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A Tax Phantom Is Stalking You Print Mail
By Kevin A. Hassett
Posted: Sunday, October 1, 2000
ON THE ISSUES
AEI Online (Washington)
Publication Date: October 1, 2000
Although inflation can no longer push Americans
into higher income tax brackets, real economic
growth still can--and does.
If you were an unscrupulous tax-and-spend
politician, you would be frustrated by the
unpopularity of tax hikes. It puts you in a bind:
Most of the money that comes in each year is
already targeted for old programs. So how are you
going to find money to pay for your own pet
projects?
Wouldn�t it be great if you could conjure up a
Tax Phantom? The Tax Phantom could take money
away from people in the dark of night. He would
be so stealthy that nobody would see him come or
go. Many citizens wouldn�t even miss the money,
and the extra revenue could be divided up among
all your friends in Congress. With luck, there
would be so much to go around that everyone could
be reelected.
Guess what? There is a Tax Phantom. Our tax
system is set up so that every year in which the
economy grows, taxes are raised automatically on
millions of people. Real growth is just about a
sure thing in America: Since 1959, there have
been only five years of economic contraction. And
so tax hikes are a sure thing as well.
I�m not describing the "bracket creep" you�ve
heard about before, in which inflation�the
watering-down of our money by
politicians�unjustly pushes folks into higher tax
brackets. That cheap trick has been ended by law.
So how does this other tax scam work? The
class-warfare specialists in the Democratic Party
have given us a highly "progressive" tax
structure. This means that as you earn additional
income, the tax rate you pay (not just the
amount, but the actual rate) goes up as well. Now
when the economy grows, the incomes of ordinary
Americans grow too. But our tax brackets are only
indexed to factor out inflation, not real growth.
As a result, almost every year a large number of
Americans are pushed into higher tax brackets and
get hit with an automatic marginal tax rate hike.
Real Bracket Creep
The following table reveals that this "real
bracket creep" is a very big deal. From 1993 to
1997, the most recent years for which we have
enough data to make the necessary calculations,
the percentage of people in the 28 percent tax
bracket increased by 7.3 percent. The increases
are even sharper in the higher tax brackets, with
the number of taxpayers in the top 39.6 percent
bracket posting a whopping 55.5 percent increase
over just those four years.
Mid-1990s Bracket Creep . . .
Tax bracket Proportion of returns falling in
each bracket
1993 1997
15 percent 64.3% 60.6%
28 percent 30.1 32.3
31 percent 3.2 3.8
36 percent 1.5 2.1
39.6 percent 0.9 1.4
Economists know that higher tax rates lead to all
sorts of economic inefficiencies. Yet our tax
code introduces steep rate increases each year,
automatically. The next table shows just how much
these rate hikes will shove tax returns into
higher brackets by the year 2010, assuming that
1993�1997 income growth patterns continue. For
comparison, I include the 1993 distribution of
returns.
The numbers are shocking. In 1993, barely over a
third of all taxpayers faced a marginal tax rate
higher than 15 percent. By 2010, if nothing
changes, well more than half will. Approximately
20 million tax returns will experience a rate
hike!
. . . Accumulates into Big Tax Increases
Tax bracket
Proportion of returns falling in each bracket
Percent Change
1993 2010 (projected)
15 percent 64.3% 46.6% -28%
28 percent 30.1 34.4 +14
31 percent 3.2 11.0 +244
36 percent 1.5 5.9 +293
39.6 percent 0.9 2.1 +133
When you�re shoved into a higher tax bracket,
your bill goes up. With 20 million Americans
jumping brackets, that means a big chunk of the
budget surpluses our politicians are racing to
spend is attributable to unlegislated rate
increases. How much?
There are two piles of revenue created by real
bracket creep. The first comes from people who
actually edge into higher brackets. If you are
right at the top of the 15 percent bracket, for
example, and have your income grow at the same
real rate as GDP, then a chunk of your income
ends up in the 28 percent bracket. If the 15
percent bracket had been expanded along with your
income, you would pay fifteen cents tax for each
new dollar, but since the bracket was not
expanded, you instead pay twenty-eight cents on
every dollar. The difference, thirteen cents, is
the new revenue from the tax hike. This pile of
money amounts to about $200 billion over the next
ten years.
The second pile is much, much bigger. Suppose you
are Bill Gates, camped out in the top tax bracket
for all time. If we move the limit on the 15
percent bracket higher to keep up with economic
growth, it will affect even your tax bill. Why?
Because the brackets apply to everybody. Bill
Gates�s first $41,000 is taxed at a 15 percent
rate. If we fight real bracket creep by
increasing the top of the 15 percent bracket to,
say, $42,000 this year, then even Bill Gates
would get a small tax cut on the $1,000 that
previously was taxed at the higher rate. This
pile of money amounts to about $1.1 trillion over
the next ten years.
Putting the two effects together, one can say
Americans will pay about $1.3 trillion extra over
the next ten years because their income tax
system is not indexed for real growth. To put
that number in perspective, it�s about the same
size as the revenue reduction from Governor
Bush�s proposed tax reduction. His
across-the-board 30 percent cut is just enough to
offset tax hikes that are already in motion!
With luck, the Bush tax cut will become law. And
when it does, Congress should be sure to index
tax brackets for real economic growth in the
future. That way, tax hikes will happen only if
politicians muster the political support for
them, and the Tax Phantom will be out of
business.
Kevin A. Hassett is a resident scholar at the
American Enterprise Institute.
Source Notes: This article appeared in the
October/November issue of The American
Enterprise.
AEI Print Index No. 12208
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