What do we mean by a “fair” income tax system?

By Matthew Cooke

Of the many subjects upon which well-meaning Americans often disagree, federal income taxes are among the most contentious. At a moment when general government gross debt (federal, state, and local) exceeds $19 trillion and income inequality is at its highest point in nearly a century, what does it mean to pay your fair share?

Ronald Reagan’s election in 1980 ushered in a new, tax-cutting philosophy that gave rise—for better or worse—to a new era in which every president competes to keep taxes as low as possible. In 1981, Reagan’s first year in office, the top tax rate was 70 percent. By 1988, it had dropped to 28 percent.

Today the top tax rate is 39.6 percent, still low by historical standards (more on that later), yet the New York Times recently reported that the super-rich are shielding their fortunes by paying “a high-priced phalanx of lawyers, estate planners, lobbyists and anti-tax activists who exploit and defend a dizzying array of tax maneuvers.” In other words, the very rich pay millions to avoid paying tens of millions in taxes.

But the issue isn’t just tax loopholes, sophisticated avoidance schemes, and legally buying political influence through super PACs, it’s about how we have historically thought about taxes from a societal perspective, and how it relates to our concept of fairness.

The 16th Amendment

For much of American history, a far smaller federal government was almost exclusively funded by customs duties (tariffs). In fact, the first federal income tax wasn’t imposed until 1862, when the Union government needed funds to pay for its part in the Civil War. The highest tax rate, 10 percent, was applied to income in excess of $10,000. When the immediate need for federal revenue decreased after the war, Congress allowed the law to expire.

A new federal income tax was enacted in 1894, but the Supreme Court ruled it unconstitutional the following year, finding that it violated the Constitution’s requirement that federal taxes must be apportioned according to the population of each state.

It wasn’t until 1913, when the ratification of the 16^th Amendment cleared away the constitutional impediment, that the federal government began to be funded by taxing the income of individuals and families. At the time, many argued that tariffs disproportionately affected the poor and were an intrinsically limited source of revenue. The newly passed income tax required both individual and joint filers to pay a paltry 1 percent of their income up to $20,000 a year.

Fast forward a little more than a century: today almost half (46 percent) of all federal revenue comes from individual income taxes.

Is the U.S. tax system still “progressive”?

The U.S. tax system is tiered so that different brackets of income are taxed at progressively higher rates. As noted earlier, the current top marginal tax rate—the rate applied to the highest income bracket—is 39.6 percent. This top rate applies to taxable income above $413,200 for a single person or $464,850 for married couples filing jointly. Again, this is a marginal rate, meaning it only applies to that income over and above those thresholds. About 1.3 million taxpayers, or less than 1 percent of all Americans, reach that top bracket.

But at past points in our history, the top marginal rate has been substantially higher. It soared to 94 percent during World War II. And during the eight years (January 1953- January 1961) of Dwight Eisenhower’s presidency, the top rate was a whopping 91 percent. Eisenhower was no socialist—he was, in fact, a Republican—and he presided over faster rates of economic growth than we’re seeing today.

Eisenhower’s approach—and the concept of fairness that drove it—has been decidedly abandoned. Fifty years of tax cuts began when President Kennedy lowered the top marginal rate to 70 percent, accelerated with the huge drops (from 70 to 50 to less than 30 percent) of the Reagan presidency, and have continued to the present day.

Tax the rich?

Recently, a report from Oxfam International concluded that the world’s 62 richest individuals now possess as much wealth as half the world’s population. That’s 3 billion people.

This massively lopsided ratio isn’t just a product of American tax structure; it’s a global phenomenon to be sure. Still, a half-century of tax cuts in by far the world’s richest and most powerful country has undeniably contributed to this extreme wealth inequality.

Americans of the last five decades have been raised in a philosophical climate that equates low taxes with prosperity, self-reliance, and the ability to “keep what you earn.” But when considering the history of taxation in this country and the hugely skewed wealth ratios we are now seeing, is it not time to at least consider landing somewhere in the middle?

According to one study, raising the top tax rate to 67 percent for the top 1 percent of earners would raise about $4 trillion over a decade. That is a lot of money that could go towards programs like tuition-free college, livable pensions, and upgrading America’s increasingly out-of-date infrastructure, to name a few.

Again, it comes down to what you think is fair.

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