity that is in charge of the taxing system in the U.S. The origin of the income tax on individuals is generally cited as the passage of the
16 th Amendment, passed by Congress on July 2, 1909 and ratified February 3, 1913; however, its history actually goes back even further. Its roots trace back to the Civil War when President Lincoln and Congress, in 1862, created the Commissioner of Internal Revenue and enacted an income tax to pay war expenses. The first income tax was implemented with a 3 percent tax on incomes between $600 and $10,000 and a 5 percent tax on incomes above $10,000. The income tax was repealed 10 years later. Congress revived the income tax in 1894, but the Supreme Court ruled it unconstitutional the following year. In 1913, the first Form 1040 was used. This form is now filled out when one first starts a job and it states how many dependents they are claiming, how much money they want withheld from their paycheck, etc Also in 1913, Congress levied a 1 percent tax on net personal incomes of individuals above $3,000, which is equivalent to about $36,000 in today s terms, with a six percent surtax on incomes of more than $500,000. This figure may seem sensible and worthwhile, but only less than 1 In 1918, some 85 percent of American households paid no income tax at all, and almost 80 percent of federal income tax revenue came from the top one-half of one-percent of households. percent of U.S. citizens actually made enough money in 1913 to reach the first income tax bracket. This is the first difference from the current tax system were nearly every citizen makes enough money to pay income
tax. This was clearly unequal and as one can see it has been changed today. In 1918 the First World War was lacking the necessary funds, so the Congress raised the income tax up to seventy-seven percent in some tax brackets. Again, the government did not plan ahead so they took it out on the citizens and increased taxes over a short period of time. This is neither a good strategy nor equal to the different income levels of the U.S. citizens. This would be an overbearing load for the working people of America today, but it really did not even affect them at all back then. During this time, some 85 percent of American households paid no income tax at all, and almost 80 percent of federal income tax revenue came from the top one-half of one-percent of households. Contrary to popular belief these days, the general public saw this as an acceptable means of being taxed. By the middle 1920 s, 75 percent of the overall income tax revenue came from the richest 1 percent of the public. These high rates remained throughout the war, but then dropped back down to twenty-four percent in 1929. Such rate fluctuations are not fair to the U.S. citizen that is trying to plan for having children, sending them to college, or preparing for retirement. Instability is unfair. Once again taxes went up. This time it was due to the Revenue Act of 1942 because of The Great Depression, which raised taxes and increased the number of Americans subject to paying income tax. Between the years 1938 and 1948 the number of Americans that actually
fell into a paying tax bracket increased ten fold. Thus this act cut the number of exempt low-income citizens in half. The cut off was at $600 there is no reason that any could not still live even a lavish life off a disposable income of $1,260,000 a year. per year, which equates to about $6,300 in today s monetary terms. The rates at the top half of the tax bracket rose dramatically to a near ridiculous percentage. Those individuals making more than $2,000,000 paid out 94 percent of their earnings to the federal income tax. This is one of the largest inequalities in the tax system, which was eventually worked out. Granted it happened nearly 60 years ago, but it was in no way creating an equal tax system in the U.S. One should make note that the value of money has grown by is 950 percent from the middle 1940 s to the present day time. The $600 tax exempt cut off back then equates to $6,300 today, and the $2,000,000 top tax bracket back then would be equivalent to $21,000,000 in today s monetary terms. The percentage is large and nearly ridiculous, but there is no reason that one could not live even a lavish life with a disposable income of $120,000 per year back then, or $1,260,000 today. The Revenue Act of 1942 also created new deductions, so that individuals could write off certain fixed expenses to ease the tax burden that had been increased. Then in 1943 Congress passed the Current Tax Payment Act, which required employers to withhold taxes from employees wages and remit them quarterly. In 1944, Congress passed the Individual Income Tax Act, which created the standard deductions on
Form 1040. This was the beginning of the individualization of taxing in the U.S. In the 1952 President Truman put forth a plan that reorganized the IRS and replaced the old patronage system with the new career civil services system. This plan also implemented other aspects, which sought to restore public confidence in the system and emphasize service to the taxpayers. During this time in 1952, a worker making $8,000 (about $46,000 in today s dollars) paid about the same effective rate as a millionaire twenty-five years before. This goes to show that the Federal income tax system was never really a fined tuned instrument to create governmental revenue. It has been undergoing a constant process of being refined to be as fair as possible in the government s eyes. The tax system underwent a minimal amount of changes until 1998 when the IRS Restructuring and Reform Act was put into play. This Act restructured the IRS to make it more efficient and had certain departments concentrate only on their field. For the taxpayers, this act established the Taxpayer Advocate Service, which sought to assist with problems that have not been resolved through normal channels. Each state also has at least one local taxpayer advocate who reports directly to the National Taxpayer Advocate. The taxpayers now had an independent voice inside the agency that was on their side and had no real affiliation with the IRS that would tempt them to agree with the IRS over the taxpayers. The Filing Day
