Historically, online the Internal Revenue Service makes an announcement the first week of April that they have arrested a public figure or two for non-payment of federal income taxes. The message is obvious with April 15 upon us.
The Internal Revenue Service tracks the tax returns with the 400 highest adjusted gross incomes each year. The average income on those returns in 2007, the latest year for IRS data, was nearly $345 million. Their average federal income tax rate was 17 percent, down from 26 percent in 1992.
I always thought the old message was effective in helping people decide to file honest tax returns. The current message won’t accomplish that goal, yet sends an interesting message.
The immediate question that needs to be answered is how canit be that the average tax rate for these 400 highest adjusted incomes each year is only 17%? In a world with an alternative minimum income tax and severe limitations on mortgage deductibility (at an interest rate of 10%, a maximum $1 million mortgage would only produce a $100,000 deduction — and no one is paying 10%), the answer is not found in the complexity of the Internal Revenue Code. While there may be an exception or two for Americans living abroad and paying very significant foreign income taxes, there are only two rules in the Internal Revenue Code that could be in play.
The lower average tax rates must be the result of the maximum 15% rate on capital gains and charitable contributions.
As to charitable deductions, the president has a proposal which would effectively have a taxpayer in the top bracket (his proposal for the maximum rate is 39.6%) pay an income tax of $11,600 on a $100,000 contribution. This would leave the taxpayer with a choice of donating $100,000 and paying an additional $11,600 in federal income taxes or keeping the $100,000 and having $41,400 to spend on whatever. We can debate the ultimate results of such a proposal.
As to capital gains, there are a few things to ponder. First, some conservatives tell us that the ultimate amount of taxes paid declines as tax rates go up and from those economists we would conclude that the total amount of income and income taxes would go down as the sales of stocks to create those capital gains would decline. Second, if the capital gains rate was raised to 20% as proposed last year by the president, this would only produce a maximum additional federal income tax of just under $7 billion. While we could have a reasonable and lively conversation about the wisdom of a fifteen percent capital gains rate with each side scoring meaningful blows, I suspect both sides of the discussion would conclude that $7 billion is barely worth discussing in an economic sense in times of $1.6 trillion dollar deficits.