Tax Freedom Day 2008

The following is a guest post from Marotta Asset Management.

This year we celebrate Tax Freedom Day on Wednesday, April 23. That's the day we stop working for the government and start working for ourselves. For average workers, all of our earnings for the first 113 days of the year go to pay federal, state and local taxes. Starting April 24, we are free--at last--to take care of our own family's needs.

The nonpartisan Tax Foundation based in Washington, D.C., measures the tax burden on Americans every year. According to its 2008 report, published in March, this year's federal Tax Freedom Day comes seven days later than it did in 2003. Interestingly, the day falls three days earlier than it did last year. This decrease in taxes is the result of the slowing economy and a onetime fiscal stimulus tax cut.

Because of our progressive tax system, Uncle Sam usually collects more taxes as inflation rises, owing to "bracket creep." As your income growth keeps up with inflation, your purchasing power remains unchanged. But as inflation drives you into a higher tax bracket you pay higher taxes.

On average, taxes take nearly 31% of a worker's gross income: 20% for federal taxes and 11% for state and local taxes. For every eight-hour day, 2 hours and 28 minutes of our labor is spent paying taxes. Without taxes, you could leave your job at 2:32 p.m.

Only since 1992 have Americans paid more for government programs than we spend on food, clothing and medical care combined. For the amount of money we pay in taxes, the federal government could provide universal health coverage and feed and clothe us as well.

At the state level, Tax Freedom Day varies depending on location. California has moved up from the 7th to the 4th highest level of state taxes with its Tax Freedom Day now delayed until April 30. Virginia has risen from 17th to 12th in the race for the highest state tax rate, even though its liberation day arrives on April 25, only two days later than the national average.

The Virginia tax rate continues to climb higher each year, despite claims of no new personal taxes because of both bracket creep and the significant increase in state business taxes. This situation reflects a national trend. Business tax receipts have risen sharply over the past two years.

Most non-economists vastly underestimate the negative impact of taxes on the U.S. economy. Taxes encourage every American to do things themselves, outside of the taxable economy, even if specializing and working together would mean greater productivity. If you add the costs of complying with the complex web of regulations, the federal government costs us Americans collectively more than 50% of our wealth.

Imagine three contractors who could build three houses if they worked separately. If they collaborated and combined their expertise, however, they could build six houses instead. It may seem incredible that these builders would not take the opportunity to double their productivity, but with any tax rate higher than 50% they have no incentive to choose the more productive partnership. Putting their production into the taxable economy means they have to pay more than three houses in taxes. A 50% tax rate halves their productivity. Envision the economic boom if the other half of workers' labor were set free!

Imagine a skilled surgeon who has a marginal tax rate over 50%. Everything she pays someone else to do costs her twice as much because she pays with after-tax dollars. From a societal point of view, it is inefficient and wasteful for her to mow her own lawn, change her own oil or paint her own house, but specifically because she is in a high tax bracket, she can save more money than the average American by doing those chores herself. Another way to look at it is that without taxes, she could afford to pay twice as much to those who provide her these services.

Economist Arthur Laffer recognized that the law of diminishing returns applies to tax rates as well. According to Laffer, at a certain point, increased taxation actually yields the collection of fewer tax dollars. As we near a 100% tax rate, we approach driving commerce into the ground and collecting no taxes.

Many economists believe we are still beyond the point of diminishing returns. In other words, tax cuts would actually result in increased economic growth and more taxes being collected.

Presidents Kennedy and Reagan understood the Laffer curve well. In 1964 Kennedy reduced the top marginal tax rate from 91% to 70% and, to many people's surprise, tax revenues increased. Seventeen years later, the Reagan tax cuts reduced the top marginal rate from 70% to 50%. Again, revenues soared. Between 1980 and 1997, the share of federal income taxes paid by the top 1% rose from 19% to 33%. The share of taxes paid by the top 25% increased from 73% to 82%.

The top 1% now pays 34% of the taxes in the United States. Do you know how to join the top 1% of taxpayers? Just sell a house in California. The top half of taxpayers pays almost 96% of the income taxes, meaning the bottom half pay just 4%. These two statistics have increased despite all the complaints that tax cuts favor the rich.

