Examining Governor Jerry Brown's Proposed Tax Increases

(Updated 27-MAR-2012)

NOTE:  This analysis is for Governor Brown's initial tax hike proposal.  Due to political infighting with the California Federation of Teachers (CFT), Governor Brown has modified his proposal to be more like the CFT's so-called "Millionaires Tax."  Essentially, the new plan has a smaller increase on sales tax revenues, has significant additional income tax increases on upper-income taxpayers, and extends the "temporary" increase to seven years.  A new analysis is in the works but all of the arguments against the increase still hold true. 

It looks like California Governor Jerry Brown is out with his proposed "fix" for California's budget shortfall.  Turning to his exhaustive play book of--how shall I say this politely?--one play, the Governor proposes tax hikes.  And this is from a Governor who sold the electorate on his vast political experience.

First, some background information.  California already has the nation's second-highest marginal tax rate of 10.3%, second only to Hawaii, at 11%.  Even California's 2nd top income tax rate is the nation's 4th highest, after Hawaii, California's top bracket, and Oregon.  California's 2nd top bracket starts at $48,000 in income for single taxpayers.

To fix the multi-billion dollar shortfall, Governor Brown proposes creating new state tax brackets and to increase taxes on those brackets by up to 21.5%.  The Governor's proposal would add the following new brackets.  The dollar brackets shown are for single tax filers; brackets for married filing jointly are doubled.

• Tax rates for those making less than $250,000 remain the same.  California would keep it's current 9.3% rate for those making more than $47,000.
• Income between $250,000 and $300,000 are taxed at 10.3%, which is the same rate currently charged for those making more than $1,000,000.
• Income between $300,000 and $500,000 are taxed at 10.8%.
• Income between $500,000 and $1,000,000 are taxed at 11.3%, which exceeds the highest marginal tax rate from any other state in the nation.
• Thanks to California's Proposition 63, those earning more than $1,000,000 are charged an extra 1% to fund mental health services--proving I guess that you must be INSANE to be a millionaire and have your tax residence in California.
• Unlike the federal government and many of its economic competitors, California treats capital gains exactly like ordinary income and taxes capital gains at the maximum applicable tax rate.  This means that California's budget greatly depends on stock market and real-estate returns on upper-income taxpayers.  The result is a watershed of revenue in good times and a drought during downturns.

The following chart helps to better compare the increased tax rates against those of other states.  (NOTE:  Oregon dropped their top rate from 11% to 9.9%)

The Governor purposely did not increase tax rates on lower incomes, perhaps in a nod to tax fairness.  After all, those making more than $300,000 only currently pay more than eight times more total tax and have an eight times higher average effective tax rate than the vast majority of other Californians.  The only thing lacking from the 1.9% of taxpayers is the votes at the ballot box to prevent more exploitation by the majority.

Those in upper brackets not only pay a higher effective tax rate, they also obvious pay far more in absolute dollars.  Those fortunate 42,517 taxpayers with incomes of $1 million or more paid an average of $304,553 in California income taxes with an effective tax rate of 8.97%.

In all fairness, all taxpayers, especially those at the lower-end of the income spectrum, will be hit by Governor Brown's proposed sales tax increase.  California ALREADY has the nation's highest sales tax rate.  Governor Brown will enshrine our first place finish by adding another 0.5% on top, not including the additional taxes charged by various California counties and cities.  This amounts to a 6% increase over current tax law.

Governor Brown's tax increase proposal will likely be popular with the two biggest spenders in California politics, the California Teachers Association (CTA) and the California State Council of Service Employees (SEIU).  Both are significant donors to the Governor's political party.  Furthermore, even fellow Democrats acknowledge that Governor Brown must kowtow to the teacher's union.

The bulk of any tax revenues is earmarked for education, which is already one of the biggest recipients of taxpayer dollars.

The big questions remain.  How will these proposed tax increases affect California's already damaged business climate--you know, the source for all that tax revenue.  California currently ranks at or near the bottom of various surveys, from multiple independent sources, for multiple years.

California's poor business climate and high taxation resulted in a net migration out of California.  According to the L.A. Times, the percentage of people from other U.S. states is the lowest it has been in a hundred years!  Because California's tax revenues are so dependent on very few, high-income taxpayers, small changes in taxpayer population can have dramatic effects on tax revenues.  Over 50% of income taxes come from less than 2% of the population.

Political columnist Dan Walters has a great summary message for those that oppose the tax increases.

Why should we pay more ...

