Would Taxing the Rich Fix the Deficit?

Antony Davies,

Release Date
July 2, 2012


Gov't Debt & Spending

In 2009, the government’s budget deficit was $1.5 trillion. Many have suggested raising taxes on the richest Americans to help offset the budget shortfall. Economics professor Antony Davies uses data to assess whether taxing the rich could possibly make up the difference.
First, Professor Davies shows that the richest 5 percent of Americans already pay a tax rate almost three times higher than the average tax rate of the remaining 95 percent. It’s hard to argue that the richest aren’t paying a fair share of taxes. Aside from that, for the richest Americans to shoulder the deficit, we would have to raise their effective tax rate to 88 percent. At 88 percent, a family earning $300,000 each year has only $36,000 after taxes—less than the average American earns.
Professor Davies shows other scenarios that would be necessary to pay the $1.5 trillion difference between government revenue and government spending. Realistically, taxing the rich is not going to be able to solve this problem. “The budget deficit is so large that there simply aren’t enough rich people to tax to raise enough to balance the budget,” Professor Davies says. It is time to start working on legitimate solutions, like cutting spending.

To view Professor Davies’ data sources, check out the Congressional Budget Office’s workbook on income and taxes here! (Prof. Davies culls his data from sheet #6 titled “Income Source Before-Tax Inc”, columns B – G)

Would Taxing the Rich Fix the Deficit?
Can we balance the budget by taxing the rich? Let’s look at how much Americans pay in federal taxes compared to their incomes. Accounting for federal income taxes and tax credits, the richest 5 percent of Americans paid almost 30 percent in taxes in 2009. The 20 percent of poorest Americans paid negative 1 percent, that is, they received more money back than they paid in. Some argue that the rich aren’t paying their fair share of taxes. Yet the tax rate on the rich is almost three times the tax rate on all other Americans. 

In 2009 the government’s budget deficit was $1.5 trillion. Let’s see how much we’d have to raise taxes to balance the budget. We’ll start by raising taxes on the rich by half, from 29 percent to 44 percent. Increasing taxes on the richest 5 percent of Americans by 50 percent only raises about $400 billion, leaving us with a deficit of $1.1 trillion. Let’s go back to the rich. How much would we have to tax the top 5 percent in order to raise enough money to balance the budget? The answer is 88 percent. Of course, the average household in this top bracket earns $300,000, which means that the 88 percent tax reduces their income to $36,000, making the average rich household worse off than the average household.
It’s true that back in the 1960s, the top income tax rate was 90 percent, but that was the top marginal rate. After adjusting for the various tax brackets and deductions and exemptions, people in the 90 percent marginal tax bracket actually paid an average effective rate of about 50 percent. That is nowhere near the 88 percent we’d need to tax the rich in order to balance the budget. In addition, in the 1960s there were only about 5,000 households that earned enough to be in the 90 percent tax bracket. To balance the budget, we’d have to apply our 88 percent tax rate to almost 9 million households. This means that to balance the budget we’re going to be forced to raise taxes on those earning between $100,000 and $180,000.
Suppose we raise taxes on this group as well. How high do the taxes need to go in order for us to balance the budget? To balance the budget, we’d have to more than double taxes on everyone earning $100,000 or more. This means that a household with two wage earners, each of whom earns $50,000, would pay an additional $21,000 in taxes annually. The lesson is that arguing about taxing the rich wastes our time and diverts our attention from meaningful solutions like cutting spending. The budget deficit is so large that there simply aren’t enough rich people to tax to raise enough to balance the budget.