Battling Income Inequality through Smart Surtax Policies

In spite of the media's developing critical narrative of the Occupy movement, Occupy protesters have succeeded in changing the national political conversation from an obsession with debt and deficits to a focus on the growth in income inequality and the concentration of wealth.

A recent Congressional Budget Office (CBO) study has found that between 1979 and 2007, the top one percent’s share of after-tax income more than doubled while the share for the bottom 99 percent shrank. One way to help fight this growing inequality is a set of targeted surtaxes on the wealthiest Americans.

Before the Occupy activities, Washington had a myopic focus on debt and deficits due to the constant drumbeat from fiscal hawks on Capitol Hill who used the economic downturn – and consequent drop in federal tax revenue – as an excuse to call for cuts in government spending. President Obama acquiesced to these concerns, creating the National Commission on Fiscal Responsibility and Reform in early 2010.

Commonly known as the Bowles-Simpson Commission, the fiscal committee spurred numerous think tanks, policy shops, and lawmakers to put forth their own deficit reduction proposals over the course of the next year. A number of these plans examined not only cuts to government spending, but also ways to raise more federal revenue. One of the options examined was an additional tax on the extremely wealthy.

For example:

  • The Center for American Progress (CAP) called for a five percent surtax on adjusted gross income (gross income less tax deductions) over $500,000 and a seven percent surtax on adjusted gross incomes over $5 million. According to CAP, this proposal would bring in about $75 billion per year, or enough revenue to close 5.8 percent of this year’s $1.3 trillion budget deficit.
  • Andy Stern, former head of the Service Employees International Union (SEIU), called for a new top tax rate specifically for millionaires in his deficit reduction proposal. Stern estimated that the measure would bring in roughly $50 billion per year, or enough revenue to close 3.8 percent of this year’s budget deficit.
  • Both Our Fiscal Security (a deficit coalition comprised of the Economic Policy Institute (EPI), Demos, and the Century Foundation) and the Congressional Black Caucus (CBC) advocated a 5.4 percent surcharge on joint filers with an adjusted gross income of over $1 million. The groups estimated that the measure would bring in between $46 billion and $57 billion per year, or enough to close between 3.5 percent and 4.4 percent of this year’s budget deficit.

Though these plans differ on rates and the level at which a surtax would take effect, the proposed measures share several key attributes. First, they target the very wealthy. Only CAP’s proposal would affect those earning less than $1 million in income each year. Second, the surtax rates are small. The current top federal income tax rate is 35 percent. If the current top rate were permanently extended, then a surtax would only bring the top income tax rate back to what it was during the Clinton era, when it topped out at 39.6 percent.

The targeting of such surtaxes is important. As the CBO study revealed, over the last thirty years, the concentration at the top of the nation’s income spectrum is the main culprit of inequality.

But income taxes aren’t the only taxes most workers pay. Over the past 30 years, more federal revenue has been coming from payroll taxes (and less has been coming from income taxes). Payroll taxes are regressive: low-income households, on average, pay more than eight percent of their income into systems like Social Security and Medicare while the top one percent pays, on average, less than two percent of their income in payroll taxes, largely due to high-income earners only having to pay Social Security taxes on the first $107,000 of their earnings.

High-income households are also more likely to receive a significant portion of their income from dividends and stock (capital gains earnings). Since this income is taxed at only 15 percent, it reinforces the upside-down character of the tax system. In fact, the top one percent of households’ federal income taxes (as a percentage of their income) dropped precipitously after passage of the Bush tax cuts in the early 2000s. In other words, there has been a large shift in the source of federal revenue from income to payroll taxes, leaving low- and middle-income workers shouldering a larger share of taxes than before.

As detailed in a recent Watcher piece, researchers at the International Monetary Fund (IMF) found that high levels of inequality are correlated with slower growth. Enacting a surtax on millionaires’ income would be a step toward reducing income equality and might pave the way for faster economic growth in the future. At the very least, it would help to lower deficits and ensure the wealthy pay their fair share in taxes.

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