AQR's head quant Cliff Asness, who as usual enjoys taking on what he believes is flawed conventional wisdom, takes on the topic of the Bush tax cut extension, and in typical fashion, presentd the upper class' view on things. What results is a piece that will likely not do much to bring the increasingly more polarized social and class extremes of America closer by even one bit.
The Bush Income Tax Cuts Were (Very Mildly) Progressive, posted in Forbes Magazine.
There is a perception that the Bush income tax cuts were a massive gift to the wealthy. Well, that's kind of true. But along with that perception seems to come the notion that they were massively regressive, benefiting the wealthy at the expense of the middle-class and poor. That's just not true.
The Bush tax cuts were ultimately a massive gift (generally I object to the notion that the government letting you keep more of your own money is a "gift," but I am using this sadly popular phraseology here for illustration) to everyone who pays taxes--the wealthy receiving a bit less than the middle-class, actually. A big part of the misunderstanding comes from a hard-to-kill confusion about marginal vs. total tax rates. A bigger part comes from something even simpler, only looking at what happened to the tax rates on the high earners and not even doing a comparison. Warning, there will be math in this op-ed.
Note, I am not writing this to argue that only a progressive tax cut is a good tax cut. The argument about how progressive/regressive the tax code should be is a topic for separate discussion. I am writing this solely to clear up a massive misconception. You can't read this essay and still call the Bush income tax cuts a giveaway to millionaires and billionaires, unless you're willing to admit it was actually a giveaway to all working people, with the middle-class getting the best deal.
To see why, let's review the basics using some made-up tax rates to make sure we are all on the same page. Say the marginal tax rate on your first $50,000 of income is 20% and on the next $50,000 of income is 40%. If you make $50,000 the tax rate is 20% or a total payment of $10,000. If you make $100,000 the tax rate is 30%, coming from a total payment of $10,000 on your first $50,000 of income, and $20,000 on your second ($10,000 plus $20,000 is $30,000 in tax divided by $100,000 in income or 30%).
Now let's examine someone making $1,000,000 and someone making $100,000 before and after the Bush tax cuts (using actual tax rates now). Pre-Bush the marginal tax rate on $1,000,000 was 39.6%, and on $100,000 was 28%. 39.6% to 28% is a ratio of 1.41x. I can't prove that ratios are the exact right way to look at this (for instance, if one person's tax rate is near 0% it gets kind of dumb), but it seems a reasonable starting point. So if one were to compare the marginal tax rate of someone making $1,000,000 to $100,000 they'd come up with a ratio of 1.41x and wrongly (as marginal rates make no sense for this) conclude that this is representative of the progressivity of the tax code.
Although his marginal tax rate is 39.6%, the far more relevant total tax rate on the guy making $1,000,000 is actually 36%, as only his income above $373,650 is taxed at 39.6%, the rest at lower brackets (a Congressional subcommittee decided on $373,650, as a round $374,000 would be a "giveaway to the rich" and $373,000 would be the start of a socialist revolution). The difference between marginal and total is much bigger at $100,000. The marginal tax rate at an income of $100,000 was 28%, but the total tax rate 20.5%.
Looking at ratios of income tax rates, the progressivity of total rates (which are clearly what are relevant) is much greater at 36% on the $1,000,000 in income divided by 20.5% on the $100,000, or a ratio of 1.76x vs. the 1.41x we obtained comparing marginal tax rates. Again, before even looking at pre- vs. post-Bush tax rates, we can see how a casual observer of the tax code who wrongly looked at marginal and not total tax rates could greatly underestimate the code's progressivity.
Now, of course, the punch line is what happened after the Bush tax cuts. The marginal tax rates at $1,000,000 in income fell to 35% (from 39.6%) and the total rate to 32% (from 36%). OK, so yes, high earners' tax rates fell a decent amount. But the marginal tax rate at $100,000 fell to 25% and more relevant the total tax rate fell to 17.4%. Comparing the total taxes paid on $1,000,000 to those on $100,000, progressivity actually rose a tad from the prior 1.76x to the new level of 1.84x (a tax rate of 32% on $1,000,000 divided by 17.4% on $100,000).
To put this another way, the total income tax rate on someone making $1,000,000 fell 11% from the Bush tax cuts. The total income tax rate on someone making $100,000 fell 15.3%. On this scale the Bush tax cuts were a progressive undertaking.
This is not particular to my choice of comparing an income of $1,000,000 to $100,000. Judged by how much their total tax rates fell, this is what happened for various income levels:
While the graph is a bit funky in the early income levels, it sends a clear message. Viewed through this prism total (not marginal) tax rates fell at least 10% for everyone, with considerable extra reduction for those earning under $45,000 and between $60,000 and $200,000.
What makes this observation uncomfortable (for some) is that it's precisely at odds with the popular notion that the middle class is being destroyed in this country, and that the Bush income tax cuts are one of the prime culprits.
One could take issue with my analysis. For instance, the Bush cuts in capital gains and dividends were undeniably regressive (which alone, again, doesn't make them bad or good). But there are plenty of high-income people without a lot of wealth who did not benefit greatly from this cut. This seems to separate the "working rich" from the rest of the rich more than the rich from the not rich.
Next, while not about the Bush cuts in particular, but the progressivity of our system in general, there are a host of other progressive taxes, features of the tax code, and transfer payments that mostly benefit the non-rich (such as Social Security, Medicare and even the capped deductibility of mortgage interest), but some that are regressive hurting everyone, but the rich less (like payroll taxes). This is clearly a complex issue and I'm only looking at one aspect of it.
But it's a pretty important and pretty misunderstood aspect. First, the tax code is far more progressive when viewed in terms of the correct total tax rate, not the misleading marginal tax rate. Second, considering federal income, and looking at it in terms of a percent reduction in a tax bill, the Bush tax cuts hurt the very high earners relative to middle-class earners (or put differently, helped the rich less than the middle-class). On this important scale, the Bush tax cuts were progressive.
I'm willing to bet that this is news to many.