The day which every American dreads each year is April 15 th. This is the day by which every U.S. citizen must have their tax forms filled out and sent into the IRS for processing. There is an interesting story behind the determination of the filing date being April 15 th. One story revolves around the notion that only the wealthy paid income taxes and they tended to spend their summers vacationing. Thus the government had to collect the taxes from them before they left town, so a time before the summer was hypothesized. March 1 st was the original filing date set by Congress back in 1913, but the date was moved forward to March 15 th 5 years later. This date stayed as the norm until 1954 when the date was again pushed forward to April 15 th. This later date did however serve two purposes it gave the IRS more time to handle the work and, more importantly, more time to hang on to your money before issuing you a refund. The implementation of the withholdings of parts of paychecks enabled the government to use some of the tax money ahead of time. They had more equity for longer periods of time, the money could gain interest for a longer period of time, etc The Current Taxing Schedule Now we jump to the present day in the history of income tax. At this time the income tax system breaks down every citizen into certain groups. These different groups are defined as tax brackets. Individuals are classified under one of four main categories; single, married filling
joint or qualifying widow, married filing separately, or head of household. Once the individual has identified themselves under one of the previous categories they then fall into a certain income range from say $29,700 to $71,950 or $150,150 to $326,450. These monetary amounts are in terms of annual income per individual or the couple depending on the first selection. Within each of these brackets an individual must pay out a certain amount of taxes according to set rate, which is usually the maximum amount from the bracket below them and a set percentage of income on anything above that until they reach the next bracket. This is illustrated in Table #1 on the following page. Table #1 Single If taxable income is over-- But not over- - The tax is: $0 $7,300 10% of the amount over $0 $7,300 $29,700 $730 plus 15% of the amount over 7,300 $29,700 $71,950 $71,950 $150,150 $150,150 $326,450 $326,450 no limit $4,090.00 plus 25% of the amount over 29,700 $14,652.50 plus 28% of the amount over 71,950 $36,548.50 plus 33% of the amount over 150,150 $94,727.50 plus 35% of the amount over 326,450
Married Filing Jointly or Qualifying Widow(er) If taxable income is over-- But not over- - The tax is: $0 $14,600 10% of the amount over $0 $14,600 $59,400 $1,460.00 plus 15% of the amount over 14,600 $59,400 $119,950 $8,180 plus 25% of the amount over 59,400 $119,950 $182,800 $182,800 $326,450 $326,450 no limit $23,317.50 plus 28% of the amount over 119,950 $40,915.50 plus 33% of the amount over 182,800 $88,320.00 plus 35% of the amount over 326,450 Married Filing Separately If taxable income is over-- But not over- - The tax is: $0 $7,300 10% of the amount over $0 $7,300 $29,700 $730 plus 15% of the amount over 7,300 $29,700 $59,975 $4,090 plus 25% of the amount over 29,700 $59,975 $91,400 $91,400 $163,225 $163,225 no limit $11,658.75 plus 28% of the amount over 59,975 $20,457.75 plus 33% of the amount over 91,400 $44,160.00 plus 35% of the amount over 163,225 Head of Household If taxable income is over-- But not over- - The tax is: $0 $10,450 10% of the amount over $0 $10,450 $39,800 $1,045 plus 15% of the amount over 10,450 $39,800 $102,800 $5,447.50 plus 25% of the amount over 39,800 $102,800 $166,450 $166,450 $326,450 $326,450 no limit $21,197.50 plus 28% of the amount over 102,800 $39,019.50 plus 33% of the amount over 166,450 $91,819.50 plus 35% of the amount over 326,450
This chart is the most recent income tax schedule, which is for the 2005 fiscal year. But since 2001, the boundaries for the different tax brackets have been raising at an average of 2.2 percent per year. In the 4th bracket * Estimation Single Begin End 2001 $65,550.00 $136,750.00 0.024409 *2002 $67,150.00 $140,100.00 0.024572 2003 $68,800.00 $143,500.00 0.022529 2004 $70,350.00 $146,750.00 0.022743 2005 $71,950.00 $150,150.00 N/A This is based off the fourth tax bracket working from the bottom up for individuals that file as a single. This tax bracket was chosen for the simple reason that most of the middle class is classified within this particular tax bracket. The classification of single was chosen because it is what the other classifications are based off of. Married filing jointly or qualifying widow(er) is simply double that of filing as single, and married filing separately has the same pay out schedule as single does. The head of household filers pay out a little bit under the average between single filers and married filing jointly or qualifying widow(er). The stipulations for the tax schedules differences will be explain in the next paragraph. There are no real inequalities to be found in the way individuals classify themselves to be put into their respective categories as they have been labeled. The system obviously accounts for the married couple that is filing together, which can easily be seen to be two single filers. As previously stated, single filers pay just half of married joint filers. Individuals that file as head of household do not necessarily take
advantage or exploit any inequalities for one particular reason. They are the individuals that provide more than half of the expenses to run a household in a given year. They are given a tax break, because they are already supporting the monetary weight of providing for at least half of all the individuals that they have claimed within their household. The Tax Inequality The real income tax inequality stems from the fact that with each increasing level of tax brackets the percentage rate at which an individual s annual income is taxed grows exponentially. This is type of tax is classified as a progressive income tax, because those who make more, actually pay more in both percentage and dollar amounts. In Table #1 under the Single category, which is our default example, displays the simple guidelines of the income tax schedule. Chart #1 (next page), shows this in a graphical form by which one can truly see the dramatic inequality increase in income tax percentage rates beginning from the lower tax brackets from Table #1. The higher tax brackets show a decreasing rate of the increase of income tax rates.
