Why You Won't See A Middle Class Tax Cut

"The One" has been proposing this "middle class tax cut" idea. It is a total fraud. Never mind that Clinton tried it and then cried big crocodile tears about how, after he was elected, he couldn't make it work. Of course he couldn't make it work. There is simply no way for anyone to make it work.

A middle class tax cut is an almost economic impossibility because of a multiple of reasons all related to simple economics. First we need to understand "quintiles", that's simply a fancy way of saying that the entire population is broken down into five groups ranging from the poor to the mega wealthy. The poor are the bottom quintile and the wealthy have the top quintile. The three middle quintiles compose the middle class with the true middle class being in the third, or middle quintile. That middle quintile contains the vast majority of America's wage earners. Consider the basic bell curve. The middle income is at the apex of the bell curve with the poor and wealthy at the opposite ends. The old adage of "the rich get richer and the poor get poorer" is quite true. People float up and down the quintiles all during the life. Right out of college most folks are near the bottom. But after a few years they are close to the top middle income quintile. Once you enter the top quintile, you can't go up any further. So, the folks in that quintile just get richer but stay in the quintile. The same goes for the poor. Most folks in that category rarely spend a lifetime there. But those who do land there and have little capacity to move up, typically just get poorer. Now, while there are more middle income tax payers, the very wealthy pay the most in taxes. That is simple math. The wealthy make more money and they are in the highest marginal tax bracket.

But why can't we simply cut the taxes on the middle income and raise the taxes of the very wealthy? Seems simple enough and it seems a fair and just way to do things. I agree. But that doesn't make it possible. For one thing, there are a ton of middle income tax payers, many more than there are wealthy tax payers. In fact, you simply can't have it any other way and still be a functioning economy. (Witness most third world countries which have virtually no middle class.) So, if you cut middle income taxes by $1000 each, as The One has proposed, you would need to generate an equal amount of money from the wealthy taxpayers or you have a shortfall in tax income to the government. No decent Democrat wants that! In fact, no one wants that since it would have a catastrophic effect on the economy. But since there are such a small number of wealthy taxpayers compared to the number of middle income tax payers, you will have to make a very large increase in the wealthy tax rate to make up for the shortfall. Now, regardless of whether you think that the wealthy can afford it or not, the government does not want to make a huge increase in the top marginal tax rate.

The reason for that is simple. In the USA we tax income and not wealth. Again, you wouldn't want it any other way. (Think about it.) Wealthy people, especially the mega wealthy, are already wealthy and don't need to make income. Middle income folks need income as they cannot live off of their wealth. Jimmy Carter learned this fact in the late 1970's when his administration ended up with an 85%+ top marginal tax rate. Suddenly this country was bereft of wealthy people. They simply decided to not earn income. At least they didn't earn it in the United States. And what income they did earn was shuttled to tax shelters such as municipal bonds, off shore banks, and tax havens. The number of divorces among the wealthy also increased as they found that being unmarried and filing separately moved them into a lower tax bracket. (I remember seeing a "60 Minutes" that showed a couple getting divorced on December 1st and remarried on January 1st.) Wage earners such as tax attorneys and accountants were making a lot of income. But the mega wealthy...well, I also remember seeing stories on the news about billionaires who weren't paying much if any income tax. They had put it all in shelters and had shut down their income production here in the USA. So congress devised the alternative minimum tax to punish the wealthy for not creating income that could be taxed. And now, since the dollar amount that is considered wealthy is always increasing, that AMT almost bit all of us since it was never indexed to inflation.

But wait, you say, what about a middle income tax break stimulating the economy? Yes, it would stimulate the economy, but not to a sufficient amount as to really spur the economy. Middle income folks don't spend their money like the wealthy do. They can't afford to do it. Note that the government actually had to run advertisements to encourage spending earlier this year when they sent out "stimulus checks". It still had an almost negligible effect. For one thing, middle income folks are the bulk of the people who are stretched thin on credit right now. Wealthy folks aren't and the poor don't get credit--well, they didn't until the congress mandated that they get home loans. But the stimulus necessary to overcome the $1000 per middle income taxpayer rate cut would be a nearly record setting stimulus to the economy. It would have to be since the majority of Americans are middle income. That just isn't going to happen given traditional middle income spending patterns. And those patterns don't change. Trust me, merchants have tried to do it for at least 100 years and are still failing.

So, the folks who decide who will pay how much in taxes are left in a quandary. They have to determine the "tipping point", that tax rate that sufficiently gouges the wealthy to appease the envious and covers a middle income tax cut shortfall, yet doesn't shut down the wealthy income engine. Frankly, given the disparity between the number of middle income taxpayers who would receive a tax cut and the amount of income tax revenue that could be accrued by raising the top marginal rates, I am positive that The One is going to see his promise of a middle income tax cut fly out the window just like Slick Willie's. "Well, close the loopholes that the wealthy use to avoid paying their fair share." First off, the wealthy pay their fair share in that according to the IRS the top quintile pays about 86% of all income taxes. But secondly, as I said before, they don't have to. Income that is taxable is optional to most of the wealthy. So, for the government the trick is to raise taxes on the wealthy just enough to keep them paying and making money that can be taxed. They don't want to shut off the spigot. But shut it off they would if they tried to pay for a middle income tax cut by raising the top marginal rates. And closing the loopholes would be devastating to the economy. Clinton tried it just a little and just about destroyed several major industries that served the wealthy, such a boat builders, high value home builders, and so forth. And again, if you close the loopholes the wealthy will cease doing the things that create taxable income.

Proof that generating taxable income is optional for the wealthy? Remember when Lee Iaccoca became chairman of Chrysler? He vowed to only take a $1 per year wage for his job until Chrysler earned a profit. Lee Iaccoca did not go broke. He paid all of his bills. His compensation package was structured in such a way as to avoid being income. It was all perfectly legal and it still is. And those things are still going on. Compensation packages for everyone from CEO's to professional athletes are structured in such a way as to expose the barest minimum of their compensation to income tax liability.

So, that is why you won't see a middle income tax cut even if The One is elected president and congress remains in Democrat hands. It is a practical, financial, and economic impossibility. But don't get your dobber down. One way that the middle income would get a tax break is the way that The Gipper did it--across the board tax cuts. Then you have a real stimulus to the economy because everyone, especially the ones who pay the most in taxes, gets more money in their pockets and therefore into the economy.

And government bean counters don't have to try to figure out what the tipping point is.