5 Myths About the American Tax System: The Devil Isn't As Black As He's Painted

Every April, Americans spend more than 7 billion hours filing their taxes and about the same amount of time arguing about them. But many claims about the tax system are actually untrue, explains Los Angeles Times.

Myth #1: The rich don't pay their fair share.

This is the most frequently repeated claim in American tax policy and one of the least supported by real data. The top 1% of income earners earn 22% of total income and pay 40% of all federal income taxes. The top 10% earn about half of the country's income and pay 72% of taxes. The bottom half of income earners collectively pays approximately 3% of tax revenue. The United States actually has the most progressive income tax system in the world.

Myth #2: We will reduce the budget deficit by taxing the rich.

We simply can't do this. The combined wealth of all American billionaires is estimated at approximately $8 trillion. The projected federal deficit for the next decade alone is approaching $25 trillion. Even a one-time, complete confiscation of the wealth of all billionaires wouldn't approach that amount, and it can only be done once.

On the subject: Three reasons why Trump's new tax cuts aren't as good as they seem

The real cause of the US budget crisis isn't a lack of tax revenue from the rich. It's the structural growth of spending on Social Security and Medicare. The Congressional Budget Office predicts that these mandatory spending and interest payments will permanently exceed all federal revenues starting next year. No amount of taxation of the rich will correct this imbalance.

Myth #3: If we can't tax the rich, let's tax corporations.

Corporations are the next obvious target for those who want to live in a wealthy country and don't want the middle class to pay for it. The problem is, corporations don't actually pay taxes. When you understand why, it begins to look like one of the worst ideas in the American tax system.

Corporations write checks to the IRS, but they don't bear the tax burden. Every dollar of corporate tax comes from a specific person. That's the employee who gets paid less, the shareholder who gets paid less, and the consumer who pays higher prices. Research shows that employees bear between one-third and two-thirds of the corporate tax burden through lower wages. If you have a 401(k), you also pay this tax—unbeknownst to you, through lower returns on the stocks in the fund.

Moreover, corporate profits are income from investments. By taxing them, you get less investment. Less investment means lower productivity, which leads to lower wages over time. Decades ago, economists Robert Hall and Alvin Rabushka proposed a better approach: replace the corporate income tax with a consumption tax system, under which businesses immediately deduct all wages and capital investments. No double taxation, no penalties for investments and revenues, no unintended economic harm.

The corporation tax remains because voters mistakenly believe that someone else pays it, when in fact they themselves bear the cost.

Myth #4: Capital gains should be taxed as ordinary income.

This proposal sounds reasonable, but from an economic perspective, it's flawed. When a company earns $1 in profit, it pays approximately 26 cents in combined federal and state income taxes before distributing the rest to shareholders. Ultimately, the government takes almost half of every dollar earned by the company. This isn't a tax on the rich—it's two taxes on the same income.

Those who want to raise capital gains tax rates assume that the US is a tax haven for investors. This is not the case. The combined federal, state, and additional tax rate on investment income from capital gains in the US already stands at 29,2%, significantly higher than the OECD average of 19,1%. The US is already an exception, and not for the better.

(The OECD, the Organisation for Economic Co-operation and Development, is an association of developed countries with market economies that coordinate economic policies, share data and make recommendations.

The OECD comprises approximately 38 countries. These include the United States, Canada, the United Kingdom, Germany, France, Italy, Spain, the Netherlands, Sweden, Norway, Denmark, Finland, Switzerland, Austria, Belgium, Ireland, Japan, South Korea, Australia, New Zealand, Mexico, Chile, Colombia, Turkey, and Israel. Approx. Ed.)

Myth #5: Tax cuts pay for themselves

Right-wing politicians have been saying this for 40 years. But it's not quite true. By lowering the marginal labor and investment rates, you get more of both, which generates more revenue than the static calculations suggest. But the higher revenue than expected doesn't necessarily offset the cost of the rate cut. The Tax Cuts and Jobs Act of 2017 demonstrated this. Growth accelerated, wages rose, business investment increased, but the deficit still widened.

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The honest argument is different: tax cuts that reduce real budget revenues but improve capital allocation and boost long-term productivity are still the right policy. The question isn't whether tax cuts are worthwhile, but whether economic growth is justified. This is harder to distill into a short slogan, but it's the version that holds up.

However, there are enough expenses that can be cut and enough tax breaks that can be closed.

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