Is Our Current Income Tax System Unfair?

From each according to his ability, to each according to his need. 

                                                                                                           -Karl Marx, 1875

In our society, the more you use, the more you pay.  Sounds fair.  A big house comes with a big price tag.  Likewise, a smaller house has a smaller price tag.

We do have a corner of our world where the pay for what you use relationship doesn't hold.  We pay income taxes not based on the amount of services we use, but rather we pay based on what someone in Washington DC thinks we’re able to pay.  A rich guy paying a $1,000,000 in income taxes doesn't use 100 times more government services than an average Joe who pays $10,000 in income taxes.  The rich guy uses the same amount of NASA, the Washington Monument, or the Air Force as everyone else.  Ours is a progressive income tax where the percentage you pay in taxes rises with your income.  Our system has evolved since the first modern income tax was instituted in 1913 from a system to pay for a relatively modest set of government services, to the current system that pays for a greatly expanded set of ‘services’.  The current system can rightly be called a transfer mechanism, i.e. your money is being transferred to someone else. 

Despite the tremendous increase in scope and dollars being sent to the taxman, there is a loud chorus of folks who believe the income tax system is terribly unfair and favors the rich. 

A few facts from our friends at the IRS:

• in 2009, 47% of households didn't pay income taxes
• In 2009, the top 10% of income earners paid 70.5% of all federal individual income taxes and earned 43.2% of the income
• In 2009, the top 1% of income earners paid 36.7% of all federal individual income taxes and earned 16.9% of the income.
• In 2009, the top 0.1% of income earners paid 17.1% of all federal individual income taxes and earned 7.8% of the income.

A couple of things jump out at me.  First, I’m sure Marx and his disciples are upset about the earnings of the top 0.1% or 1%.  In their perfect world, there is no top 0.1% because everyone makes the same amount of money.  In the world I live in, hiring a top brain surgeon, quarterback, CEO, or movie star means forking over a lot of money. Second, in all instances, the percentage that high income people pay in taxes is much larger than their earnings.  The top 10% made 43.2% of the income, but paid 70.5% of the income taxes!

The top marginal income tax rate currently sits at 35%.  Those who believe the income tax system is unfair are mad that some rich folks don't pay the top marginal rate. They claim some rich folks are 'cheating' the system because they're paying taxes at a rate less than the top 35% rate.  People like Warren Buffett don't have traditional jobs with a salary.  These folks make money through long term capital gains (selling stocks, real estate, or businesses that have grown in value) which are taxed at a 15% rate.   The government has a provision for taxing long term capital gains at a lower rate vs. ordinary income to encourage investment.  

People who don't agree with the lower capital gains tax treatment usually have a sudden change of heart when they sell the house they bought 10 years ago at a $100,000 profit.