BLEEDING OUR
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GOVERNMENT TO
DEATH
Some tax facts hardly anyone knows
David Cay Johnston is a columnist for tax.com and
teaches the tax, property and regulatory law of the ancient
world at Syracuse University College of Law and Whitman
School of Management. He has also been called the “de
facto chief tax enforcement offi cer of the U.S.” because
his reporting in The New York Times shut down many tax
dodges and schemes, just two of them valued by Congress
at $260 billion.
Johnston received a 2001 Pulitzer Prize for exposing
tax loopholes and inequities. He wrote two bestsellers on
taxes, Perfectly Legal and Free Lunch. Later this year
Johnston will be out with a new book, The Fine Print,
revealing how big business, with help from politicians,
abuses plain English to rob you blind.
F
or three decades we have conducted a
massive economic experiment, testing a
theory known as supply-side economics.
The theory goes like this: Lower tax
rates will encourage more investment,
which in turn will mean more jobs and
greater prosperity — so much so that tax
revenues will go up, despite lower rates.
The late Milton Friedman, the libertarian
economist who wanted to shut down public parks because
he considered them socialism, promoted this strategy.
Ronald Reagan embraced Friedman’s ideas and made them
into policy when he was elected president in 1980.
For the past decade, we have doubled down on this
theory of supply-side economics with the tax cuts sponsored
by President George W. Bush in 2001 and 2003, which
President Obama has agreed to continue for two years.
You would think that whether or not this grand
experiment worked would be settled after three decades.
You would think the practitioners of the dismal science
of economics would look at their demand curves and the
data on incomes and taxes and pronounce a verdict, the
way Galileo and Copernicus did when they showed that
geocentrism was a fantasy because Earth revolves around
the sun (known as heliocentrism). But economics is not
like that. It is not like physics with its laws and arithmetic
with its absolute values.
Tax policy is something the Framers left to politics.
And in politics, the facts often matter less then who has the
biggest bullhorn.
The Mad Men who once ran campaigns featuring
doctors extolling the health benefi ts of smoking are now
busy marketing the dogma that tax cuts mean broad
prosperity, no matter what the facts show.
As millions of Americans prepare to fi le their annual
taxes, they do so in an environment of media-perpetuated
tax myths. Here are a few points about taxes and the
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economy that you may not know, to consider as you prepare
to fi le your taxes before April 18 this year. (All fi gures are
infl ation adjusted.)
1. Poor Americans do pay taxes.
Gretchen Carlson, the Fox News host, said last year “47
percent of Americans don’t pay any taxes.” John McCain
and Sarah Palin both said similar things during the 2008
campaign about the bottom half of Americans.
Ari Fleischer, the former Bush White House spokesman,
once said “50 percent of the country gets benefi ts without
paying for them.”
Actually, they pay lots of taxes — just not lots of federal
income taxes.
Data from the Tax Foundation shows that in 2008,
the average income for the bottom half of taxpayers was
$15,300.
This year the fi rst $9,350 of income is exempt from
taxes for singles and $18,700 for married couples, just
slightly more than in 2008. That means millions of the poor
do not make enough to owe income taxes. But they still
pay plenty of other taxes, including federal payroll taxes.
Between gas taxes, sales taxes, utility taxes and other taxes,
no one lives tax-free in America.
When it comes to state and local taxes, the poor bear a
heavier burden than the rich in every state except Vermont,
the Institute on Taxation and Economic Policy calculated
from offi cial data. In Alabama, for example, the burden on
the poor is more than twice that of the top 1 percent. The
one-fi fth of Alabama families making less than $13,000
pay almost 11 percent of their income in state and local
taxes, compared with less than 4 percent for those who
make $229,000 or more.
2. The wealthiest Americans don’t carry the burden.
This is one of those oft-used canards. Sen. Rand Paul,
the Tea Party favorite from Kentucky, told David Letterman
recently that “the wealthy do pay most of the taxes in this
country.” The internet is awash with statements that the top
1 percent pays, depending on the year, 38 to more than 40
percent of taxes.
It’s true that the top 1 percent of wage earners paid 38
percent of the federal income taxes in 2008 (the most recent
year for which data is available). But people forget that the
income tax is less than half of federal taxes and only one-
fi fth of taxes at all levels of government.
Social Security, Medicare and unemployment insurance
taxes (known as payroll taxes) are paid mostly by the
bottom 90 percent of wage earners. That’s because, once
you reach $106,800 of income, you pay no more for Social
Security, though the much smaller Medicare tax applies to
all wages. Warren Buffett pays the exact same amount of
BY DAVID CAY JOHNSTON
Social Security taxes as someone who earns $106,800.
3. In fact, the wealthy are paying less taxes.
The IRS issues an annual report on the 400 highest
income taxpayers. In 1961, there were 398 taxpayers who
made $1 million or more, so I compared their income tax
burdens from that year to 2007.
Despite skyrocketing incomes, the federal tax burden
on the richest 400 has been slashed, thanks to a variety of
loopholes, allowable deductions and other tools. The actual
share of their income paid in taxes, according to the IRS,
is 16.6 percent. Adding payroll taxes barely nudges that
number.
Compare that to the vast majority of Americans, whose
share of their income going to federal taxes increased from
13.1 percent in 1961 to 22.5 percent in 2007. (By the way,
during seven of the eight Bush years, the IRS report on the
top 400 taxpayers was labeled a state secret, a policy that the
Obama overturned almost instantly after his inauguration.)
4. Many of the very richest pay no current income
taxes at all.
John Paulson, the most successful hedge fund manager
of all, bet against the mortgage market one year and then
bet with Glenn Beck in the gold market the next. Paulson
made himself $9 billion in fees in just two years. His current
tax bill on that $9 billion? Zero. Congress lets hedge fund
managers earn all they can now and pay their taxes years
from now.
In 2007, Congress debated whether hedge fund
managers should pay the top tax rate that applies to wages,
bonuses and other compensation for their labors, which is
35 percent. That tax rate starts at about $300,000 of taxable
income; not even pocket change to Paulson, but almost 12
years of gross pay to the median-wage worker.
The Republicans and a key Democrat, Senator Charles
Schumer of New York, fought to keep the tax rate on
hedge fund managers at 15 percent, arguing that the profi ts
from hedge funds should be considered capital gains, not
ordinary income, which got a lot of attention in the news.
What the news media missed is that hedge fund managers
don’t even pay 15 percent. At least not currently. So long as
they leave their money, known as “carried interest,” in the
hedge fund, their taxes are deferred. They only pay taxes
when they cash out, which could be decades from now for
younger managers. How do these hedge fund managers get
money in the meantime? By borrowing against the carried
interest, often at absurdly low rates — currently about 2
percent.
Lots of other people live tax-free, too. I have Donald
Trump’s tax records for four years early in his career.
He paid no taxes for two of those years. Big real-estate
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