Why Soaking The Rich Won't Solve The Deficit The rich are paying an increasing share of federal income taxes. That sounds like good news to most of us — but it's a policy that ultimately puts more strain on government finances, experts warn.

Why Soaking The Rich Won't Solve The Deficit

If you think you're paying too much in taxes, be grateful you're not rich.

It makes sense to tax the highest earners: That's where the money is, and the federal income tax has sought to be progressive -- by giving bigger breaks to low earners -- since it was first imposed nearly a century ago.

But despite all the complaints -- which were mostly fair -- that the Bush tax cuts disproportionately favored the rich, the share of federal income taxes paid by the wealthy continues to rise. And heavy reliance on top earners has turned into one of the threats to the nation's fiscal health.

The ever-expanding number of credits and tax breaks for the poor and middle class have translated into a record number of people with modest means paying no net taxes at all. The discrepancy between the large amount of taxes paid by the rich and the lack of taxes paid by people with low incomes is only going to grow, given President Obama's vow not to raise taxes on the middle class.

That might be good politics, and it's arguably a fair way to redistribute wealth. But a Robin Hood tax code will make it increasingly difficult to address mounting deficits, experts warn.

Who's Paying Taxes

Summary of Federal Income Tax Data for 2007, Updated July 2009

($ millions)
Share of
All Taxpayers $1,115,504 100%
Top 1% $450,926 40.42%
Top 2-5% $225,367 20.20%
Top 5% $676,293 60.63%
Top 6-7% $118,139 10.59%
Top 10% $794,432 71.22%
Top 11-25% $171,443 15.37%
Top 25% $965,875 85.59%
Top 26-50% $117,368 10.52%
Top 50% $1,083,243 97.11%
Bottom 50% $32,261 2.89%

Soaking The Rich

There's a compelling rationale behind Obama's often-repeated promise not to raise taxes on individuals making less than $200,000 or families making less than $250,000. Over the past 30 years, incomes for the bottom 40 percent of the population went up by only 15 percent, after inflation. The top 20 percent, by contrast, saw their incomes rise by 75 percent over the same period.

The top 1 percent did even better. Their incomes tripled. And they get a break on payroll taxes, which top out at $106,800.

So the well-off can clearly afford to pay more in taxes. But how much more?

The top 1 percent of earners took home 23 percent of the nation's adjusted gross income in 2007. That sounds like a huge haul, but these top earners also paid a huge share of federal income taxes -- just over 40 percent that year, according to the Tax Foundation.

Relying on a narrow tax base can lead to uncertainty for tax collectors -- even if that base consists of top earners. That's certainly been the case in states such as California and New York. Their taxes fall disproportionately on people with big incomes. During recent recessions -- when top incomes, stock options and capital gains all dropped -- those states have seen their revenues go into a nosedive.

And at the federal level, the problem is that the rich are very good at sheltering their incomes. Congress has sought in recent years to prevent citizens from expatriating themselves for tax avoidance purposes, but it continues to happen.

"The most mobile thing in the economy is wealth," says Scott Hodge, president of the Tax Foundation. "It's not just that people will move physically. People can move money to shelter it from taxes by buying municipal bonds or engaging in other low-tax activities."

Simply Not Sustainable

The Tax Foundation is a conservative group, but they are not alone in worrying about Washington's heavy reliance on top earners. A trio of researchers at the more centrist Urban Institute recently presented a paper looking at ways that the federal government could reduce its deficit to 2 percent of GDP in the second half of this decade. Relying on top earners alone was not a realistic option.

In Focus

If everyone's taxes were raised enough to lower the deficit, all tax rates would have to go up by 15 percent. That's a lot. But relying on higher earners alone makes the climb much steeper. Limiting the pool to individuals with incomes above $200,000 and couples earning more than $250,000 would mean the top two tax rates would have to increase more than 40 percent, with a top rate of 56.4 percent.

And those numbers are based on fairly optimistic scenarios. Top tax rates might actually have to go higher -- especially after factoring in the tax-avoidance strategies that some of the highest earners would certainly employ.

"The rich just don't have enough money," says Roberton Williams, a senior fellow at the Urban Institute and one of the paper's authors. "You either have to tax more of the income distribution, or find other sources of revenue."

Free Rider Problem

One reason the rich are paying proportionately more is that lower-income households are paying less -- or nothing at all. Last year, a record 51.6 million filers -- 36 percent of the total -- paid no income taxes.

That's thanks to breaks and benefits such as the earned income tax credit. The number of credits and deductions -- for children, for students, for Prius owners -- is increasing. Williams estimates that 47 percent of single filers and 38 percent of joint filers will owe no taxes this year.

What does it mean when more than a third of the nation is paying no income taxes? You can look at it two ways.

Leonard Burman, a public policy professor at Syracuse University, suggests that today's tax code is not just about taxes, but transferring wealth. Families at all income levels are receiving credits and breaks -- with top earners still getting a higher share, he says. So there's nothing wrong with those closer toward the bottom getting credits, particularly ones that reward work.

But others will argue that having such a huge percentage of the population paying no taxes means there's less restraint on government. If it's not coming out of your pocket, you may demand more services -- and you'll certainly protest when programs are being cut.

"Everybody should pay something so we don't fall into this trap of the free lunch," says Ronald C. Fisher, an economist at Michigan State.