Between 1977 and 1989, the percentage of income paid to

Question

Between 1977 and 1989, the percentage of income paid to federal taxes by the richest one percent of Americans decreased from 40 percent to 25 percent. By the end of that same period, however, the richest one percent of Americans were paying a larger proportion of all federal tax revenues from 12.7 percent in 1977 to 16.2 percent in 1989.

Which of the following, if true, contributes most to an explanation of the discrepancy described above ?

(A) Between 1977 and 1989, the IRS increased the percentage of its staff members responsible for audits and tax collection.

(B) Between 1977 and 1989, the before-tax income of the richest one percent of Americans increased by over 75 percent when adjusted for inflation.

(C) Between 1977 and 1989, many of the richest one percent of Americans shifted their investments from taxable to untaxable.

(D) Between 1977 and 1989, the tax rate paid by middle-income Americans was reduced, but several tax loopholes were eliminated.

(E) Between 1977 and 1989, the amount of federal taxes paid by the richest one percent of American increased by $45 billion, while the amount paid by all Americans rose by $50 billion.

mikemcgarry · Accepted Answer

Hi, there. I'm happy to help with this.

CR questions with percents are particularly tricky, because you have to ascertain, in each instant, what is a percent of what? So, here's the prompt again: " Between 1977 and 1989, the percentage of income paid to Federal taxes by the richest one percent of Americans decreased, from 40 percent to 25 percent. By the end of that same period, however, the richest one percent of Americans were paying a larger proportion of all Federal tax revenues, from 12.7 percent in 1977 to 16.2 percent in 1989 ." So, the first percentage ---- "percent of income paid to Federal taxes" for the 1% --- that means, each one-percenter person went from paying 40% of his income in 1977 to 25% of his income in 1989 (that would have been Mr. Reagan's policies). That is only a percent --- if my income went, say, from $1 million in 1977 to $10 million in 1989, then I would have paid 40% of $1 million = $400,000 in taxes in 1977, and I would have paid 25% of $10 million, or $2.5 million in taxes in 1989. In other words, if the overall amount of income has increase, the dollar amount of taxes paid can increase even if it's a smaller percent of the income. The second percent: "a larger proportion of all Federal tax revenues" --- so, here, if you look at the big pie, the total dollar amount that the IRS rakes in each year, then the share contributed by the 1% would have increased. In other words, the rich got richer, and the poor got poorer: an oft-repeated description of the 1980s. The basic way to explain this discrepancy: the dollar amount of income of each 1% person had wildly increased . That's something you need to have sorted out before you look at the answer choices. Now, the choices. A. Between 1977 and 1989, the Internal Revenue Service increased the percentage of its staff members responsible for audits and tax collection . Almost wholly irrelevant --- audits might account for a little more money here and there, but not for a massive increase in revenue. B. Between 1977 and 1989, the before-tax income of the richest one percent of Americans increased by over 75 percent when adjusted for inflation . Bingo! Just what we suspected. C. Between 1977 and 1989, many of the richest one percent of Americans shifted their investments from untaxable to taxable assets . First of all, there's no historical evidence for that, but think about it. If the tax rate declines, maybe some 1% folks move a little more from tax shelters to something taxable, but it simply doesn't make sense that person would move so much that the overall dollar amount in taxes paid increases to more than what it was at the higher tax rate. It's unlikely one person would do that, and it's unimaginable that "many" of the 1% would do something so daft. D. Between 1977 and 1989, the top tax rate was reduced from 70 percent to 31 percent and several tax loopholes were eliminated . Lower taxes, doesn't explain more tax income from those folks. Eliminating loopholes -- may result in some more income, but a result in a substantially larger slice of the Federal pie? Unlikely. E. Between 1977 and 1989, the amount of Federal taxes paid by the richest one percent of Americans increased by $45 billion, while the amount paid by all Americans rose by $50 billion. Here we have dollar amount increases. For the 1%, we have the percentage increase, so we could figure out the before & after dollar amounts. For the 99%, we have no info --- no way to figure out the dollar amounts before or after. To borrow DS language, this choice gives us "insufficient" information. Answer: B Again, it's very important to have a clear idea of what the discrepancy is and what would resolve it before you start analyzing answer choices. Does that make sense? Please let me know if you have any questions on what I've said. Mike

KapTeacherEli · Answer

On this explain question, we know two facts--tax rates of the top one percent plummeted, but the amount of taxes they paid relevant to the rest of us skyrocketed. This leads us to only one conclusion: the top one percent is earning more money to be taxed! (B) matches perfectly.