Chart #1 (Data taken from Table #1: Single) Tax Rate Schedules 2005 Annual Income $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $0 0% 10% 20% 30% 40% Tax Rate My Thoughts This chart graphically displays the exact inequality for which this paper was written about. The beginning of this paper was used to build the mind set and the history of how easily the income tax rates have been changed. Inequalities arose for such reasons as funding world wars or fighting the depression. Such fluctuations in tax rates are not even considered in today s economy, for such jumps in income tax rates would most likely bring the U.S. economy to a stop. Also in those pages was the set up how individuals classify themselves under the income tax schedules with regards to income level and classifications with regards to living situations. I would like to propose the idea of a proportional or a flat tax. This type of tax requires every tax paying individual to give up a certain, consistent percentage of their income to pay to the government for income
tax purposes. Every qualifying citizen would pay an equal percentage of their income to the government. This in my opinion is an equal system of income taxation. I believe a twenty-seven percent tax rate would be a fair rate for all individuals that make above $25,400 a year. This would I believe a twenty-seven percent tax rate would be a fair rate for all individuals that make above $25,400 a year. allow for the individuals who earn $25,400 a year to make enough after-tax income to be just above the poverty level. This would give them an after tax income of $20,000, where the poverty level is at $19,000 per year (Miller, Gerald). This clause would be implemented in order to help the less fortunate workers of America; not to create an inequality that I am trying to eliminate. Something is really only an inequality when a situation is unfair. Taxing the person that already lives below the poverty level and makes only $6,000 a year would be unfair to that person and unethical in my mind. Allowing individuals in situations such as that to be taxed would be putting a strain on the U.S. economy. It would push individuals out of their jobs, because it would seem to them that their little amount of money is going straight to the government without a return. Any fair tax system should not drive its own people farther down into poverty in order for it to create revenue. Rather it should help shelter them, if not help them on the road out of poverty.
Upon further evaluation, a hole was found in my proposal. There seemed to be no incentive for an individual to earn any more money over $20,000. Once they reached an annual income of $20,001 the 27 percent tax would bring an individual s disposable income down to $14,600. To account for this situation, every individual that makes between $20,000 and $25,400 per year will pay the difference over $20,000 up to $5,400. This would in essence create three different tax brackets but not any inequalities. If taxable income is over- - But not over- - $0 $20,000 Nothing is paid out The tax is: $20,001 $25,400 Pay the difference above $20,000 up to $5,400 $25,401 no limit Pay 27% of the amount of income These brackets do not create inequalities, but instead follow the laws within my train of thought that have been instilled in me. Every individual should be given the right to live a good life and prosper in society. I am merely trying to follow a moral law of equality, which is respectful of every human. Just as the current tax system works, I would use the same categories by which each individual should classify themselves; single, married filing jointly, qualifying widow(er), etc I would however not allow the married filing separately category. This is to prevent a married couple from creating an inequality by cheating the system out of taxes that should be going to the government. Take for example a doctor that makes $500,000 a year and a childcare worker that makes $20,000 a year.
The childcare worker could file separately and cheat from paying $5,400 in taxes. There is really no need for a couple to gain $5,400 on top of their $365,000 disposable income in order to have a decent lifestyle. They would already be classified as a wealthy family. I am certain that if these measures were taken, the inequalities in the tax system would be nearly washed away in every possible stand that could be taken on the subject. One last issue to look at is the amount that the revenue from taxes will be decreasing by. I do believe with the carelessness that we throw around the national debt figure, and do nothing about it the U.S. economy will not be hurt that much. The national debt is at $7.78 trillion as of April 27, 2005. There have been no plans to pay it back lately and in reality there would little reason to have Treasury Bonds if the government had no need to obtain money. Even then it would be a on and off market when the government would issue bonds and I imagine that the risk would be greater and less appealing to potential buyers. As long as the interest payments to the banks are paid enough not to hurt the banks that help support our economy we will be fine. In addition, government usually finds a way to cut costs and minimize the increasing deficit. Equality had by all, will be upon us shortly.