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Pearlstein: Right level of taxation lies between the extremes

I almost choked on my scrambled eggs while reading the paper Thursday morning. There, in black and white, was Dick Armey — the former Republican House leader and an archbishop of the anti-tax movement — acknowledging that federal tax rates were now "at a good level."

Praise the Lord! A Republican leader finally dared to utter that taxes had been cut enough and that the optimal tax rate is not zero. It's probably only a matter of time before Armey is declared a heretic by Rush Limbaugh and sentenced to 20 lashes with a Laffer curve.

Armey was right about something else this week: that unless we're prepared to make major cuts to defense and entitlements — and there is no evidence of a political will to do so — there's no way to balance the budget and do everything the president wants without a modest increase in the share of national income that goes to taxes.

In thinking about taxes, let's start with a few hard realities:

About 20 percent of household income is paid in federal taxes — income, payroll, excise, corporate. That number can rise to 23 or 24 percent once the current recession has passed without hurting long-term economic growth.

Still, it's not a good idea to raise all that extra money just from households with annual incomes of more than $250,000. That was a winning campaign promise for candidate Obama, but it makes for lousy economic policy.

A lot of liberals make the argument that it's okay to soak the rich because the rich have captured virtually all the income growth in the past couple of decades. There's no disputing that income inequality has increased. But it's also important to remember that there is only so much a progressive tax code can do to counteract the market. With the top 10 percent of households paying 55 percent of the total federal tax bill, we're hitting against that limit.

So what's the "right" level of taxation?

President Obama wants to raise the top income tax rate from 35 to 40 percent, which is probably as high as it ought to go. Add in state income taxes and the marginal rate would get close to 50 percent in many states.

The marginal rate, of course, is not the same as the overall tax burden — the percentage of all household income that goes to paying all forms of federal taxes. According to the Congressional Budget Office, the richest 10 percent of households had a federal tax burden of just under 28 percent in 2006, the last year for which data are available. Even if President Obama succeeds in pushing through his tax increases for those households, the federal tax burden would rise only to where it was in 1996, a pretty good year for the economy.

Given the stagnation of incomes for working-class families in recent decades, those households are probably not in much of a position to absorb a tax increase. But for those with incomes from $100,00 to $250,000, it's hard to argue that returning the federal tax burden to Clinton-era levels would lead to serious economic hardship.

The old Republican fantasy was that tax cuts were the magic elixir that would solve every problem. Now that the public has finally rejected it, it's disappointing to see Democrats offering up the equally fantastic notion that Americans can have all the government they want while getting someone else to pay for it.

Pearlstein: Right level of taxation lies between the extremes 04/19/09 [Last modified: Sunday, April 19, 2009 4:30am]
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