Note that the "adjusted for inflation" is a phrase that is almost guaranteed to show up at least once on the GMAT. It's a sure thing that the wealthy earned more dollars in 1989 than in 1977. Inflation during that period means that each dollar was individually worth less; the same value of pay or income would be measured in a larger number of dollars! However, that change in number affected  all income brackets  in that time period, so would have no effect on the  proportion   that the wealthy paid. By adjusting for inflation, we are told that the rich's amount of wealth--not merely their number of dollars--had increased.

(C) is a tempting trap because it seems to provide a possible explanation for the discrepancy. However, being told that "many" of the wealthy had tax-free "investments" doesn't give us much to go on. Without the proportion of the wealthy that make up "many," or a proportion of their income put into "investments," we have zero clue how much money is actually being newly taxed.

KapTeacherEli · Answer

How would an explanation of this fact contribute to our understanding of the mystery?

It could that the rich paid less taxes due to a change in laws, a change in banking strategies, a change in nationality. But none of these would explain how they were paying a larger portion of the nation's taxes, despite paying a smaller portion of their own income.

B, however, makes the change clear. For whatever reason--we don't know, or need to know--the wealthy are paying a smaller portion of a  larger amount of money . This explains how they can be paying less in relation to themselves, but more in relation to others, and so is the correct answer.

Hope this helps!

mikemcgarry · Answer

Thank you for your kind words. Here's a free video lesson about CR questions that you may find helpful. https://gmat.magoosh.com/lessons/579-dis ... n-argument At Magoosh, we have a series of video lessons to guide your approach to CR questions on the GMAT. I hope that's helpful. Let me know if you have any further questions. Mike

mikemcgarry · Answer

Dear kraizada84 Thank you for your kind words. Mastering the high levels of CR is indeed a difficult task. I would recommend checking out Magoosh. We have 200+ GMAT lesson videos, including a whole series on mastering the CR. Here's a sample: https://gmat.magoosh.com/lessons/579-dis ... n-argument We have 800+ practice questions, each with its own video explanation. Here's a sample: https://gmat.magoosh.com/questions/1309 After you submit your answer to that question, the following page will have the video explanation. I believe the strategies we teach might be just what you need to crack the ceiling you are current hitting on CR. You may also find this blog article helpful. https://magoosh.com/gmat/2012/arguments- ... -the-gmat/ Let me know if you have any questions. Mike

mikemcgarry · Answer

Dear Jp27 , Think about it this way. We are being asked for an "explanation of the discrepancy." An explanation is something that makes something clear --- explanations resolve uncertainty & ambiguity --- that's the job of an explanation. Choice (C) contains that beautifully vague word "many" --- how many? a majority? almost all? or just a substantial minority? And then we have the question of --- what was the dollar amount of the investments that were shifted "from untaxable to taxable assets", and how does that compare in dollar amount to the assets that were already being taxed? Much more? much less? about equal? More uncertainty. We have been asked to explain something. A statement awash in uncertainty does not make a cogent explanation. Does all this make sense? Mike :-)

mikemcgarry · Answer

Dear thebigr002 My friend, if you are studying for the GMAT and headed for business school, you need to get used to arguments just like this. This argument is very typically, in scope and language, of what the GMAT will test. Furthermore, this is precisely the sort of information that managers need to process to make business decisions. If you are aiming for the MBA, hoping to pursue a career in business, you have to acclimate yourself to all these ideas until reading a passage like this is totally natural. I would strongly suggest reading the Economist magazine to build familiarity with fundamental economic ideas. I'll also recommend this series of blogs on real-life issues to understand for the GMAT. https://magoosh.com/gmat/2012/gmat-supply-and-demand/ Let me know if you have any further questions. Mike :-)

ChiranjeevSingh · Answer

From the discussion above, I think many of us consider option B & option C to be the two major contenders for the answer. However, some of us are, ultimately, falling for the wrong guy, option C. I think, in our discussion above, we have missed one crucial point, which is very apparent in the question passage and which is missed by option C.

Let me offer my two cents to the discussion.

As Mike has very brilliantly explained the paragraph of the question, the paragraph states two things about period 1977 to 1989:

1. The proportion of income paid to federal taxes by the richest (i.e. top 1%) people has decreased. 
2. Proportion of federal taxes contributed by the richest has increased

Now, option C says that many of the richest people shifted their investments from non-taxable to taxable assets. Now, such a thing would have impact on both the above statements. Though such a move by the richest would help explain statement 2, it would run completely counter to statement 1, since this option talks about increased tax outflow from the richest, without suggesting any corresponding increase in the income of the richest. Thus, this option leads to increased proportion of income paid to taxes, which is opposite of statement 1.

I hope the above explanation removes option C from the race, leaving us with only option B.