Economists understand that the optimum rate of taxation is zero. The second-most ideal is as low as possible. In contrast, many Americans seem to believe that tax rates should be increasingly punitive. One notable exception is Alaska, where Tax Freedom Day arrived weeks ago on March 29.

Low taxes should not be a political issue that divides us. Every American should agree with the goal of keeping taxes as low as possible. In 2011 all of the federal tax cuts enacted since 2001 are scheduled to expire. If this happens, Tax Freedom Day will move an entire week later. In the words of John F. Kennedy, "An economy hampered by restrictive tax rates will never produce enough revenues to balance our budget--just as it will never produce enough jobs or profits."

Comments

[Jake]

I've been reading this blog for almost two years. The next Marrotta post I read here will be the last. Not that you, FMF, should be held hostage by the opinions of one reader, but that you should at least be aware of them.

And I do not know of a single serious economist who thinks we are still past the point of diminishing returns on the laffer curve. This was painfully clear even before the latest Bush tax cuts and is more clear now. Maybe if Marotta Asset Management had a single economist, CFA, or CFP among their financial planners they would be aware of this.
http://www.cbo.gov/ftpdocs/69xx/doc6908/12-01-10PercentTaxCut.pdf

Anyway, regardless, my guess is that the blog will continue to publish drivel from Marotta, including the often-repeated LIE that freaking TBILLS are the riskiest investment in the world, and if my guess proves correct, this reader will be gone forever with no further fanfare. Frankly I have better things to do with my time than to read from a source that does not seem to care about the innaccuracies and dishonesty of its content. I sincerely hope that FMF will choose another, more credible and accurate source for this kind of content.

[FMF]

Jake --

Good luck to you.

As I've stated before, this blog is about letting all sorts of monetary opinions be expressed -- including those of Marotta's. I'm not going to be "held hostage" by anyone threatening to leave because of this post or that post (believe me, there's at least one person who hates something about every post I write.) If I started posting pieces based on the fact that "everyone will like them", I'd soon have nothing to say.

I truly hope you can find a site where you agree with 100% of what's being said. I haven't found one yet (including this one.) ;-)

[Lily]

Jake is right, even if he's a little too fired up.

"This year we celebrate Tax Freedom Day on Wednesday, April 23. That's the day we stop working for the government and start working for ourselves."

"Working for the government" is still, to a small degree, working for ourselves. Unless you want to pave your own roads, maintain your own police force, enforce your own drug and food standards ...

"On average, taxes take nearly 31% of a worker's gross income: 20% for federal taxes and 11% for state and local taxes."

Still less than the more socialist countries in Europe. I'm not saying we should move to, say, the Swedish system, but contextually, 31% isn't bad.

"Only since 1992 have Americans paid more for government programs than we spend on food, clothing and medical care combined. For the amount of money we pay in taxes, the federal government could provide universal health coverage and feed and clothe us as well."

By "government programs" we mean primarily the military, Social Security, and Medicare/Medicaid. I'm all for reduced military spending, but should we screw over the elderly and the poor, as well? Given that the current budget provides healthcare coverage to less than a quarter of the population, even if we completely eliminated, say, the military and debt servicing, we would still need to raise taxes even higher to "provide universal health coverage and feed and clothe" everyone.

"Most non-economists vastly underestimate the negative impact of taxes on the U.S. economy.... Economist Arthur Laffer recognized that the law of diminishing returns applies to tax rates as well. According to Laffer, at a certain point, increased taxation actually yields the collection of fewer tax dollars. As we near a 100% tax rate, we approach driving commerce into the ground and collecting no taxes."

Economists recognize that taxes create dead-weight losses in the economy. But economists that apply theory to reality would also never say that we should eliminate taxes, just because this inefficiency exist. Taxes get us things that we wouldn't otherwise have. Taxes fund public goods that generate externalities no one pays for.

Plus, as Jake noted, most economists would at least say that we don't know where we are on the Laffer curve. There are several valid critiques of the Laffer curve, and while many economists would agree with the basic idea Laffer puts forward, few would agree that we're necessarily past the point of diminishing returns or that we could even know where this point is (research has pointed to 65% to even 80% taxation before diminishing returns).

