Deep in the Heart of Taxes

Governor Sarah Palin, the Republican vice presidential hopeful, recently suggested that Democratic presidential candidate Barack Obama's tax plan could undermine the capitalist economy. "Now is not the time to experiment with socialism," she warned, echoing accusations also leveled by her running mate John McCain.

If taxing wealthier taxpayers at higher rates is socialism, however, the Internal Revenue Service has been flying the red flag for nearly a century.

Since 1913, the U.S. income tax, like that of most other countries, has been progressive: people who make more money pay taxes at higher rates on the upper segments of their income.

Tax brackets resemble a ladder with an increasing rate applying to each rung as you climb. For 2008, the U.S. income tax has six brackets ranging from 10 percent for those who earn less than 8,025 dollars to 35 percent for those earning over 357,000 dollars. With exemptions and deductions, most taxpayers pay considerably less than the nominal rates.

Even for a person who makes over 357,000 dollars, the 35 percent rate applies only to earnings above that figure. For each lower rung of that person's income, the corresponding lower rate for that bracket applies.

This means that even if Joe the Plumber were able to take home income of 280,000 dollars, the increased tax rate of Obama's proposal - from 36 to 39 percent - would be charged only on the top 80,000 dollars, the portion of his income over the 200,000-dollar limit for single taxpayers. So the total tax increase in this bracket would be 3 percent of 80,000 dollars, or 2,400 dollars. The rest of his income would receive the same cuts as lower-income taxpayers.

For a simpler example, consider a hypothetical tax system with three brackets: 10 percent for income from 0 to 50,000 dollars, 20 percent for income from 50,001 to 100,000 dollars, and 30 percent for income from 100,001 dollars up. A taxpayer who makes 150,000 dollars would pay 5,000 dollars on the lowest part of their income, 10,000 dollars on the middle part, and 15,000 dollars for the upper part, for a total of 30,000 dollars. This taxpayer's average tax rate would be 30,000 dollars divided by 150,000 dollars, which equals 20 percent.

If the top tax rate were raised from 30 percent to 33 percent, the tax for that bracket would increase from 15,000 to 16,500 dollars. The total tax would then increase from 30,000 to 31,500 dollars, for an average tax rate of 21 percent.

The non-partisan Tax Policy Centre told Bloomberg that its analysis of the candidates' proposals found that Obama would "give bigger tax cuts to middle-income Americans." According to TPC researcher Roberton Williams, "The higher you get, the more you get under McCain's plan.''

TPC calculated that middle-income taxpayers making between 37,595 and 66,354 dollars a year would save an average of 1,118 dollars under the Democratic plan, compared to 325 dollars under the Republican one. By 2018, TPC projected that McCain's proposals would increase the federal deficit by 5 trillion dollars while Obama's would lead to a 3.5 trillion dollar increase.

Although analysts say both campaigns have made misleading or false claims, the Annenberg Political Fact Check project says McCain has engaged in a "pattern of deceit" by misrepresenting Obama's tax plan.

Economist Paul Krugman, winner of this year's Nobel Prize, compared McCain's strategy with that of President Richard Nixon 40 years ago. Nixon, he observed in the New York Times, reinvented the Republican brand: "The party of plutocrats was repackaged as the party of the 'silent majority,' the regular guys - white guys, it went without saying - who didn't like the social changes taking place."

Under an Obama administration, Krugman wrote, the typical plumber would pay lower taxes and have a better chance of getting health insurance. But not everyone would benefit: "Joe the plumber would almost certainly be better off, but Richie the hedge fund manager would take a serious hit."

The McCain campaign also criticises Obama's proposals for tax cuts that might refund taxes to some low-income taxpayers as "welfare". However, a popular existing programme does just this: the earned-income tax credit was established by the Tax Reform Act of 1986 and signed by President Ronald Reagan. He called it "the best anti-poverty, the best pro-family, the best job-creation measure to come out of Congress."

Currently, all capital gains and dividends from stocks, which are received mainly by the wealthy, are taxed at a top rate of 15 percent, a much lower rate than the marginal rate on wages and salaries.

McCain favours keeping the 15 percent rate in the long run, and has proposed lowering the top capital gains rate to 7.5 percent for 2009 and 2010. Obama's plan would allow rates on capital gains and dividends to return to 20 percent, the rate prior to tax cuts by the George W. Bush administration.

In all this political trench warfare, missing in action has been serious discussion of whether tax cuts are actually the best way to get money to people who need it and create a stimulus to help ease the economic downturn.