Ten Myths About Tax Policy

April 15, 2009

10 Myths in Tax Policy

1. You aren’t legally required to pay the federal income tax (for whatever reason, such as 16th Amendment was never ratified)

Researchers and activists sometimes make claims like this, but it should be treated as an academic argument and not advice for taxpayers. The federal income tax is here and it is collected; not paying it means fines, penalties, and often jail time. We at the Tax Foundation work for a tax system that is simple and transparent, and doesn’t inhibit our economy with excessive burdens. But we’re not there yet. If someone tries to convince you that there’s no obligation to pay income taxes, it’s too good to be true.

2. Cigarette smokers cost the government money and thereby should have to pay high taxes on cigarettes

Some have argued that since cigarette smoking leads to certain health costs that governments are in some cases responsible for (Medicaid and Medicare), that cigarette smokers should have to pay for this. Seems reasonable, right? What those same people won’t tell you is that because smokers tend to have an earlier life expectancy than non-smokers, smokers actually save the government money relative to non-smokers, ceteris paribus. This is largely because the federal government has two huge programs that are age-based: Social Security and Medicare.

3. Taxing businesses allows us to lower taxes on people

It may sound nice to “shift” the tax burden from individual taxes like the personal income tax to businesses through say the corporate income tax. But all taxes are eventually paid by people, because after all, consumers, owners of the businesses and workers are people.

4. The FairTax would solve all the problems in federal tax policy

A debate over tax reform is one that we need to have, and that’s helped by having various tax reform ideas with enthusiastic proponents. It is important to remember, however, that any tax reform plan will face political controversy and have short-term transition issues and these will have to be thought through carefully. The FairTax, for instance, would keep in place federal excise taxes and unconstitutionally tax government spending, suffer from evasion problems, and face the same political pressure that have made income and sales taxes full of deductions and exemptions. Like other consumption taxes, however, the FairTax has some economic advantages over income taxes. Regardless, whether we have a graduated income tax, flat tax, or national sales tax at the federal level, there are still many contentious and important tax issues at the state and local levels.

5. A carbon tax to fight climate change would definitely lower our standard of living

It is true that a carbon tax would likely lower GDP and income, as we measure it. However, if global warming is truly a problem that a carbon tax can help solve, such a Pigouvian tax would actually increase economic well-being, broadly defined. The problem is that environmental quality isn’t counted in measures like GDP that we often associate with well-being.

6. Raising the top two income tax rates would not affect small businesses much

It is true that raising the top 2 income tax rates wouldn’t affect a high number of small businesses. However, the small businesses that would be affected by such a tax hike make up such a significant amount of the small business income that raising the top 2 rates would indeed hit a large chunk of small business activity. (Now, personally, I don’t really care much for this small business argument. In my view, the tax treatment of $1 of business income shouldn’t depend upon the size of the business unit.)

7. The Bush tax cuts raised revenue

Many will often point to the fact that after the 2001 and 2003 tax cuts, federal tax revenues increased. The problem with this correlation proving causation argument is that we must answer the question, “what would have happened if the tax cuts had not passed?” Merely because two things occur at one time doesn’t prove that X caused Y. In order to truly estimate what the impact was of the tax cuts on revenues, we must hold everything else constant. Most serious studies of the 2001 and 2003 tax cuts showed that the tax cuts cost the Treasury revenue compared to what would have otherwise happened. There was some dynamic effect, but it’s not anywhere close to the case that the tax cuts paid for themselves.

8. Massachusetts is a high tax state (i.e. Taxachusetts)

Massachusetts used to have a high state and local tax burden. But ever since Prop. 2 1/2, Massachusetts’s state and local tax burden has fallen rather dramatically. The state ranks in the middle of the pack when it comes to state and local taxes as a percentage of income.

9. Raising revenues via cigarettes, alcohol and other such taxes as well as lotteries is okay because those are voluntary taxes

Here’s what this statement is actually saying: because a certain economic activity is voluntary, then the tax that is required as part of that economic activity is voluntary. By that same argument, your income tax is voluntary because you choose to work. The reality is that no tax is voluntary. It is just the economic activity that requires a tax be paid when it is conducted (such as consumption, labor, investment) is voluntary.

10. The rich don’t pay taxes, or, the rich pay all the taxes.

There is a perception among some that the rich can easily evade taxes. Unfortunately for the rich, that is not the case. Significant amounts of money are paid to Treasury from those in top 1, 5, and 10 percent of the income spectrum, especially individual income taxes. On the other hand, the rich do not pay all the taxes. While the top 1 percent of tax returns pay around 40 percent of the individual income tax, every other federal tax (except estate) is significantly less progressive than the individual income tax.

If you think I have left off anything, e-mail us.

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