Washington has a mess on its hands.
To close the budget gap and start paying down the nearly $15
trillion in debt we've already incurred, legislators will have to
make some very tough choices regarding which programs to cut.
Defense, education, transportation, social security, homeland
security -- none of these will be spared the budget cutter's
How many cuts take place will depend on changes in tax policy -- a
subject that seems to rub everyone the wrong way, regardless of how
they feel on the issue. The overwhelming consensus (or at least the
loudest) is that corporations and individuals alike are already
The trouble is, history argues otherwise. If anything, taxes are at
a multidecade low thanks to major tax breaks granted by both the
Bush and Obama administrations.
Don't believe me? Let's look at the numbers.
Back in the early 1950s, corporate America paid enough in taxes to
account for roughly 5% of the size of the U.S.
. Not anymore. This figure now stands at 1%.
with more than $100,000 in
is supposed to pay a roughly 35% tax rate. But few companies
actually pay that. Instead, the last few decades have seen an
explosion of corporate tax loopholes for research and development
(R&D), energy exploration and many other goodies.
In fact, M
all paid a tax rate below 20% in 2010 thanks to all the loopholes
in place. And they were comparatively lucky.
Morgan Stanley (NYSE:
paid less than 12% of their income to the tax man.
By collecting fewer taxes from corporations, other taxpayers must
take up the slack. In 1934, individuals paid $420 million in taxes
and corporations paid $364 million -- a roughly 54%/46% mix.
By 1950, individuals were paying 58%. In 1960, it had grown to 68%.
In 1990, it was 77%. Today, individuals pay 83%, meaning that less
than a fifth of federal taxes come from corporations. It looks like
decades of corporate lobbying have really paid off.
Still, many legislators insist that companies are overtaxed, so
they repeatedly push for the 35% tax rate to drop to 25%. This can
be accomplished, but only if many cherished loopholes such as the
R&D tax credit, the ability to write off the expense of
corporate jets, the capital-gains tax rate (of 15%) on investment
money managers, etc. are abolished.
What about individuals? Are they overtaxed relative to history?
No way. For starters, roughly half the U.S. population pays no
thanks to the earned Iicome tax credit (though they are heavily
taxed in terms of gas taxes, user's fees, state and local taxes,
etc. so characterizing them as freeloaders is a bit unfair).
ks to tax cuts established under George W. Bush and maintained by
President Obama, tax rates for the upper and middle classes have
been reduced since the 1990s. The top 1% in particular has seen a
notably sharp drop in effective tax rates, thanks to a virtual
explosion of tax shelters cooked up by accountants. According to a
study conducted by the
Detroit Free Press
, the top 5% of earners in 2009 paid an effective rate of 20%.
So if the top earners and bottom earners are doing okay, what about
the middle class? That seems to be the heart of the emotional
debate about taxes. Many will tell you it's getting harder by the
year to make ends meet, and they instinctively assume that rising
taxes are part of the problem.
According to the Brookings Institution, a family of four in the
exact middle of the income spectrum paid only 4.7% of its income in
federal income taxes in 2010, the third-lowest percentage in the
past 50 years, after 2008 and 2009.
Here again, those in the median income range have gotten tax
breaks, even when they don't notice it. When the Obama
administration took office, it enacted a payroll tax holiday to
boost the size of people's paychecks. But pollsters found that the
majority of Americans had simply not noticed their paychecks had
suddenly grown larger.
The real squeeze on the middle class: income. Wages have been
stagnating for nearly two decades, even as the cost of many items
keeps rising. This is the flip side of a world where corporations
are boosting record profit margins by keeping a tight lid on
OK, so if corporations and most individuals are paying less than
they used to (as a percentage of income), what does it
for the government's income?
A February 2011 article in
noted "federal tax receipts will equal 14.8% of the
gross domestic product (
, the lowest level since Harry Truman was president." Meanwhile,
government spending, which averaged 20.8% of
from 1971 through 2010, is at its highest level since World War II,
as the following chart shows.
Social programs such as unemployment benefits, along with rising
defense spending and an increasing number of people on Medicaid and
social security get much of the blame.
Not only do lawmakers need to close the taxation (14.8%) and
spending gap (25.36%), but they also need to start paying back past
Looking at all these factors, it's clear that everyone will need to
pull their weight to help pull us out of this morass:
- As Warren Buffett suggests, the very rich need to stop
standing by loopholes and pay their share (he specifically calls
for a 35% tax rate on those earning $1 million or more and
boosting the capital gains rate to the ordinary income tax rate).
- Companies need to be sure that they are paying salaries that
can truly sustain a middle class family in these toughening
- Companies also need to start parting with vigorous tax
breaks. (Do we really need to give
tax incentives to look for oil?)
- Individual taxpayers need to start accepting the reality of
tougher health care and retirement cost structure.
- Defense hawks have to settle for a pullback in our vast
Of course, it all starts at the top. Washington needs to show
leadership to help us see the tough choices we face.
So as we turn the corner to the upcoming election year, these are
the questions you should be asking yourself and potential
If any tax hikes are out of the question, then what sacrifice will
you make? A smaller military? Larger classroom sizes? Fewer police
officers and fire fighters? Reduced medical benefits for the
elderly, indigent and veterans? Bridges that operate long before
the intended useful life?
Each of us is willing to identify specific sacrifices that others
find unnecessary. For example, I have no children so I am not a fan
of my ever-rising school taxes. (Then again, I want to live in a
society where the next generation is as well-educated as my
generation.) I live in a low-crime area and question why my town
needs such a large police force. Then again, what would crime
levels in my town be like if there were fewer police officers? I
drive a lot, so strong bridges are important to me. If you live in
a city, that's not as much a priority.
Action to Take -->
The real takeaway is that there is no free lunch. We simply can't
afford to make our individual choices when it comes to taxes and
spending. We must find a middle ground that (mostly) satisfies all
One thing's for sure. Without a real solution -- and fast -- our
fiscal mess gets only deeper.
-- David Sterman
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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