The Laffer curve is a tool of economic philosophy, not of economic practice.

"Economists understand that the optimum rate of taxation is zero. The second-most ideal is as low as possible."

Really? Please name them, their credentials, and peer-reviewed published works espousing these views.

If economists understood that the optimum rate of taxation is zero, then this would be a foregone conclusion and there wouldn't be a whole branch of economics devoted to the study of optimal taxation.

Moreover, the Laffer curve itself betrays this idea that the optimal rate of taxation is zero. Up to a point, increasing taxes actually increase tax revenue. This means that, for example, going from 25% to 35% results in a greater marginal gain in tax revenue than the marginal loss from people dropping out of the work force. So, no, the optimal tax rate is not zero.

"Low taxes should not be a political issue that divides us. Every American should agree with the goal of keeping taxes as low as possible.... In the words of John F. Kennedy, 'An economy hampered by restrictive tax rates will never produce enough revenues to balance our budget--just as it will never produce enough jobs or profits.'"

No one likes paying high taxes, but I think it would be a horrible world where we all pay 0% taxes. John F. Kennedy should have also realized that an economy unsupported by any taxes will never produce enough (tax) revenue to balance our budget, as long as we clamor for government money to fund our schools, our roads, our clean water, our national defense, our parks, our police, our teachers, our equal opportunities ...

By the way, I think if this blog is about letting all sorts of monetary opinions be expressed, maybe you should publish some articles on the other side of the fence - ones that show what taxes provide for us. Otherwise, I think it implies that you endorse Marotta Asset Management and its views on taxation. That's fine if you do agree and endorse their view, but then you can't really say that this blog is fair and balanced, at least on this matter. ;)

[rwh]

From the post: "The top 1% now pays 34% of the taxes in the United States".

From the following web site: http://www.ctj.org/pdf/wealth0506.pdf

"The wealthiest 1% of Americans owned 33.4% of the wealth in 2004, up from 30.1% in 1989".

"The very wealthiest 1% of Americans now own a bigger piece of the pie (33.4%) than the poorest 90% put together (30.4%).

[FMF]

Lily --

"By the way, I think if this blog is about letting all sorts of monetary opinions be expressed, maybe you should publish some articles on the other side of the fence - ones that show what taxes provide for us."

By all means, write one and send it to me and I'll publish it. I'd love to cover this point of view.

[Zook]

I just keep scratching my head with this guy. Can you ask Marotta (or whoever pens this stuff) to come on and answer some questions about his work?

I mean he has had articles posted a hundred times and has received thousands of hits to his site, the least he can do is answer some questions.

I wouldn't hide behind "I am trying to give opposing views on the site", FMF, especially when the pieces are really off the cuff and sub-par. You shouldn't even touch 'D+' work like this.

[FMF]

Zook --

I'll email him and see what he says.

[Michael Blackburn]

This stuff is really, really bad. "The optimal tax rate is zero." Really? So if we didn't have police, the economy would really soar, wouldn't it! We shouldn't keep those lousy firefighters on the city payroll, because think of all the jobs that would be created rebuilding the city every single time someone forgets to put out the candles after dinner.

FMF, there are good arguments for reducing taxes. This guy doesn't have them, and he hurts everyone who remotely agrees with his ideology with ridiculous statements like that.

[Rod Ferguson]

Michael - I don't know if you realize that the US operated for about a century without an income tax. We've had three rounds of income taxes that I am aware of - one was instituted as a revenue source to pay off the loans from the Revolutionary War, the next was implemented to pay off the Civil War and the last one was to pay the interest on loans from the Federal Reserve, but was later modified to add to the General Fund. The two things you mention (police and firefighters) are generally paid for by property taxes and (sometimes) excise taxes - not income taxes (much the same way as our federal highway system is maintained by a gas tax and not the income tax.)

