* Marilynn and Ronald Grossman Professor of Taxation, New York University School of Law.
1 Martin J. McMahon, Jr., The Matthew Effect and Federal Taxation, 45 B.C. L. Rev. 993, 993–94 (2004).
2 See id. at 998–1012.
3 Id.
4 Id.
5 See id.
6 McMahon, supra note 1, at 999.
7 See Cong. Budget Office, Effective Federal Tax Rates, 1997 to 2000, at 3–4 (2003).
8 See, e.g., Internal Revenue Serv., Tax Year 2001: Individual Income Tax Returns 13–15, 18 (2004), available at http://www.irs.gov/taxstats/article/0,,id=96586,00.html (last visited Oct. 15, 2004). Congress’s definition of adjusted gross income does not include unrealized appreciation. See I.R.C. � 61 (2000) (defining gross income); Id. � 62 (defining adjusted gross income).
9 McMahon, supra note 1, at 1006. The “Fortunate 400” are the four hundred taxpayers reporting the highest individual income. See Michael Parisi & Michael Strudler, Internal Revenue Serv., The 400 Individual Income Tax Returns Reporting the Highest Adjusted Gross Incomes Each Year, 1992–2000, Statistics of Income Bull., Spring 2003, at 7–9, available at http://www.irs.gov/pub/irs-soi/00in400h.pdf; Martin A. Sullivan, The Rich Get Soaked While the Super Rich Slide, 101 Tax Notes 581, 581 (2003).
10 McMahon, supra note 1, at 1006.
11 See Thomas Piketty & Emmanuel Saez, Income Inequality in the United States, 1913–1918, 68 Q.J. Econ. 1, 15 tbl.III (2003).
12 The only possible exception is home ownership, which would occur in quintiles other than the top one, but probably not in the bottom quintile, which is the focus of concern.
13 See McMahon, supra note 1, at 1019. Data from the Survey of Consumer Finances indicate that approximately one-third of wealth is held by the top 1%, one-third by the next 9%, and one-third by the bottom 90%, of which the lowest 50% held only 3% of the total wealth. Id. The data indicate that the top group holds a disproportionate share of stocks, bonds, and real estate investments, which are likely to include unrealized appreciation. Arthur B. Kennickell, A Rolling Tide: Changes in the Distribution of Wealth in the U.S., 1989–2001, at 15 (2003), available at http://www.federalreserve.gov/pubs/oss/oss2/papers/
concentration.2001.10.pdf.
14 Compare, e.g., McMahon, supra note 1, at 1001 (presenting data on income), with McMahon, supra note 1, at 1019 (presenting data on wealth).
15 Id. at 1012–16.
16 Id.
17 See Cong. Budget Office, supra note 7, at 3–4.
18 See Internal Revenue Serv., supra note 8, at 96–97.
19 McMahon, supra note 1, at 996.
20 I agree with Professor McMahon and others who support progressivity, but I have nothing to add to his recitation of the arguments.
21 McMahon, supra note 1, at 1128.
22 Id.
23 Id. at 1122–28.
24 Id. at 993–98.
25 See id. at 1101.
26 These are not the same. Even if the rich did not get any richer nor the poor any poorer, there would still be a significant—and unacceptable—income gap.
27 See Internal Revenue Serv., supra note 8, at tbl.1.1, col. 15.
28 Table 1 is calculated using IRS figures for the 2001 tax year. See generally Internal Revenue Serv., supra note 8.
29 See generally id.
30 The tax liability in column three is divided by the number of returns in column two to get the average tax per return for each cohort.
31 As explained further below, each taxpayer in the cohort is presumed to have the mid-level of income for the cohort and to have $6000 of current government benefits constituting income (although not taxable income). Thus, someone in the second cohort starts with $6500 of income.
32 See U.S. Dep’t of Health & Human Servs., The 2001 HHS Poverty Guidelines, at http://aspe.hhs.gov/poverty/01poverty.htm (last updated May 3, 2004) (presenting data from Annual Update of the HHS Poverty Guidelines, 66 Fed. Reg. 10,695 (Feb. 16, 2001)). In 2001, the poverty level for a family of four was $17,650. Id.
33 It is likely that no matter what the government did with the additional revenues, there would be some change in the income gap. For example, if all of the funds were dedicated to the military, it is possible that military salaries would increase, raising the income of privates at the bottom of the income scale.
34 See Internal Revenue Serv., supra note 8, at tbl.1.1, col. 15.
35 This approach would do very little to eliminate either the income gap or the Matthew effect, but even this limited effort will serve to illustrate the basic point—that it would be very difficult to eliminate either through the tax system.
36 See Internal Revenue Serv., supra note 8, at tbl.1.1, col. 1. These statistics include the number of taxpayers in each income cohort. Id. At the bottom on the income scale, each cohort has a $1000 range; at the top end, they jump by $500,000 to $5 million with everyone over $10 million landing in the same cohort. Id. As Professor McMahon points out, that lumps the super-rich with the merely rich. See McMahon, supra note 1, at 1002.
37 U.S. Dep’t of Health & Human Servs., supra note 32.
38 Id. To make the experiment simple, I have used only two of the guidelines, one for individuals and one for families. It is thus too high for some small families to escape poverty and too low for large families.