• when we already have one of the nation's highest tax burdens,

• when the Legislature is handing out raises to its staff,

• when politicians haven't curbed rapidly increasing pension costs,

• when they're wasting billions on prisons, 

• when they've shunned a spending limit,

• when they've squandered money on a hapless bullet train project and unworkable computer systems, 

• when they're spending tens of millions on illegal immigrants' college educations, and 

• most importantly – when the state is mired in recession and 2 million-plus are jobless?

Well said, Mr. Walters!

Who's bankrolling the initiative?


Brown, Teachers, Business And Public Safety, Californians To Protect Schools, Universities And Public Safety, A Ballot Measure Committee Supported by Governor Jerry
www.electiontrack.com/lookup.php?committee=1343257

(as of 13-FEB-2012)

See also ...

• Governor Jerry Brown:  An Open Letter to the People of California (5-DEC-2011)
  www.jerrybrown.org/sites/default/files/GovernorsLetter12_5_11-1.pdf
• Governor Jerry Brown: The Schools and Local Public Safety Protection Act of 2012www.jerrybrown.org/sites/default/files/TheSchoolsandLocalPublicSafetyProtectionActof2012.pdf
• Sacramento Bee: California's high-income taxpayers dropped sharply
  http://blogs.sacbee.com/capitolalertlatest/2012/02/californias-high-income-taxpayers-have-dropped-sharply.html
• Dan Walters: Jerry Brown's tax plan tries easy political routewww.sacbee.com/2011/12/07/4104882/dan-walters-jerry-browns-tax-plan.html
• Soquel by the Creek: Who Pays Their "Fair Share" in California?soquelbythecreek.blogspot.com/2011/10/who-pays-their-fair-share-in-california.html
• Soquel by the Creek: American Federation of Teachers: Part of the Solution or Part of the Problem?
  soquelbythecreek.blogspot.com/2011/10/american-federation-of-teachers-part-of.html

Pretty Pictures and a Political Rorschach Test

"The power to tax is the power to destroy"
John Marshall, Chief Justice of the United States (1801-1835)

A recent blog post regarding U.S. income tax caught my eye. The post included an aesthetically beautiful infographic from data artist Stephen Von Worley and his Data Pointed blog that, according to multiple blog posts, purports to show once again that those #@*&# rich people are just not being taxed enough.

"Chart shows low tax burden for rich"news.yahoo.com/s/yblog_thelookout/20110316/ts_yblog_thelookout/chart-shows-low-tax-burden-for-rich

"Shifting Burdens"www.datapointed.net/2011/03/relative-us-income-taxes-1913-2011

"Chart of the Day, US taxes edition"blogs.reuters.com/felix-salmon/2011/03/15/chart-of-the-day-us-taxes-edition

Unfortunately, as an engineer and scientist, I have a number of problems with the infographic. One problem is that the original chart is mislabeled, based on the data that it presents as I will explain below. Another problem is that many people apparently misinterpreted what the chart actually tells you.

Infographics, though often useful, are essentially "visual statistics," which reminds me of a favorite quote.

"Statistics are like bikinis. What they reveal is suggestive, but what they conceal is vital." -- Aaron Levenstein

Why the Chart is Mislabeled

The original post proclaims "The tax man cometh, and to illustrate the inequities of his cleft-hoofed embrace, we’ve charted the shift in U.S. income taxes from rich to poor over the past century." Unfortunately, the data behind the chart does NOT show this.

The chart claims to show relative tax burden, which in the post is defined as "the amount of tax due relative to the long-term average at each income level."

So what does the infographic actually show? After some reverse engineering, it actually shows the relative change in marginal income tax rate compared to historical averages. Keywords here are "relative change, " "marginal income tax rate," and "historical averages" It’s a common mistake, but high marginal tax rates DO NOT equate to actual tax burden or increased revenues for the government. High marginal tax rates do affect behavior and dissuade earning and investment plus encourage tax avoidance strategies.

Choose Your Average

The non-obvious distortion is that the chart relies on historical averages. Averages themselves can be greatly deceiving.

"Then there is the man who drowned crossing a stream with an average depth of six inches." -- W.I.E. Gates

"The average human has one breast and one testicle." -- Des McHale

Fist, a little background information. Since the inception of the federal income tax, the top marginal tax rate ranged from 7% to 94%. The chart below is color coded according to a chart used later in this post. The source data is available here.

Marginal Tax Rate for Top Income Category, by Year (1913-2011)

Meanwhile, for the bottom tax bracket, the tax rate varied from a low of 0% in the 1970's/1980's to a high of 23% during the New Deal, World War II.

