Last fall’s Republican congressional victories, coupled with growing concern over the federal budget deficit and periodic crises related to government shutdowns and debt ceilings, have brought tax policy back to the forefront of public policy debates.

We need to raise taxes on the fat cats say some, while others propose cuts in government spending. We need to be fair. We need to create jobs. We need to confront the reality of unrealistic promises coming due. We need to protect the most vulnerable among us.

As with all such debates, the issues soon become extraordinarily complicated, and competing advocates become increasingly strident.

As in all matters of tax policy, it is important to begin by focusing clearly on two basic facts — the base and the rate.

First, what is it we are going to tax? Second, what rates are we going to apply to potential taxpayers.

In our municipalities, the distinction is quite clear. We tax real estate, and we apply the same rate to all property owners. The debates are quite distinct.

We say to the assessor, “You think my property is worth WHAT!” And we say to the town manager, “You want to spend WHAT for a new Town Hall!”

With our federal income tax, in theory, the base is the income we earn and the rate is whatever rate we decide is “fair” — generally some percentage that rises as income goes up.

Unfortunately, both the idea of a clearly defined and universally understood base — think property value — has been lost in a muddle of credits, exemptions, deductions and rebates.

In 2008, the most recent year for which IRS statistics are available, approximately 142 million individuals and families filed federal income tax returns reporting a total adjusted gross income of nearly $8.3 trillion.

Of these returns, however, only slightly more than 90 million actually paid income taxes. Approximately 52 million filing returns paid no taxes.

Dividing the slightly more than $1 trillion in taxes collected by the 90 million paying returns yields an average tax per return of approximately $11,400.

If we divided the same $1 trillion in taxes by the 142 million who actually filed returns, the average tax would be about $7,200.

In other words, we’ve got about a $4,200 credit/exemption/deduction — call it what you will — spread out unevenly across all income levels before we even get to a discussion of rates.

Imagine town meeting with a 36 percent homestead exemption composed of thousands of separate forms for special credits and deductions. Not a pretty thought. And it would certainly make the issue of deciding what rate to apply to the remaining taxable property take a back seat to the debate over who got what rebates, credits and exemptions.

And that is precisely why a debate over our federal taxes and spending will always generate more heat than light until we get serious about digging into this crucial distinction between base and rate.

Individuals and families reporting incomes of $1 to $5,000 paid federal income taxes of approximately $77 million. Dividing by the approximately 500,000 paying filers in this category, the average tax paid is $153. Dividing by the 11.6 million total reporting filers in this category, the average payment would be $7.

Is the $146 difference going to the non-paying filers “fair” or better than a rate calculated on adjusted gross income? Without a deep dive into the tax code, who knows?

At the other end of the scale, 13,480 individuals and families reported adjusted gross incomes of $10 million or more. Of these, 13,374 paid income taxes.

Was the $49,000 per return difference between the taxes per paying return and the taxes per reporting return “fair?” It’s hard to imagine how, but its rationale is clearly there somewhere in a tax code our elected representatives made into law.

Looking at taxes paid and adjusted gross income, our federal income tax system is broadly progressive.

Those in the $1 to $5,000 income tax category pay 0.3 percent of their collective adjusted gross incomes. This rate increases up to those in the $500,000 to $1 million range, who pay 23.9 percent of adjusted gross income.

At higher income levels, the rate remains at about 24 percent before dropping to about 21 percent for the 13,374 in the $10 million plus category. Is this system “fair?” Who knows, because, as we have seen, taxes paid aren’t based on adjusted gross income but on a vastly different base called “taxable” income whose determination has nothing to do with tax rates.

So what’s the solution?

Simplicity. Drop the complicating, lobbyist generating, tax calculation industry supporting, financial crisis inducing difference between gross income and taxable income and start a discussion of fairness around the current flat tax rate of 12 percent.

How much less than 12 percent should those in the $1 to $5,000 category pay? How much more than 12 percent should those in the $10 million plus category pay?

And, most importantly of all, how far down and up from the middle should the 12 percent rate extend?

Charles Lawton is senior economist for Planning Decisions, a public policy research firm. He can be reached at:

clawton@maine.rr.com

 

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