39 This could be in kind transfers such as food stamps or tax benefits such as the earned income tax credit.
40 In practice, stopping the demogrant abruptly without a phase-out is unworkable because it is inefficient and unfair, but adding a phase-out would not change the basic proposition.
41 It is impossible to tell exactly how many individuals and families fall into each poverty category. The U.S. Census Bureau reports extensive data about those in poverty, but does not break the data out into cohorts matching the poverty guidelines. The figures for 2001 roughly indicate that individuals without families make up about one-quarter of the total number of people living in poverty. Bureau of Labor & Statistics & Bureau of the Census, Detailed Poverty Tables: 2001 P60 Package, in Current Population Survey, Annual Demographic Supplement (Sept. 2002), http://ferret.bls.census.gov/macro/
032002/pov/toc.htm (last revised July 14, 2004).
42 This is not to suggest that this is a good way to accomplish the goal of providing minimum incomes. A demogrant to those with no incomes and a guaranteed minimum income has work disincentive effects. The income effect of a demogrant would discourage labor efforts.
43 Table 2 is calculated using IRS figures for the 2001 tax year. See generally Internal Revenue Serv., supra note 8.
44 McMahon, supra note 1, at 997.
45 See I.R.C. � 1 (2000).
46 The point of this exercise is to see how the income gap might be eliminated through direct redistribution through the tax system. That is not the only way, of course, to accomplish this. Redistribution might be accomplished, for example, by significantly increasing the incentives for charitable giving, particularly to those organizations that increase the “income” or the standard of living of those in the bottom cohorts.
47 Column four is calculated by dividing the number of returns in the second column into the total taxable income for the cohort in the third column. The number of returns and taxable income in each cohort is found in Internal Revenue Serv., supra note 8, at tbl.1.1, cols. 1–2. Note that the number of returns with taxable income in each cohort is less than the number of returns with the same AGI in each cohort because itemized deductions reduced the AGI. See id.
48 Column six is calculated by applying the top marginal tax rate in the last column to the amount of income that exceeds the minimum in the cohort and multiplying the result by the number of returns. For example, each individual in the first cohort is assumed to have $533,455 of taxable income. The amount exceeding $500,000 or $33,455 would be subject to a 40% marginal rate, producing an additional tax of $13,382 for each return. The additional tax owed by the 354,612 individuals in this cohort produces $4.7 billion more in revenue. One effect of using this averaging rule is that average taxable income per return falls below the minimum for the cohort for several of the cohorts.
49 Table 3 is calculated using IRS figures for the 2001 tax year. See generally Internal Revenue Serv., supra note 8. I ran similar calculations with the CBO numbers and ended up in approximately the same place.
50 The revenue produced by a top marginal rate of 65% on the cohort with AGI over $10 million is only $51 billion. The amount of revenue necessary cannot even be produced with marginal rates running from 50% to 90% on the super-rich. There is nothing that precludes extremely progressive rates on the super-rich, although this calculation does not include other taxes such as Social Security and Medicare taxes, state income taxes, sales and property taxes, corporate taxes, excise taxes, and the like.
51 The surtax is calculated by multiplying the surtax rate times all income that exceeds $500,000.
52 See generally J.A. Mirrlees, An Exploration in the Theory of Optimum Income Taxation, 38 Rev. Econ. Stud. 175 (1971). The notion behind the experiment is not to choose the optimal rate but to show that it would have to be fairly high.
53 Table 4 is calculated using IRS figures for the 2001 tax year. See generally Internal Revenue Serv., supra note 8.
54 Professor McMahon proposes eliminating the preferential rates on capital gains. McMahon, supra note 1, at 1127–28.
¹ See, e.g., Joseph Bankman & Thomas Griffith, Is the Debate Between an Income Tax and a Consumption Tax a Debate About Risk? Does It Matter?, 47 Tax L. Rev. 377, 393–95 (1992). For proofs of the proposition that given certain assumptions, an income tax imposes a burden only on the risk-free return, see No�l B. Cunningham, The Taxation of Capital Income and the Choice of Tax Base, 52 Tax L. Rev. 17, 29–39 (1996), and Alvin C. Warren, Jr., How Much Capital Income Taxed Under an Income Tax Is Exempt Under a Cash Flow Tax?, 52 Tax L. Rev. 1, 6–13 (1996).
55 When subject to a nominal tax on capital, investors will make portfolio adjustments such that the tax burden is no more than the nominal rate times the risk-free rate on their entire portfolio. The risk premium bears no tax burden. Investors accomplish this by scaling up the amount of their risky investments. Unless the government adjusts its portfolio, the government becomes a “co-investor” in the larger amount of risky investment and its expected return; that is, revenue rises.
56 Deborah H. Schenk, Saving the Income Tax with a Wealth Tax, 53 Tax L. Rev. 423, 456–74 (2000).
57 See, e.g., I.R.C. � 168 (2000) (accelerating depreciation); Id. � 179 (same); Id. � 354 (deferring taxation of gains); Id. � 1031 (same); Id. � 103 (exempting certain interest).
58 For example, taxpayers often use financial instruments to defer the tax on unrealized appreciation by monetizing the gain without an appreciation event. One example is an equity swap.
59 See Deborah H. Schenk, A Positive Analysis of the Realization Rule, 57 Tax L. Rev. (355 2004).
60 Table 1, supra note 28.
61 Luke 18:22–23 (New Revised Standard).
62 Id. at 18:25.