The majority of the American population are taxed at high levels, yet the country continues to run a deficit. We will look at the primary factors explaining the current tax situation in the United States.

History

The past 100 years have presented broad patterns in American tax policy. (For more, see: What Is Fiscal Policy?) During the 1920s, income tax rates were above 70 percent on the top earners. For the roughly fifty years following the Great Depression, between 1932 and 1981, income taxes on the most wealthy were typically above 60 percent. A wide middle class emerged over this period of time, characterized by social mobility and strong economic conditions that propelled the United States to its global economic predominance. When President Ronald Reagan came into office, this pattern of tax rates diverged. He instigated top tax rate cuts, which have continued to follow a downward trend. (For more, see: The History of Taxes In The U.S.)

Present

Our current tax policies reflect an extension of President Ronald Reagan’s tax cuts in the 1980s, particularly on the highest income earners in the country. In contrast, the middle class are taxed at higher rates than are the top quintile of Americans. In 2010, approximately 80% of the government revenue was from personal income taxes and payroll taxes. “The mega-rich pay income taxes at a rate of 15 percent on most of their earnings but pay practically nothing in payroll taxes. It’s a different story for the middle class: typically, they fall into the 15 percent and 25 percent income tax brackets, and then are hit with heavy payroll taxes to boot,” says Warren Buffet in the New York Times. (For more, see: The Most Controversial Tax Deductions.)

For the State of the Union Address, President Obama presented proposals to reconfigure the tax system that would increase taxes on the wealthiest individuals and largest firms in order to decreases taxes on middle class Americans. These changes would provide room to fund education, retirement savings, and triple child care credits. Many elements of his proposals prompted criticism. In response to his proposal, Republican Senator Orrin G. Hatch, chairman of the Finance Committee stated that these tax increases, “…only negates the benefits of the tax policies that have been successful in helping to expand the economy, promote savings and create jobs.”

Many Republicans claim that lowered taxes on the wealthiest support a growing economy and job creation. However, competing claims have found that tax cuts on the top income earners create a downward trend in real per capita GDP.

According to research, countries that have decreased their tax rates on the top earners have not grown at a faster rate than those who did not. Take, for example Germany or France, who both have growth at approximately the same rate as the United States and the United Kingdom, without instigating significant tax reductions for the most wealthy.

While taxes on the top earners have remained low in the U.S., other patterns have emerged including an aging population, lowered social mobility and a rising deficit. 

Demographically, the population is aging at a faster rate and the need for healthcare is continuing to rise. According to a report from the Congressional Budget Office, by 2025 Social Security spending will increase from 4.9 percent to 5.7 percent of the economy and health care spending will rise from 5.3 to 6.2 percent.

As the economy continues to mend, research has shown that social mobility has declined. According to a Pew study, a child born in the lowest quintile has a 4% chance of reaching the top quintile in his lifetime. These measures are lower than both in Canada and in the majority of Europe. Social rigidity is not only affecting the lowest earners, it is also affecting the middle class.

When you look at the fiscal path of the United States, the national debt is near record levels, and is projected to grow over the long-term. On one hand, significant fiscal progress has been achieved in recent years; however, according to the report from the Congressional Budget Office, by 2025 the amount spent to pay for the national debt will double from 1.5 percent to 3 percent.

Federal Deficit

Let us consider how the economic and tax climates have changed since 1993, the last time the United States experienced a surplus budget. Lawrence Summers, who was Undersecretary of the Treasury at that time explained it this way, “In 1993, here’s what the situation was: Capital costs were really high, the trade deficit was really big, and if you looked at a graph of average wages and the productivity of American workers, those two graphs lay on top of each other. So, bringing down the deficit, reducing capital costs, raising investment, spurring productivity growth, was the right and natural strategy for spurring growth.” However, economic conditions have changed, affecting the approach to the deficit debate. “Today, the long-term interest rate is negligible, the constraint on investment is lack of demand, productivity has vastly outstripped wage growth, and the syllogism that reduced deficits spur investments and you’ll get more middle-class wages doesn’t work in the same way." Summers claims that in the 1990s a hawkish approach seemed to fit the economic logic. Now an expansionary bias may support one approach to deficit spending.

The Bottom Line

Even as the American economy has seen some consistent growth since the crash of 2008-09, these benefits have not been realized by either the majority of Americans or by the federal budget. Tax policies are complex. Currently, taxation on Americans remains high (with the exception of the top 1 percent). Moreover, the sustainability of the tax system remains under question to generate enough long-term revenue for the federal budget, under present tax policies.

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