Marginal Tax Rate for Bottom Income Category, by Year (1913-2011)

The average marginal tax rate for top earners was over 59%, with a standard deviation of ±25% for the specified 99 year period (1913-2011) since the 16th Amendment was passed. If considering the entire 235-year history of the United States, the average drops to 25%. If using just the last 25 years, then the historical average is 35.8%. Choosing the specific time period dramatically affects the average.

Relative Difference in Top Marginal Tax Rate Compared to
Historical Average, by Year (1913-2011)

Marginal tax rates for all income taxpayers were at historic highs for twenty years, from 1944 to 1963. For upper income taxpayers, the top marginal rate was 90% or more. Even for the bottom of the income ladder, the rates were over 20%.

However, there was a ten year period (1977-1986) when the marginal rate for lower-income taxpayers was 0%--zip! Mathematically, these zeroes reduce the average. For example, the average marginal tax rate for low-income taxpayers over the thirty-year period (1944-1963, 1977-1986) drops to 13.7%.

The History Embedded in the Charts

With due apologies to Stephen Von Worley for mashing up two of his beautiful infographics, here is some of the history of the U.S. income tax embedded in the charts. The numbered annotations are described below.

Marginal Tax Rate

This is an excellent infographic showing how the marginal tax rate changed over time. The tax rate is presented as a heat map. The higher the tax rate, the closer the color is to white hot. The lower the tax rate, the closer the color is to cool black. The data is also adjusted for inflation, which shows the effect of "bracket creep" over time.

Original, unmodified image:

http://www.datapointed.net/visualizations/money/historical-us-income-tax-brackets/

I re-oriented this graphic to match the "tax burden" chart.

(click image to enlarge)

Changes in Marginal Tax Rate Compared to Historical Average

This is an aesthetically beautiful infographic showing how the marginal rates changed compared to their historical average, over the lifetime of 99-year history since the 16th Amendment was ratified.

Original, unmodified image:

http://www.datapointed.net/2011/03/relative-us-income-taxes-1913-2011

(click image to enlarge)

Note 1:Two lines are added to the United States Constitution upon ratification of the 16th Amendment, legalizing federal income tax.

"The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration."

Congress subsequently passed the Revenue Act of 1913. The 18 pages of legislation imposed a federal income tax ranging from 1% to 7%, depending on income. The 1913 federal income tax form and instructions are simple and run just four pages.

Note 2:

Due to the costs of World War I, Congress passes the War Revenue Act of 1917 and the Revenue Act of 1918, dramatically increasing the top marginal tax rate to 67%, then to 77%.

Treasury Secretary Mellon understood the negative impact on the high level of taxation.

"The present system is a failure. It was an emergency measure, adopted under the pressure of war necessity and not to be counted upon as a permanent part of our revenue structure. The high rates put pressure on taxpayers to reduce their taxable income, tend to destroy individual initiative and enterprise, and seriously impede the development of productive business…. Ways will always be found to avoid taxes so destructive in their nature, and the only way to save the situation is to put the taxes on a reasonable basis that will permit business to go on and industry to develop."

Note 3:

Due to the unpopularity of the Wilson Administration and World War I, Warren G. Harding was elected President, along with solid Republican majorities in Congress. Congress reduced tax rates by passing the Revenue Act of 1921.

Note 4:

Congress, under the leadership of President Coolidge, reduced all income tax levels by passing the Revenue Act of 1926. The bottom marginal rate was reduced to 1.5%. The top marginal tax rate was reduced to 25%.

Note 5:

The Republican Congress had previously passed the disastrous Smoot Hawley Tariff, heavily opposed by Democrats. Democrats made major gains in the Congressional election of 1930.

Congress, under President Hoover, increased income taxes for all income levels by passing the Revenue Act of 1932. The bottom marginal rate was increased from 1.5% to 4%. The top marginal tax rate was increased from 25% to 63%. It was the largest peacetime tax increase in U.S. history, up to that point.

The combination of bad policy and increased taxation lead to disastrous unemployment, shifts in economic activity, and decreased investment activity. Welcome to the Great Depression.

Note 6:

Congress, under the President Franklin Roosevelt (FDR), passes the "soak the rich" tax policies of the Revenue Act of 1935 (The Wealth Tax Act) and the Revenue Act of 1936. Top marginal tax rates increased to 79%.

Roosevelt’s leadership was challenged by previous Democratic Presidential candidate, Alfred E. Smith, in his famous 1936 radio address, "Betrayal of the Democratic Party."