If anyone finds any issues with this, I would be grateful if you point it out.

I would also like to use this forum to emphasize one very important point here. We should never use outside knowledge to judge the validity of any statement. The reason is simple that the critical reasoning questions are designed to test your reasoning skills, not your knowledge. They are not designed to favor people possessing certain knowledge (which, in this case, could be about the tax regime in 1980s in the US). Official GMAT website clearly states this in the test structure of GMAT.

I am emphasizing this because I see that Mike’s argument for not going for option C begins with “First of all, there's no historical evidence for that...”. This is an incorrect approach to attempt critical reasoning questions.

Even the second part of this argument is fallacious. The second part says that:
“If the tax rate declines, maybe some 1% folks move a little more from tax shelters to something taxable, but it simply doesn't make sense that person would move so much that the overall dollar amount in taxes paid increases to more than what it was at the higher tax rate. It's unlikely one person would do that, and it's unimaginable that "many" of the 1% would do something so daft. “

Looking closely at the argument, a question arises, why would even some people move some proportion of their assets, if the tax rate was lowered? No-tax is always better than lower tax. Why would some people do that?

They would do only when the after-tax return on taxable investments becomes greater than return on non-taxable income. So, when the tax rate is lowered to such an extent that after tax return on taxable assets become greater, people would start switching to them, thereby increasing tax revenues for the government. And in this case, they may shift their entire assets to taxable ones, which would possibly generate enough taxes for the government, to more than offset the decrease in tax rate.

Helium · Answer

The words “contributes most to an explanation” indicate that this is an Explain question. Expect there to be a paradox or apparent contradiction in the stimulus, and the answer to explain how both parts of the apparent contradiction can be true at the same time.

Untangle the Stimulus:

The two parts of the apparent contradiction in an Explain question are often separated by a contrast word, such as “but,”“yet,” or, in this case, “however.” On the one hand, the richest one percent paid a lower percentage of their income to taxes. On the other hand, the amount they paid represented a larger proportion of all tax revenue collected.

Predict the Answer:

Explain questions are typically not predictable. Here, just keep in mind that the correct answer will explain how the income taxes paid by the richest one percent could make up a larger proportion of all tax revenue than before, even though those taxes represent a lower percentage of their income than before.

Evaluate the Answer Choices:

(B) explains the discrepancy, and is the answer. If the income of the richest one percent increased greatly, then the tax on that income - even at a lower tax rate than before - could still represent a larger proportion of all Federal tax revenues.

(A) is wrong because there is nothing in the stimulus to suggest how an increase in staff handling audits and collections would affect the amount of taxes being collected from any particular segment of taxpayers.

(C) is incorrect because although “many” of the richest one percent may have shifted their investments to taxable assets, many more may have shifted their investments in the other direction, from taxable to untaxable assets, which would lower their taxable income. (C), therefore, doesn't explain the discrepancy, and is incorrect.

(D) perhaps explains why the percentage of income paid by the richest one percent has decreased (the first part of the discrepancy). But this doesn't explain the second part of the discrepancy - how the rich ended up paying a larger proportion of tax revenues. This also doesn’t indicate who exactly is affected by the elimination of the loopholes, and how.

(E) tells how much the taxes paid by the two groups increased. But this doesn't explain how the proportion paid by the richest one percent increased, while at the same time the percent of their income paid decreased.

DavidTutorexamPAL · Answer

If the share of the 1%'s income decreased, but the share of the total payments made increased - this  must  mean the 1% got much richer: more income - a smaller percentage of it can still be a larger number than before. 
 This is exactly what B tells us: Between 1977 and 1989, the before-tax income of the richest one percent of Americans increased by over 75 percent when adjusted for inflation.

Bunuel · Answer

KAPLAN OFFICIAL EXPLANATION:

B

We're told that from 1977 to 1989 the percentage of their own income that the richest one percent of Americans paid to federal taxes decreased. At the same time, the proportion (or percentage) of all federal tax revenues that was paid by these same rich Americans increased. We're asked to clear up this apparent discrepancy: A lighter tax burden on the wealthy resulted in their carrying more of the overall tax load. If, as (B) has it, the richest one percent are making much more money-than they once did, then the actual amount of money they pay in federal taxes can increase, even though the percentage of their own income that this amount represents decreases. This increased amount of taxes paid could represent an increased proportion of the total federal tax revenues.

