The benefits of government expenditures, that is: roads, national security, people sitting in chairs making sure airplanes don’t crash into each other. The two sentiments are in perpetual conflict.

Last week’s vice presidential debate featured repeated exchanges on the subject of tax policy, with each side claiming the mantle of middle-class champion, and each accusing the other of having reckless tax plans. One aspect of the debate concerned fairness, with both candidates making exaggerated claims in support of their positions. Regarding fairness, is it right to increase taxes on wealthy Americans while cutting taxes for the middle class?

For decades, America (like most democracies) has had graduated federal tax rates, meaning wealthier tax payers contribute a higher percentage of their income. That is thought to be fair for a variety of reasons I won’t go into here. Sarah Palin accused Obama of wanting to redistribute wealth because of his plan to roll back tax cuts for wealthy Americans. That’s just a negative spin, because the overall approach is no different from what has been going on for a very long time, including the 1980’s, when, as Senator Biden correctly pointed out, marginal tax rates for wealthy Americans were higher than they are now. From 1932-1986, the highest marginal tax rate was at 50% or higher, compared to 35% today. Obama proposes going back to 39.6% percent, the rate that prevailed from 1993-2000, years of almost unprecedented prosperity.

Just who are the wealthy Americans? Currently the top marginal tax rates apply to those earning more than $349,700. Obama’s plan protects anyone earning less than $250,000 from any tax increases. This includes those small business owners who report their business income as individual income, which explains Biden’s response to Palin’s claim that Obama wants to raise taxes on small business owners.

But back to the mysterious dividing line between wealth and middle class? Who are these people? Sarah Palin’s rhetoric would have you believe that taxes would go up for just about everyone under Obama’s plan. That’s nonsense. According to the IRS, less than 3% of all individual returns filed in 2007 reported adjusted gross income of more than $200,000. Palin is right that there are millions of these tax payers, but that’s misleading, because there are more than 138 million total tax payers in the US. 3% is a small number, even if it represents millions of households. So, a $200,000 threshold is clearly above any definition of middle class, $250,000 even more so. Amazingly, though, the 3% of tax payers with incomes higher than $200,000 pay more than half of all individual taxes.

What does this mean? In part, it means that regardless of your objective with tax policy, it’s tax rates on wealthier Americans that matter most. If you believe that taxes must be raised to generate revenue so the government can pay its bills, it’s the tax rate on wealthy Americans that matters. Conversely, if you believe that taxes must be low so that tax payers can keep more of their money to invest in the economy, then it’s still the tax rate on wealthy Americans that matters.

This also means that Senator Biden made a slightly disingenuous claim during the debate. He claimed that a tax cut for the middle class would inject money into the economy. While it’s certainly a benefit to middle class tax payers to have their taxes reduced, it doesn’t inject as much money into the economy as would a tax cut for those earning more than $200,000, especially if the tax cut on the middle class is accompanied by a tax increase for the wealthy. I’ll leave it to academic economists to debate exactly what the impact would be. But what Obama’s plan really reflects is his belief that the distribution of the tax burden should look more like it did between 1932 and 2000 than it has since 2000. It also reflects his belief overall tax revenue needs to rise in order to balance the federal budget and support planned spending.

Incidentally, taxes paid to the federal government are not simply removed from the economy, as low tax advocates would have us believe. It may be true that the market is better suited than the federal government to make efficient choices on how to spend and invest money. But the fact that the government spends all of its tax revenue (and then some) means that most taxes are in fact returned to the economy in some form.

Misstatements about tax plans were made by both candidates in the vice presidential debate. Sarah Palin was wrong to imply that the Obama plan would raise taxes on most Americans. She didn’t actually use the word “most”, but while her use of the word “millions” was technically accurate, her tone suggested Obama’s plan would raise taxes for a far higher percentage of Americans than it actually would. Biden sought to couch the middle class tax cut in terms of a boon to the economy. While any tax cut has the potential to inject money into the economy, the middle class as a whole pay a minority of overall taxes.

As usual, once you get all the facts straight, it comes down to a matter of belief as to what’s the right course. I support the Obama plan, believing that we need to increase tax revenue to support necessary spending and to avoid increasing the federal debt; and that it’s fair to ask wealthier Americans to increase their share to more historical levels.

http://money.cnn.com/2008/06/11/news/economy/candidates_taxproposals_tpc/index.htm and learn the tax plans proposed by each Presidential candidate from CNN. From their websites: Barack Obama and John McCain

Dan Goodman is a veteran of the digital media industry and an avid follower of politics and social issues. He has particular interests in foreign policy, energy, environment, and education, but being opinionated, he’ll write about almost anything. He’s also passionate about finding common ground among seemingly divergent viewpoints. As a graduate student, he founded and edited Spectrum, a journal of student opinion at Harvard’s Kennedy School of Government, and was later a volunteer for Youth Building Bridges, a DC-area group helping teens from different social and ethnic backgrounds explore their differences and what they have in common.

(Photo from freeparking’s Flickr Photostream)