Tax the Rich? Is It Really That Simple?

By Hightower Omaha on July 11, 2024

July 10, 2024

Today I wanted to take a stab at what it would take to get the federal government’s budget deficits under control. In this Market Commentary, I will focus on the tax revenue generated from individual income taxes as opposed to payroll taxes, corporate taxes, excise taxes and all other sources of federal government revenue. As discussed below, individual income taxes usually contribute a little less than half of total federal government revenues. I will be using recently released data from the Internal Revenue Service that summarize individual income taxes paid by income level. Unfortunately, this data is released with a significant lag, with the most recent data from 2021. Still, I think we can draw some broad conclusions using this data along with the historical data published by the Congressional Budget Office. 

Again, the most recent data we have is for the year 2021, a year in which the budget deficit was a massive $2.8 trillion, or 12.1% of GDP, compared to the long-term average (from 1962-2023) of 3.2% of GDP. The massive budget deficit in 2021 (which was actually lower than the deficit in 2020!) was due to a surge in outlays related to the COVID crisis. Those high government expenditures continued in 2022 and 2023 even as the economic effects of COVID began to recede significantly. In 2023, the federal government had total outlays of $6.1 trillion – still $1.7 trillion above the 2019 level – while the government’s revenues increased by just $976 billion compared to 2019. The net effect was a 2023 budget deficit of $1.7 trillion, or 6.3% of GDP – still almost double that long-term average of 3.2%. 

The first thing to note is that from 1962 to 2023, individual income taxes accounted for an average of 46% of total revenue for the federal government (Congressional Budget Office). That figure has been higher recently, coming in at 51% in 2021, peaking at 54% in 2022 and falling back to 49% in 2023. For our purposes today, I just wanted to make the point that individual income taxes as a percentage of total revenue are still above that long-term average and account for about half of the total. 

Next is a chart that shows the federal government’s historical revenues, outlays and budget deficits, all as a percentage of GDP. You can see that outlays (orange line) are still running well above revenues (blue line), resulting in a budget deficit (green bars) of 6.3% of GDP in 2023. 

Here’s where things get interesting. The pie charts below show the shares of adjusted gross income earned and income taxes paid by income percentile. You will see that the top 1% of earners accounted for 26% of total adjusted gross income and paid 46% of total individual income taxes. The bottom 50% of earners, on the other hand, accounted for just 10% of adjusted gross income and paid just 2% of total individual income taxes. The top 10% of earners accounted for 53% of total adjusted gross income and paid 76% of total individual income taxes. So my point is that a relatively small percentage of wealthy people are generating most of the income and paying the lion’s share of the taxes.

Next, I show the averages within each income group. As would be expected in a progressive tax regime, the highest earners are incurring much higher tax rates. The average taxpayer in the top 1% of earners reported an adjusted gross income of over $2.5 million and paid taxes of about $654,000, resulting in an average tax rate of 25.9%. The next highest earning group, those in the 95-99^th percentiles, earned an average of $376,000 and paid average taxes of nearly $71,000 for a tax rate of 18.9%. The bottom 50% of earners, though it’s hard to tell from the chart, earned an average of around $20,000 and paid average taxes of $667 for a tax rate of 3.3%. 

The next chart shows the breakdown of aggregate individual income taxes paid (blue bars) across the income spectrum along with the effective average tax rates paid (orange line). In the aggregate, the top 1% paid a bit over $1 trillion (46%) of the total $2.2 trillion in individual income tax revenue in 2021. The bottom 50% paid just $51 billion, or a little over 2% of the total tax haul. 

And finally, the next chart shows what it would take to raise an additional $1 trillion from individual income taxes by increasing the tax rates on the top 5% of earners but not changing the rates for the bottom 95%. By my calculations, the average tax rates would have to increase to 42% from 26% on the top 1% and to 35% from 19% on those in the 95-99 percentiles. That may not sound like a big increase, but we need to remember that tax rates in the lower tax brackets would not change due to campaign promises to shield the vast majority of taxpayers from tax increases. Because high earners get to take advantage of the lower tax rates in the lower brackets, marginal rates in the highest two income brackets would have to more than double from current levels in order to generate that additional $1 trillion in tax revenue. 

Would doubling marginal tax rates for incomes over $400,000 affect economic activity? You better believe it. We’re not talking about the uber rich here. There is simply no way to cover the massive deficits we have been running by raising marginal individual tax rates for the highest earners. Not even close. Putting a meaningful dent in the $2 trillion deficits we’ve been running (and well over $3 trillion in 2020) would require much lower spending and higher corporate tax rates as well. All of the options are politically and economically perilous. At some point, we will have to have serious discussions about the third rails of politics – entitlement spending (SS and Medicare) and defense spending. 

My message here is not a political one. I am just trying to highlight the size of the hole we’ve dug ourselves as a result of our chronically high budget deficits. I don’t have the answers, but policymakers need to recognize that you can’t get blood from a stone. The heavy concentration of wealth and income at the top, combined with high and rising corporate profits, likely means that affluent individuals and thriving businesses will at some point have to bear the brunt of the deficit/debt problem. That much seems fairly undeniable. The bigger question is how best to cut spending and raise revenues while avoiding a meaningfully negative impact on the economy. 

Peace,

Michael