What rates should we be paying on tax day?

BY Simone Pathe  April 15, 2014 at 6:13 PM EDT
What's the right balance of tax rates in America? Photo from Flickr user AgriLife Today/Royalty-Free/Corbis.

What’s the right balance of tax rates in America? Photo from Flickr user AgriLife Today/Royalty-Free/Corbis.

It’s tax day in America. Some of us ducked out of work to dash to the post office, while organized types had their checks written months ago, and still others filed for extensions. (Your chances of being audited by the IRS, by the way, are the lowest in years, AP reports.)

But what should Americans be paying each year, and where does that money go?

Fifty-two percent of Americans think their taxes are too high, according to Monday’s Gallup Poll. But how high is too high?

Two years ago, when many Republicans’ pledge not to raise taxes animated budget talks and the 2012 elections, Paul Solman spoke with the man as responsible as anyone for bringing the tax rate on top earners down from the 70 percent it was in 1980 to the 35 percent it was in 2012. Arthur Laffer was President Ronald Reagan’s economist and is father of the eponymous curve showing the relationship between taxes and revenue. He first doodled his curve on a napkin for Dick Cheney and Donald Rumsfeld in the Ford administration back in 1974, and he did so again for us.

The central question for Laffer is, at what point will tax rates reduce government revenue? The answer: well below the point of maximum short-term government revenues. As he explained, “At 100 percent tax rate, if you make nothing for doing the activity, you won’t do it, and there will be no revenue.”

A lower tax rate on top earners, Laffer maintains, will have positive economic effects because the rich will work harder, invest more and create more jobs — generating more revenue for government over the long term.

But tax journalist David Cay Johnston, himself a member of the one percent, disputes the idea that higher tax rates are a disincentive for top earners to work harder. In fact, he says, they may work even harder to boost their take-home pay after taxes.

Either higher taxes disincentivize work or they make people work harder to maintain their post-tax income, says Duke psychologist and behavioral economist Dan Ariely. But in reviewing with us his most surprising research from 2013, he explains that people just don’t care much about taxes. In a lab-simulated working environment, Ariely changed workers’ tax rates — some paid none, some paid 25 percent and some 50 percent. Curiously, there was no difference in performance among those three levels.

Regardless of how taxes affect work, MIT economist and Nobel laureate Peter Diamond is concerned with how much lower income brackets are paying. Rates should be lowered on those workers, he thinks, because they need all the take-home pay they can get to contribute to the economy.

As long as they’re kept below the point at which they begin to discourage work, Diamond would like to see taxes raised on the wealthiest — say, to about 49 percent — to finance infrastructure, education and research and development, all key engines of economic growth. (See just where tax dollars go in this chart from the Center on Budget and Policy Priorities.)

Just as a slight majority of Americans think that their taxes are too high, a slight majority (54 percent) also think their taxes are fair. (Although this is trending downward from a high of 64 percent in 2003.)

Making the wealthy pay more is a hot topic in this year’s debate over income inequality, which has seeped from the ivory tower into the political mainstream. The tax system, Nobel economist Robert Shiller, wrote in The New York Times this weekend, “can be viewed as a colossal insurance system, guarding against extreme income inequality.”

Some inequality provides incentives, Thomas Piketty said at a Tax Policy Center forum Tuesday about his new book “Capital in the Twenty-First Century.” But, he explained, “we don’t need extreme inequality to grow.” Piketty would like to see a global tax on capital but admits that’s unlikely. (Making Sen$e will be interviewing Piketty later this week for a future segment, so stay tuned.)

Shiller, whom we interviewed after he won the Nobel, proposes a tax system that factors inequality into inflation indexing. When inequality goes up, so would the marginal tax rate for the top earners.

But as we explored with former IMF chief economist and MIT professor Simon Johnson, Americans have almost always preferred debt to taxes to fund the government. If you believe popular mythology, America was partially born, Johnson said at the site of Boston’s tea party, out of a tax revolt. Simply put, we’ve often preferred paying later to paying now.

That pay-it-later psychology is part of Shiller’s thinking about building inequality indexing into the tax code now. “It pays to ask people to decide on measures to uphold egalitarian ideals,” he writes, “when they don’t have to cough up the money immediately.”

As things stand now, few really want to pay for the services many people want government to keep, including the Social Security and Medicare spending for aging baby boomers that is increasing our debt load. “That mindset,” Johnson said, “is incredibly dangerous. That is what has broken many governments and many countries. It’s never been the American problem, but it is the American problem today.”

If nothing else, on this April 15, you can take comfort in Jon Shayne’s argument that by paying your taxes, you’re giving the U.S. dollar value.