“Joe the plumber” from Ohio had become an overnight celebrity when John McCain mentioned him 21 times on the last presidential candidates’ 90 minutes debate on Oct 15th. McCain has used him repeatedly since as the face of the claim that Senator Barack Obama, if elected, will raise taxes and hurt small businesses. McCain, Palin and their campaigns have also been pounding on and amplifying it further; they accused Obama being a socialist that has been one of the most derogative labeling in US politics, short of calling someone a commi.
While one may discount it as a desperate move of McCain’s in the final weeks of the struggling campaign, I was a bit concerned for a while since such an attack had worked against democrats before. Fortunately the odd is it would not work this time around, primarily because the lack of coherent and credible policies and ideas by McCain. Nevertheless this is an important issue and warrants a deeper look. As one reviews the video footage of Obama’s 2 minutes tax policy discussion with Joe the Plumber on the street (that is wonderful), one can see how Obama came to step onto a significant mine field of American politics when he said to Joe at the end “When you spread the wealth around, it’s good for everybody.”
Of course, such a comment can be interpreted in many different ways; that is where the fuss is about. At one extreme, it could be construed as a basic socialistic concept, that is exactly McCain is trying to do, where government, i.e., a centralized authority would “collect and re-distribute the wealth” to care for all somehow.
Being a federated nation where the revolution was started on a spark like the Boston Tea Party (protesting against the British’s unfair import tax policy of the colonies) in 1773, U.S. has had an interesting history and evolution of its tax system. Benjamin Franklin, one of the founding fathers, was quoted to have said “… In this world nothing is certain but death and taxes.” Thus the issue and debate were never about if there need be some taxes but rather who shall be paying for how much and on what bases. It would not surprise anyone that most of us react myopically and selfishly that the best tax policy is one that takes the least from “me” directly. Over the years, the result is the United States Internal Revenue Code, Title 26 of the U.S. Code (26 USC) that stands at about 8,000 letter-size pages long with over 3 million words. Indeed there is a huge industry of many segments whose primarily purpose in life is to support (and make a living of) the tax system from legislation through interpretation and implementation, to enforcement. To give you some ideas, the software giant Intuit whose popular TurboTax software dominates the market had generated over $700 million dollars revenue in 2006. Yet that is only 3-4% dollar wise of the tax preparation market that is dominated by professionals of CPAs and alike!
Perhaps more interestingly, it wasn’t until 1913 when the 16th amendment was ratified that Federal government could impose direct tax on personal incomes as the Constitution had previously required the federal tax be levied in proportion to each State's population. Today, tax structure wise, federal government generates (and spends) its revenue primarily through income tax of individuals and corporations of many flavors, big or small or one-person. On the other hand, state governments tax mainly on income and consumption, i.e. sales and exercise taxes and local governments tax mostly on wealth like property tax. All together, the total tax revenue is about 28% of our GDP. Note that according to the IRS statistics for FY2007, net collections of federal individual and corporate income tax were approximately 1.1 trillion and 370 billion dollars respectively. The rest, approximately 900 billion dollars, was mostly employment taxes such as for social security.
Thus the first take-away is that U.S. corporate income tax is quite modest unlike what McCain and many Republicans have been claiming (that American business needs more tax breaks because its top marginal income tax rate is 35%, one of the highest among developed countries.) The truth is that according to the recent OECD (Organisation of Economic Co-operation and Development) Report, the actual U.S. corporate income tax as a percentage of the GDP is at about 3.3% and is one of the lowest among the developed nations in the world. The only logical and intuitive conclusion is that thanks to pages and pages of all kinds of loopholes and tax credits/deductions for business by the congress with the “help” of lobbyists, marginal tax rate table does not tell us much about the effective tax.
Now let us turn our attention to the individual income tax that accounts for almost half and is the biggest chunk of the federal government revenue. There are tons of statistical data and analysis of all kinds on this for a long time. According to the IRS statistics of tax year 2006, there were about 135 million income tax returns (thus some include more than one person) with positive AGI (Adjusted Gross Income) after deduction etc. Out of these returns, about 43 million returns paid no federal income tax or in some cases, received refunds (note this does not suggest these returns are necessarily low incomes). Further the top 10 percent of those filings contributed about 70% of the total income tax revenue and the top 5% of those filings had AGI of at least 150+K dollars. This would probably explain Obama’s target and claim of tax breaks for 95% of people whose income (before adjustment) are below $250K. Thus it seems reasonable to expect his tax cut plan for modest and lower income families are doable since it accounts for less than 20% of the total federal tax revenue.
The more important question though is what observations and learning can one derive from these voluminous data; that is where different ideas, ideologies, and biases began to show. If you look at the analyses of these IRS data by conservative think tanks like the 2007 Hoover article or of conservative-leaning organizations like the recent Tax Foundation Report, you will notice that they highlighted the trend that the top individual income tax payers are accounting for increasingly more percentage of the total federal revenue. This is where the difference of conservatives vs. liberals lies: the conservatives argue this is unfair to the “rich” who would have to contribute to a larger share of the revenue. The liberals, on the other hand, noted that this proves that middle class hard working majority of Americans are not keeping up and falling further behind, not to mention the increasing populations of the poor and gaps (that drove down the % of contribution).
I have no desire to go into the debate of the impossible fairness question. It is more productive to look at the fundamentals so that we don’t get fooled by the half truths and labels. Let us be real; U.S. has had a long history of being a capitalistic society that is not going to change anytime soon. Further, a nation’s tax-to-GDP ratio is a more widely accepted quantitative indicator of degree of influence by government on social policies and how socialistic it is. Compared to socialistic democratic countries like Sweden and Denmark whose total tax revenues are close to 50% of their GDP, U.S. scored at about 28% and the tweaking of the marginal tax rates will not change much of anything; the socialism accusation of Obama’s is clearly a red herring.
I am not optimistic there will be any fundamental changes with the U.S. tax policy as there are too much imbedded interests and inertias. I do wish some smart guys would come up with a better policy that can simultaneously increase the total economic output, boost the middle class, and reduce the gap between the rich and the poor. Until them, I would be happy if the tax code can be streamlined and simplified significantly so that at the minimum, we do away with the wrong incentives and waste of non-productive work.
If McCain wants to engage in a more serious ideological debate, let me point out there are other indices of interest such as “happiness” (he doesn’t look very happy lately, does he?). Not that long ago, there was a Business Week report of a ranking of world’s happiest countries by researchers from Britain's University of Leicester. U.S. ranked 23rd in that study. And 9 out of the top 12 most happy countries including Canada, Denmark, Sweden have their tax-to-GDP ratios higher than U.S.’s (the other 3 were not available), and are more socialistic than U.S. in some sense. Senator McCain, just remember: keeping more money in your own picket does not necessarily buy you more happiness!
Talk to you soon!
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