I'm not agreeing with the article, mind you (the author pulls what I call a "Rush Limbaugh" - mentions the income tax and then segues to talk about taxation in general, which is very misleading), but it's a common misconception that our income taxes pay for societatal maintenance when they don't. Now, they mainly pay for shortfalls in other governmental programs (in essense, they pay for bad bookkeeping.) Check the OMB (http://www.whitehouse.gov/omb/budget/fy2008/summarytables.html) to see just what your income taxes contribute to. While you are there, take a look at the deficits, how much we have to borrow and then look at what we're spending all that on. If you have the time, read the whole budget (http://www.whitehouse.gov/omb/budget/fy2008/budget.html) and then ask yourself if the current system of taxation is one you are still comfortable with.

[Lord]

Bracket creep does not exist in Federal income tax as brackets are indexed for that. It does exist in capital gains and the amt which are not indexed. The gross confusion of gross and marginal rates is repeated ad nauseum. I seriously hope this guy has no clients as he would be doing them a great disservice.

[David John Marotta]

Author post (from David John Marotta):

A post on lower taxes, especially on those who pay them is sure to bring out the political divide. I'll try to clarify my thoughts with a few comments.

First clarification:

"Economists understand that the optimum rate of taxation is zero."

From an economic standpoint, any rate of taxation makes the pie smaller, not simply by what it takes, but by the behavior it changes. Imagine a relatively low 20% rate of tax. If you and I specializing and working together can exchange services and be 15% more efficient in our production, the tax rate prohibits this from happening. Better for me to do it myself and not pay 20% taxes than contract with you even if you would be 15% more efficient.

Those of us who understand the negative consequences of government intervention in the economy understand that from an economic standpoint any tax rate higher than zero has unintended consequences that rob value from society, sometimes in much greater amounts than simply the collection of taxes. Tax the exchange of services and you discourage the exchange of services.

This is why many advocate a consumption tax to replace an income tax.

Second clarification:

"On average, taxes take nearly 31% of a worker's gross income: 20% for federal taxes and 11% for state and local taxes."

FMF: Still less than the more socialist countries in Europe. I'm not saying we should move to, say, the Swedish system, but contextually, 31% isn't bad.

Yes, and as amazing as it sounds, the Swedish system is in many ways freer economically than the US system. Sweden ranks high in the Heritage Foundations annual study of countries with the most economic freedom. The only category they rank low is personal taxation.

It is true that they have high personal tax rates, but their corporate rates are extremely low. In the United States we get this point backward thinking that corporate taxes somehow aren't paid by people. Corporate tax rates discourage the very thing we should be encouraging.

My political view are not anarchistic. There is clearly a legitimate role for government, but much of government's good intentions cause more harm than good and are better done through private means.

Regards,

David John Marotta

[Brandon]

"From an economic standpoint, any rate of taxation makes the pie smaller, not simply by what it takes, but by the behavior it changes. Imagine a relatively low 20% rate of tax. If you and I specializing and working together can exchange services and be 15% more efficient in our production, the tax rate prohibits this from happening. Better for me to do it myself and not pay 20% taxes than contract with you even if you would be 15% more efficient."

I think any businessmen who believes in this assumption is really looking at the numbers wrong. Either that, or I am :)

Alright, let us say that I own a business that makes $100,000 a year in profit from my work. After 20% taxes, this leaves $80,000.

I am going to assume for the sake of this example 15% more efficient in production means 15% more profit. My company's new profit is $115,000 a year, after a 20% tax rate, I am still left with $92,000 which is STILL 15% more than my old take-home pay. Similarly, if a 15% in efficiency only lead to a 5% increase in profits (the rest being absorbed into the costs of doing the extra business I now have time to do), I'd still get 5% more salary on my take-home amount.

I don't believe that there is a definitive point in marginal tax rates where doing more work will lead to making less money. That being said, I do understand that at the highest tax rates, there would become a point where it might not be worth the RISK of expanding business if you are only going to get 10% of the excess profits generated by the venture if it succeeds. I think that is much less of a concern with personal tax rates as they are currently though.

On the other hand, the phase-out points for some deductions and credits might create a disincentive to make extra money.

