The rich do pay taxes and other little-known facts

U.S. Rep. Alexandria Ocasio-Cortez created quite a stir Sept. 13 when she showed up at the Metropolitan Museum of Art gala with “Tax the Rich” splashed in red across the back of her white gown.

Ed Maydew

But is “tax the rich” just a catchy slogan or a viable economic policy? To find out, The Well asked faculty expert Ed Maydew, senior executive director at the UNC Tax Center and the David E. Hoffman Distinguished Professor of Accounting at Kenan-Flagler Business School.

“Taxes are a strange subject,” Maydew said. “There are few things that seem to generate more interest than tax proposals involving rich people and large corporations.” As with many decisions, there are trade-offs. In tax, often there is a trade-off between equity and efficiency. Efficiency considers the effects taxes have on production, incentives and the like. Equity refers to whether the tax burden is spread fairly over people.

“While researchers can help shed light on efficiency, we have less to offer about equity, because decisions about fairness depend on personal values,” Maydew said.

Are there are any common misconceptions about taxes and the rich?

Sometimes, I hear people say that the rich don’t pay anything. You can definitely find examples of rich people who pay less than you think they should, but overall the government is pretty dependent on upper-income taxpayers for its revenue. Like most countries, the United States has a progressive tax system, so higher-income people pay more tax in total and also pay a greater percentage of their income. In 2019, the highest income 1% of Americans paid about 25% of all federal taxes. The percentages vary depending on the kinds of taxes included, the measure of income, etc. How progressive the tax system should be is a debate that has been around for centuries.

Would the government collect more revenue if it increased taxes on the rich?

If you increase taxes on the rich — like the surcharge on income over $5 million that’s being proposed — it will raise more revenue, for sure. Will it also lead to more planning and avoidance? Yes. Because the higher the rate gets, then the incentive to restructure things to avoid that tax gets bigger and bigger.

For example, I like to run. So the optimal temperature for me running is around 55 degrees. When it gets to be 80 degrees, I’ll still try to go out and run. I just won’t run as far. There’s no magical number where I’m going to stop running. But every degree that you pile on, the less likely it is that I will run.

And so that’s kind of the way it is with taxes. It’s not like there’s some magic number where the world falls apart, but you start laying on higher and higher rates, and it will eventually discourage productivity.

What if the government increased the corporate income tax?

Taxing corporations can sound like a great idea. But the economic incidence ultimately falls on people. Part of that tax falls on the shareholders of the corporation, which tend to be wealthier people, and part of the economic incidence falls on the firm’s employees and customers.

Another issue is competitiveness. Just like companies compete for business, so do countries. Countries benefit from the jobs and investment that firms provide, and taxes are one way they compete. There’s an old saying that you don’t want to kill the goose that lays the golden egg. In this context, if you tax the goose too heavily, it may just decide to fly to the next pond. On the other hand, the goose may stay if the taxes are used to provide things it values like a clean environment, public safety, education for its goslings, etc. Taxes are just one factor.

About 50% of federal revenue comes from individual income taxes, 7% from corporate income taxes and another 36% from payroll taxes that fund social insurance programs. The rest comes from a mix of sources.

How could Congress make taxes more equitable?

That depends on your point of view. At one extreme, there’s something called a lump sum tax, where you split the cost of government equally. It exists only in textbooks because it’s perceived as very unfair. If you split the cost equally, you’d have people who don’t have enough money to pay for their share of the taxes.

There’s also a flat tax, in which you have a very broad base and a single, low tax rate. It has appeal from an efficiency and simplification perspective, but it’s also perceived as unfair by a lot of people. Why should the person making a million dollars a year only pay the same tax rate as the nurse at the hospital or a firefighter? Even though it’s the same percentage of income, it may feel like a heavier burden on the middle-income people.

In the Tax Reform Act of 1986, the Democrats and Republicans came together to reduce tax rates and broaden the base. It wasn’t a flat tax per se, but it brought tax rates down, which is generally thought to improve efficiency. But reducing the progressivity of the tax system also conflicts with some people’s notion of fairness. That’s just a trade-off you face.

So is there a brilliant tax policy idea that you think the government should try?

You could make a good argument for funding the Internal Revenue Service. The IRS really is an unpopular organization, so it has been popular to defund the IRS. That’s a risky thing to do. It’s wishful thinking to rely on people voluntarily sending their money to the government with little oversight. Good luck with that. It promotes cheating and it leaves a heavier burden on honest people. The money spent on the IRS tends to pay for itself because they collect taxes that would otherwise go unpaid.

What are some other examples of people putting a certain spin on tax policies?

You can phrase things different ways. One example I talk about in my class is the estate tax. The estate tax is a tax on the transfer of wealth at death. A couple of decades ago, there was a big push to repeal it or at least cut it back. And the people promoting repeal were very clever because, instead of an “estate tax,” they started calling it a “death tax.” It’s the same tax, but if you call it an “estate tax,” that conjures up images of people in top hats and the landed gentry. And people say, “Oh, yeah, we can tax them.” But if you call it a “death tax,” people say, “Why would you kick someone when they’re down? They just died. You’ve got this grieving family. And you want to tax them? That’s very unfair.”

Also, in the late 1990s, Congress got much smarter at marketing their tax acts. Before then, tax acts had technical-sounding names like “The Tax Reform Act of 1986” or “The Revenue Reconciliation Act of 1993.” Later, you started to get things like “The American Jobs Creation Act” and “The Working Families Tax Relief Act.” And ever since then, pretty much every tax act has positive words like “jobs,” “families” or “relief” in the title.

Ed Maydew is one of the authors of “Taxes and Business Strategy,” now in its sixth edition.