The ‘working rich’ pay a disproportionately large share of income taxes, Sen. Klobuchar, that’s why income tax cuts ‘disproportionately’ benefit them

President Trump is in Minnesota today where he will, we are told, be touting the impact of his tax cuts on the U.S. economy. Our own Sen. Klobuchar got her response in early. A candidate for President herself in 2020, yesterday, according to MPR News, she “criticized Trump’s tax cuts, saying they added trillions of dollars to the nation’s debt and disproportionately helped the wealthy”.

Too much spending is driving up the federal government’s debt, not too little revenue

On the first point, it is true that the fiscal position of the federal government is worsening. But this is due to surging spending rather than any great deficiency in revenues. The federal deficit was 77% higher for the first four months of 2019 than it was for the same period in 2018. But, while tax revenue for October 2018 through January 2019 fell by 2%, spending increased by 9%.

In January, the Congressional Budget Office (CBO) released its Budget and Economic Outlook for 2019 to 2029. As I wrote at the time,

The CBO forecasts that over the coming decade, deficits “fluctuate between 4.1 percent and 4.7 percent of gross domestic product (GDP), well above the average over the past 50 years.” These deficits will raise federal government debt. The CBO forecasts that this will rise to 93 percent of GDP by 2029, “its highest level since just after World War II.” Federal debt is forecast to be “about 150 percent of GDP in 2049 — far higher than it has ever been.”

Where is the flood of red ink coming from?

The CBO is clear that it isn’t caused by a shortage of revenue. They forecast federal revenue to rise from 16.5 percent of GDP in 2019 to 17.4 percent in 2025, and more rapidly after that, reaching 18.3 percent of GDP near the end of the decade.

Instead, the culprit is increased federal government spending. The CBO projects federal outlays to climb from 20.8 percent of GDP in 2019 to 23.0 percent in 2029. This will be driven by “the aging of the population and the rising cost of health care,” which will “contribute significantly to the growth in spending for major benefit programs, such as Social Security and Medicare.” On top of this, rising debt and higher interest rates are forecast to drive up the federal government’s net interest costs.

Income tax cuts ‘disproportionately’ benefit ‘the rich’ because they pay most of the income taxes

But what about Sen. Klobuchar’s second point, that the Tax Cuts and Jobs Act “disproportionately helped the wealthy”?

Well, the Act helped most income tax payers. As the Cato Institute noted last week,

The table below from the Tax Policy Center (TPC) shows the share of households that received individual cuts in 2018 within five income groups (see top of table 2).

Overall, 65 percent of households received a tax cut and just 6 percent had an increase. However, the bottom two income groups, on net, do not pay any individual income taxes. The tax “cuts” for those two groups are mainly increases in refundable tax credits.

Looking at households that pay federal income taxes—those in the top three groups—more than 82 percent received an individual tax cut under the GOP tax law. If you include the effects of the corporate tax cuts, more than 90 percent of households in these tax-paying groups received a cut (see bottom of table 2).

Looking at the this table you might still think that Sen. Klobuchar has a point. The dollar amount of the tax cut increases with income. But that is because we have a ‘progressive’ taxation system in the United States. This means that the tax burden grows with income.

Data from the Tax Foundation shows just how ‘progressive’ the system is. In 2016, the top 10% of income earners earned 46.6% of all income in the U.S. and paid 69.5% of the total income tax received by the federal government. The top 1% of income earners earned 19.7% of all income in the U.S. and paid 37.3% of the total income tax. In other words, the top 10% of income earners pay, as a percent of total taxes, 50% more than what they earn. The top 1% pay, as a percent of total taxes, twice what they earn as a percentage of total income. When people say that the rich should pay their ‘fair share’, how much more disproportionate those people want these numbers to be?

‘The rich’ generally work for their money

Ok, but the predictable response to this graph is that the rich don’t make most of their money off income but instead off capital gains and other sources which are taxed at much lower rates.

This was one response I saw to this data. It it wrong. As I wrote last week, in a recent paper for the National Bureau of Economic Research titled ‘Capitalists in the Twenty-First Century’, economists Matthew Smith, Danny Yagan, Owen M. Zidar, and Eric Zwick ask the question “Are the richest Americans idle rich—who derive most of their income from their non-human capital—or are they entrepreneurs and other working rich—who derive most of their income from their human capital?”

After examining the data on how the top income earners make their money, their answer is that,

Consistent with the labor income view…top earners are predominantly working rich rather than idle rich, and that the majority of top income accrues to the human capital of these wage earners and entrepreneurs.

It isn’t popular to stick up for ‘the rich’ these days. But the data shows that, generally, they work for their money. It also hows that they pay a disproportionate share of income tax. As a consequence, a tax cut is going to ‘disproportionately’ benefit ‘the rich’; they pay a ‘disproportionate’ share of the taxes.

John Phelan is an economist at the Center of the American Experiment.