Tax Freedom Day Arrives on April 30, 2007

with No Comments

This year’s Tax Freedom Day arrives on Monday, April 30th. That’s when we stop working for the government and start working for ourselves. For the average worker, all of his or her earnings for the first 119 days of the year go to pay federal, state, and local taxes. Starting May 1st, we are free — at last — to take care of our own family’s needs.

The 2007 report, published this month by the non-partisan Tax Foundation based in Washington, D.C., measures the tax burden on Americans. According to the report, the 2007 federal tax freedom day comes twelve days later than it did in 2003.

Tax Freedom Day falls two days later than it did last year, even with the absence of tax increases. Gross Domestic Product has been strong, growing by at least 6.3% per year for the last three years. More wealth for Americans means an increase in Uncle Sam’s share.

Due to our progressive tax system, Uncle Sam collects more taxes as inflation rises due to “bracket creep”. As your income growth keeps up with inflation, your purchasing power remains unchanged. However, inflation drives you into a higher tax bracket and you pay higher taxes!

On average, taxes take nearly 33% of a worker’s gross income – 22% for federal taxes and 11% for state and local taxes. For every eight-hour day we work, 2 hours and 35 minutes of our labor goes to paying taxes. Without taxes, you could leave work at 2:25 p.m.

Only since 1992 have Americans paid more for government programs than they spend on food, clothing, and medical care combined. For the amount of money we pay in taxes, government could already provide universal health coverage and feed and clothe us as well.

At the state level, tax freedom day varies from state to state. California has the 7th highest taxes with its Tax Freedom Day being delayed until May 7th. Virginia places 17th in the race for the highest tax state rate even though its Tax Freedom Day arrives on April 30th, exactly the national average.

The Virginia tax rate continues to climb higher each year despite claims of no new personal taxes because of both bracket creep and the significant increase in state business taxes. This has been a national trend. Business tax receipts have risen more than 20% over the past year.

Most non-economists vastly underestimate the negative impact of taxes on the U.S. economy. Taxes encourage every American to do things themselves, outside of the taxable economy, even if specializing and working together would have produced greater productivity. If you add the costs of complying with the complex web of regulations, our government costs Americans, collectively, over 50% of our wealth.

Imagine three builders who could build three houses if they worked separately. If they worked together and combined their specializations, they could build six houses instead. It may seem incredible that these builders would not take the opportunity to double their productivity, but with any tax rate higher than 50% they have no incentive to choose the more productive partnership. A 50% tax rate halves their productivity. Imagine the economic boom if the other half of workers’ labor were set free!

Imagine a skilled surgeon whose marginal tax rate is over 50%. Everything she pays someone else to do costs her twice as much because she pays with after-tax dollars. It may be very inefficient to society for her to waste her time mowing her own lawn, changing her own oil or painting her own house, but specifically because she is in a high tax bracket, she can save more money than the average American by doing those chores herself. Another way to look at it is that without taxes, she could afford to pay those who provided her services twice as much.

Economist Arthur Laffer recognized that the law of diminishing returns applies to tax rates as well. According to Laffer, there comes a point beyond which increased taxation actually yields fewer tax dollars being collected. As we approach a 100% tax rate, we approach driving commerce into the ground and collecting nothing.

Many economists believe we are still beyond the point of diminishing returns. In other words, tax cuts would actually result in increased economic growth and more taxes being collected.

Presidents Kennedy and Reagan understood the Laffer Curve well. In 1964, Kennedy reduced the top tax rate from 91% to 70% and, to the surprise of many, tax revenues increased! Seventeen years later, the Reagan tax cuts reduced the top marginal rate from 70% to 50%. Revenues soared again. Between 1980 and 1997 the share of federal income taxes paid by the top 1% rose from 19% to 33%. The share of taxes paid by the top 25% increased from 73% to 82%.

The top 1% now pays 35% of the taxes in the United States. The top half pays almost 97% of income taxes. These two statistics have increased despite all the complaints that tax cuts have favored the rich.

Economists understand that the optimum rate of taxation is zero. The second most optimum rate of taxation is as low as possible. In contrast, many Americans seem to have the attitude that tax rates should be increasingly punitive.

Low taxes should not be a political issue that divides us. Every American should agree with the goal of keeping taxes as low as possible. In 2011, all of the federal tax cuts enacted since 2001 are scheduled to expire. In the words of John F. Kennedy, “An economy hampered by restrictive tax rates will never produce enough revenues to balance our budget – just as it will never produce enough jobs or profits.”

Photo used here under Flickr Creative Commons.

Follow David John Marotta:

President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.