Note 7:The immense costs of the "New Deal" policies of FDR's Administration plus World War II lead to the highest marginal tax rates for all income levels. Top marginal rates reach an astonishing 94%. Even low-income taxpayers faced a 22.2% rate.

The United States emerged from World War II with its industrial and manufacturing capacity relatively untouched. Much of Europe and Asia were enslaved by oppressive Communist regimes. India was seduced by the unfulfilled promises of Socialism. The United States helped rebuild Europe and Japan and was engaged in a Cold War with the Soviet Union and the Communist Chinese.

Because the United States was essentially the only game in town for those that enjoy Western-style democracy, the federal government could continue to oppressive tax rates.

Note 8:
The Revenue Act of 1964 cut all income tax levels by about 20%. Top rates were reduced to 70% while bottom rates were reduced to 14%.

The tax cut was made popular by Democratic President John F. Kennedy and was an attempt to spur the U.S. economy. Unfortunately, President Kennedy was assassinated before the legislation was finally enacted.

Note 9:The Tax Reduction and Simplification Act of 1977 essentially reduced bottom tax rates to 0% for the next ten years. Top rates were unaffected.

This 0% rate effectively reduces the historical average for lower income taxpayers and causes the "birds eye" pattern in chart of relative marginal tax rates.

Note 10:Congress passes Economic Recovery Tax Act of 1981 (ERTA), better known as the Kemp-Roth tax cut. Top rates were reduced to 50% while bottom rates remained at 0%.

Tax brackets indexed to inflation, reducing "bracket creep." Note how the white line in the tax brackets chart flattens after this point.

Note 11:

Congress passes the Tax Reform Act of 1986, eventually reducing top tax rates to 28%, their lowest levels in modern history. The act also increased bottom tax rates from 0% to 14%.

Although many consider it the second Reagan Tax cut, the act was officially sponsored by Democrats, Richard Gephardt of Missouri in the House of Representatives and Bill Bradley of New Jersey in the Senate.

Note 12:
Congress passes the Omnibus Budget Reconciliation Act of 1993, raising top marginal tax rates from 28% to 39.6%.

The act received no Republican votes and was opposed by some Democrats. Vice-President Gore provided the tie-breaking vote in the United States Senate.

Note 13:
In response to recession from the Dot-Com bubble, Congress passes the Economic Growth and Tax Relief Reconciliation Act of 2001. The act is also known as the first of the Bush tax cuts. Rates were reduced at all levels. The top marginal tax rate was reduced to 35% while the bottom marginal tax rate was reduced to 10%.

In response to the further recession caused by the September 11, 2001 World Trade Center terrorist attack, Congress accelerated some of the changes by passing the Jobs and Growth Tax Relief Reconciliation Act of 2003.

The Open Question

So the question remains, are marginal rates too low for top income earners?

By international comparison, no.

Marginal Tax Rateshttp://www.nationmaster.com/graph/tax_hig_mar_tax_rat_ind_rat-highest-marginal-tax-rate-individual

The marginal tax rate is less important than the effective tax rate. Despite the official tax rate, how much to people really pay. This is measured as the tax paid divided by the adjusted gross income.

The Tax Foundation tracks this information (see Table 8), but only since 1980. Using their information, the following chart shows that top tax payers pay more as a share of the adjusted gross income (AGI). The calculations for AGI changed with the 1986 tax law, which results in the apparent spike on the chart.

Because top taxpayers have more income, they would also pay more taxes in absolute dollars, even if their tax rates were the same or lower. However, the chart shows that high-income taxpayers do indeed pay a larger share of their income in taxes than do almost all income classes.

Average Effective Tax Rate by Income Class and by Year

This effect is also obvious looking at the amount of share of revenue contributed by different income levels. Not surprisingly, high-income taxpayers pay the bulk of U.S. income tax.

See also ...

"The Rich Don't Pay Taxes" Lie: Purposely Deceptive, Or Backed Up by Data?

soquelbythecreek.blogspot.com/2010/02/rich-dont-pay-taxes-lie-purposely.html

The Oppressive Progressive Income Tax: California Edition

soquelbythecreek.blogspot.com/2009/07/oppressive-progressive-income-tax.html


Is Warren Buffett Paying His "Fair Share"?
soquelbythecreek.blogspot.com/2011/08/is-warren-buffet-paying-his-fair-share.html

Who Pays Their "Fair Share" in California?
soquelbythecreek.blogspot.com/2011/10/who-pays-their-fair-share-in-california.html