[Matt]

Marotta: I was with you in your rebuttal right up to the point where you said "This is why many advocate a consumption tax to replace an income tax." Non sequitur. If taxation discourages the exchange of services, how is it any better to discourage the exchange of goods? There are many good arguments for a consumption tax, but that's not one of them (or at least it's incomplete).

There is a system of taxation that would avoid the problem without resorting to 0% taxes: per capita taxes. So every able-bodied adult owes, say, $10,000 per year. Short of crippling yourself, there's nothing you can do to avoid that tax, so it won't change behavior at all vs. no taxation. Of course if your frame of reference is the way taxes are now, it would change behavior a lot: the idle poor would finally get off their butts!

Steven E. Landsburg explains further: http://www.slate.com/id/2030/

See, Lily? It is fair and balanced. I still found room to attack it from the Right! ;)

[Jim]

I'm confused. Is the article arguing that income taxes should be lowered 0% (abolishing income taxes)? The article seems to be making the point that 0% income taxes are optimal so it follows the author think income taxes should be abolished. But the article is also arguing that cutting income taxes would increase tax revenue. Obviously if you abolish income taxes then the revenue from income taxes are not maximized. Do you propose that 0% income tax rate would increase taxation from other means to compensate for the loss in income taxes? How would a 0% income tax rate increase tax revenue?

Or is the 0% tax rate really meant to be taken literally? Maybe you're just saying closer to 0% is better than closer to 100%?

Jim

[mrm]

Sorry but anyone who feels good about paying high tax rates is either naive or benevolent to the point of self-destruction. If we privitized half of the stuff our "efficient" government funded with the money they forcefully remove from our income, our economy would be much better off.

Heck, just privitize education and that's a good savings right there and you get the benefit of actually having GOOD school systems as a result of increased competition.

Obviously some taxes are needed but lets not all turn into bleeding heart liberals who think that the harder a person works to achieve a high income, the more they should shell out for those who don't give a flip about anything other than free "government" money, food stamps, and a smooth ride through life without working hard.

As for 0% being optimum? Of course not. We need a military, etc.

I like to check back to FMF about once a month or so. I find myself reading over the Marotta posts, despite myself. It's a little like being drawn to glancing at the roadkill on the highway. I've noticed that the Marotta posts start with a kernel of truth, then twist and torture it until it is unrecognizable.

All institutions need oversight. We have elections. People make choices. As far as the free market goes - how about this one?

I like to celebrate "fee freedom" day. That's the day after which an american starts working for himeself, after paying all those inefficient ask-bid ratios, expense ratios, banking fees, usury credit card rates, payday loan rates, whole-life insurance fees, ridiculous annuity fees, stick-it-to-you 10% restocking fees, and so on! And this nasty stuff is from the so-called efficient free market. It almost makes the government look efficient!

[Uncle Bob]

We need a tax that is fair for all Americans. The FairTax will eliminate the IRS and the income tax, something that used to be unconstitutional, and replace it with a tax on consumption. Right now, we have a tax on productivity - the more you work, the more tax you pay. It just shouldn't be so.

[David John Marotta]

Author Post (from David John Marotta):

I wanted to reply to Brandon's post. Brandon posted the following:

"Alright, let us say that I own a business that makes $100,000 a year in profit from my work. After 20% taxes, this leaves $80,000. I am going to assume for the sake of this example 15% more efficient in production means 15% more profit. My company's new profit is $115,000 a year, after a 20% tax rate, I am still left with $92,000 which is STILL 15% more than my old take-home pay. Similarly, if a 15% in efficiency only lead to a 5% increase in profits (the rest being absorbed into the costs of doing the extra business I now have time to do), I'd still get 5% more salary on my take-home amount."

But that isn't the setup. The choice our business owner is making is to add another project. One which he could outsource (not counting taxes) for $10,000 or do himself for $11,500 (15% less efficient). Without taxes outsourcing the project saves him 15%. But with a 20% tax rate imposed on transactions it would cost him $12,000 to outsource it and he would "save" money being 15% less efficient.

By taxing transactions between people (and not work you inefficiently do yourself) we discourage much of the savings that come from specialization.

David John Marotta