Deeply ingrained in the federal tax system is the populist principle that the rich should pay a higher tax rate than those with less income.
"The tax upon incomes is levied according to ability to pay," the House Ways and Means Committee wrote in 1913 when the current income tax was first enacted. "It would be difficult to devise a fairer tax." This concept was translated into an income tax system in which the very poor are exempt, and the rates progressively rise as the taxpayer's income grows.
But over the past generation, this basic principle--that the affluent should pay more than the working man or woman through what is called a progressive rate system--has been severely eroded.
Until recently, the decay of the progressive system of federal taxation has not resulted from a conscious decision by Congress and past administrations.
Instead, the decline in the progressivity of the system has grown out of the fact that the Social Security payroll tax has grown by leaps and bounds while the corporate income tax has taken a nose dive.
Unlike the federal income tax, the Social Security payroll tax is regressive: The effective rates are higher for the poor than for the rich.
The Social Security tax has an inherently regressive effect on the system because it is a flat tax with a ceiling on the amount of income on which it is collected (13.4 percent, paid in equal parts by employer and employe, of the first $35,700, at present). Because of this ceiling, the rate for persons making more than $35,700 is lower than for those making less than $35,700.
Over the past 25 years, Social Security revenues, as a percentage of total federal revenues, have nearly tripled. During the same period, the percentage of revenues provided by the individual income tax has remained almost constant, while the percentage provided by the corporate income tax has plunged to barely more than a quarter of what it had been.
The consequences for the distribution of the tax burden between income groups have been dramatic.
When the two basic federal taxes paid by individuals--the income tax and the payroll tax--are combined and compared over time, the results are as follows:
* In 1955, according to the Treasury Department, a four-person family with one earner making $2,424, half the median income, faced an average tax rate of 4 percent. For a similar family making twice the median income, $9,694, the tax rate was 12.4 percent. In other words, the rate of the more affluent family was just over three times that of the poorer family.
* By 1982, the family making half the median income, $14,066, faced an average tax rate of 20.1 percent. The family making twice the median income, $56,252, had a tax rate of 25.95 percent. Over the 27-year period, what had been a three-to-one ratio had fallen to a 1.3-to-one ratio.
While both families faced a significant increase in their average rate of taxation, the rate for the family making half the median income grew from 4 to 20.1 percent, a five-fold increase, while the family making twice the median income saw its rate slighty more than double.
In addition, average earnings in the United States grew much faster than the inflation rate during this period from 1955 to 1982. As a result, both families may have faced higher tax rates in 1982, but, in terms of constant dollars, both families had more after-tax income in 1982 than in 1955.
(The Treasury study assumed, as many economists do, that the entire cost of the payroll tax is passed on to the employe. In addition, by selecting a one-earner family instead of a two-earner family, the study emphasized the decline in progressivity, but, in either case, the trend would be the same.)
In recent years, the decline of the progressive rate structure has been actively encouraged by Congress and Reagan administration policy. Congress, acting in defiance of the Carter administration in 1978, passed a tax cut that was not tilted to benefit the poor, but instead was targeted to help the upper middle class and the rich.
In 1981, the shift in policy became more extreme under the Reagan administration. The three-step tax cut, along with the reduction in the tax rate on income from investments from 70 to 50 percent passed that year, is significantly reducing the progressivity of the income tax.
Now President Reagan and Congress are preparing major tax legislation that will accelerate the decline of progressivity. Almost certain to be enacted is a proposal that would raise Social Security taxes by about $110 billion over the next seven years, to rescue the Social Security System from insolvency.
The administration and the congressional tax-writing committees are also considering raising an additional $130 billion in new taxes starting in 1985 and 1986 to reduce huge prospective budget deficits. Two of the major proposals--a surtax on income and an energy excise tax--would further reduce the progressivity of the tax system.
Before 1978, a Democratic-controlled Congress generally attempted to skew tax cuts to the poor.
The targeting to the poor was, however, relatively minor. And the cuts' progressive effects were overwhelmed by the massive growth in the Social Security tax, a regressive levy.
From 1955 to 1982, no other federal tax grew at the rate of the Social Security tax. It went from $8.7 billion, or 12.9 percent out of $67.4 billion in total federal tax receipts, to $201.5 billion, or 32.6 percent of $617.8 billion in total federal taxes.
Just as the Social Security tax was shooting upward, the corporate income tax, as a percentage of federal receipts, declined sharply. In 1955, corporate income taxes produced $18.9 billion, or 28 percent of federal tax receipts. By 1982, corporate taxes were $49.2 billion, or 8 percent of federal revenues.
There is a running debate over who actually pays the corporate income tax--shareholders, management and employes, or consumers--but to the degree that it falls on shareholders and corporate management, both of whom tend to be in upper-income brackets, the corporate tax would be considered progressive.
Just over half of the decline in corporate taxes results from a decline in corporate profits. The rest, however, results from tax cuts.
The Reagan administration's 1981 tax cut provided for a business tax cut of $153 billion over six years, about half of which was later taken back by Congress in the 1982 bill. The individual tax cut provisions in the 1981 legislation, however, are accelerating the erosion of the progressivity of the system.
The measure cut all tax rates, but it did not alter either the personal exemption or the standard deduction. These two provisions in the code function to give far greater tax relief to the working poor and the lower middle class than to the rich: A $1,000 personal exemption eliminates 10 percent of income subject to taxation for someone making $10,000, but only 1 percent for someone making $100,000. While failing to increase the benefits of these provisions, the bill gave the single largest cut--the reduction from 70 to 50 percent on the maximum rate on unearned income--to the affluent holders of stock and other forms of capital income.
A Congressional Research Service study of the 1981 tax bill that concentrates on tax rates for different income classes from 1980 through 1984 demonstrates who the major beneficiaries of the tax cut are:
For a person making $10,000 and filing a joint return in 1980 whose income grows in proportion with inflation through 1984, there will be no tax cut at all. Instead, this person's after-tax disposable income will be $67 less in 1984 than it was in 1980. This amounts to a 0.71 percent decline.
For higher categories of income, the tax cut does result in some benefit, but the amount, in either dollar or percentage terms, grows steadily as the 1980 income approaches $350,000 a year. At $20,000 in 1980, the tax cut will amount to $185 in 1985, or an increase in disposable income of 1.05 percent. At $50,000, the 1984 cut amounts to $898, or a 2.16 percent increase in disposable income. At $350,000, this grows to $19,287, or an increase of 8.72 percent of disposable income.
From another vantage point, the study found that there will be a significant compression of the range of effective income tax rates--in other words, a lessening of the progressivity--from 1980 through 1984. In 1980, the effective rate for the $10,000 person was 5.7 percent while for the $350,000 earner the rate was 36.8 percent, a spread of 31.1 percentage points..
By 1984, the range for the same two persons (with their incomes adjusted upward for inflation) would be 6.4 percent to 31.3 percent, a spread of 24.9 percentage points. This means that the progressivity in the income tax system between the $10,000 taxpayer and the $350,000 taxpayer will be reduced by one-fifth in five years.