When considering a lower tax rate we can make one of two assumptions. We can assume that changes to taxes rate will not change behavior, or we can assume that changes to tax rates do change behavior.
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Yesterday, Democratic Presidential Candidate John Edwards laid out his economic plan should he become President in 2009, including his tax agenda. Edwards argued that special interests need to be taken out of the tax process, which is true. And then he said the middle class is shouldering the federal tax burden, which is totally untrue. From Yahoo News:
Democratic presidential hopeful John Edwards on Thursday unveiled a plan that would increase taxes for the wealthy and create tax breaks for the middle class.
It's time for us to put America's economy back in line with our values. It's time for us to put an end to George Bush's war on work," he told a packed theater at Grand View College in Des Moines, Iowa. "It's time to restore fairness to a tax code that has been driven completely out of whack by the lobbyists in Washington, by the powerful interests in Washington and by those who value the few above the interests of many."
He added that, "It should not be in America that the middle class carries the tax burden, and that's exactly what's happening."
Well, the truth of the matter is that's exactly what's not happening. If you define "middle class" as the middle 20 percent of American households, that group only paid 9.7 percent of federal taxes in 2004, according to the Congressional Budget Office (CBO), while making 13.9 percent of the nation's pre-tax income. On the other hand, the top 20 percent of American households paid 67.1 percent of federal taxes in 2004, while making 53.5 percent of the nation's income.
Even if Mr. Edwards wants to expand the definition of "middle class" to include the three middle quintiles, from the 20th percentile to the 80th percentile, they would only be paying 31.8 percent of the tax burden despite earning 43.2 percent of the nation's income, according to CBO. Finally, at the state/local level, the tax burden is only flat to slightly regressive across the top three income groups, so Edwards' statement wouldn't really be correct there either.
Mr. Edwards also needs to be aware of the fact that 43 million tax returns already pay nothing in federal individual income taxes, and most of these are lower-income taxpayers or middle-income taxpayers with many children. Therefore, unless you create more refundable credits as Edwards has suggested (which are no different than increasing spending programs) or reduce excise taxes (like cigarettes) or payroll taxes (or even the corporate income tax), you cannot cut taxes for the poor much further.
Regarding his point about lobbyists and special interests, it is true that oil and pharmaceutical companies are the big beneficiaries of some special tax treatment. (Note: The pharmaceutical industry receives much from the R&D credit, which some argue is a public good, and the oil companies are responsible for many other sources of tax revenue such as the federal gas tax and diesel fuel tax.) But while they do receive some special treatment, the two biggest beneficiaries are the real estate sector and the health care sector as a result of the two largest tax expenditures: the exemption of employer-provided health insurance and the deduction for home mortgage interest as well as the exemption of capital gains on most primary home sales.
But Edwards, like most politicians, wasn't specific in terms of which breaks he wanted to get rid of. Going after oil companies may be politically popular, but it's not going to raise much revenue. If he wants to raise revenue by getting rid of special tax breaks, it's going to have to be the big ones like all production manufacturing credits, the home mortgage interest deduction and the exemption of employer-provided health insurance from adjusted gross income. Unfortunately, politicians tend to like many of these "tax breaks," despite the fact that their tax savings do flow disproportionately to upper-income taxpayers.
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29 Democratic members of Congress from California today urged California to make its film tax credit more generous. A bill to do so, AB 1839, has passed the state Assembly and is pending in the Senate.