(A) suggests that the IRS has increased its tax-collecting efficiency, but this is irrelevant to the question of how one percentage can increase while the other decreases. (C) could explain how taxes on the rich account for more of the total tax revenues (because more of their investments are taxable), but it doesn't explain why these increased taxes account for a smaller percentage of their incomes. (D) raises new questions. If we assume (which we can't) that the elimination of loopholes hurt the rich more than the tax cut helped them, we could see how they might pay more taxes despite the cut in the top tax rate. But that just presents us with the old problem: If they're paying more taxes, how can they be paying less of their income to taxes? On the other hand, if we assume (which we can't) that the tax cut in (D) means they're paying less in taxes, how can they be bearing more of the tax burden?  On a question asking for an explanation, avoid any choice that leaves you wondering , (E) shows how the richest one percent account for a higher percentage of overall tax revenues. They've paid an additional 4 5 billion dollars while everyone else has only had to come up with an additional 5 billion—the 5 billion left from the 50 billion after subtracting the 45 billion that the very rich paid. However, this leaves out the other part of the dilemma-it doesn't show how they can be paying less of their income.

Judus1010 · Answer

Why is D not a viable answer here? I am not understanding the explanations from people like Bunuel here. The question states that the tax rate for the top 1% had dropped, yet the top 1 % makes up a larger portion of the total tax revenue. Answer D states that "Between 1977 and 1989, the tax rate paid by middle-income Americans was reduced, but several tax loopholes were eliminated." One possible reason for the discrepancy is that since the tax rate for middle-income Americans has gone done, they are contributing less to the total tax revenue. That would clearly explain why the top 1% makes up a larger portion of the total tax revenue.

According to Bunuel, "(D) raises new questions. If we assume (which we can't) that the elimination of loopholes hurt the rich more than the tax cut helped them, we could see how they might pay more taxes despite the cut in the top tax rate. But that just presents us with the old problem: If they're paying more taxes, how can they be paying less of their income to taxes? On the other hand, if we assume (which we can't) that the tax cut in (D) means they're paying less in taxes, how can they be bearing more of the tax burden?" I think Bunuel has misunderstood the answer choice. "The tax cut in (D) means they're paying less in taxes, how can they be bearing more of the tax burden?"- Who is they? The top 1% or middle-income? The middle-income individuals are paying less in taxes and therefore, the top 1% is caring more of the tax burden.

Also the elimination of loophole could explain why the total taxable income of the top 1% has gone up. Beforehand, the top 1% could have funds in holdings which made it untaxable. Now with the loopholes removed, the total taxable income has gone up. Any explanation would be greatly appreciated. Thanks.

ParamjitDasGMAT · Answer

Hi  Judus1010 , I'll try to help address this particular issue.

Note that the loopholes were eliminated for    ALL    people -- so there is no particular reason to assume that the loopholes would have hurt   only   the rich by increasing their total taxable income. The elimination of the loopholes could have had equally detrimental effects on the poor and middle-class folks as well as far as their seeing an increase in their total taxable income. So this does not quite explain why the top 1%ers are suddenly paying only about three-fifths, in terms of the % of their incomes, of the old income tax contributions. The relative % contributions should have remained the same for all (economic) classes of people.

Hope this helps.

RudreshKal · Answer

mike  and all the experts above kindly consider my below opinion -

Between 1977 and 1989, the percentage of income paid to federal taxes by the richest one percent of Americans decreased from 40 percent to 25 percent By the end of that same period, however, the richest one percent of Americans were paying a larger proportion of all federal tax revenues from 12.7 percent in 1977 to 16.2 percent in 1989.

(B) Between 1977 and 1989, the before-tax income of the richest one percent of Americans increased by over 75 percent when adjusted for inflation.

Suppose Taxable income of 1% is 100 Mn which grew to 175 Mn by 1989. So tax in 1977 is 40 Mn and around 40 Mn in 1989. Op B is only telling us that income grew by 75% of top 1% people.

It doesnt tell that rest of 99% people Stayed same or decreased or increased less than 75%, neither does overall ratio of both in 1977 and 1989. So it can not be conclusively said top 1% people share grew in tax.

either the argument is flawed or options are flawed.

VerbalBot · Answer

Hello from the GMAT Club VerbalBot!

Thanks to another GMAT Club member, I have just discovered this valuable topic, yet it had no discussion for over a year. I am now bumping it up - doing my job. I think you may find it valuable (esp those replies with Kudos).

Want to see all other topics I dig out? Follow me (click follow button on profile). You will receive a summary of all topics I bump in your profile area as well as via email.

Between 1977 and 1989, the percentage of income paid to

Prep Toolkit

Top 5 GMAT Debrief Videos

615 to 715 in 15 Days (Ria's Strategies)

More than Quant/Verbal Abilities: Speed vs. Accuracy

745 with Only Self-Prep and GMAT Club

From 555 to 765: 210-point Improvement

Perfect 805 Score Debrief by Julia

My Rewards

GMAT Critical Reasoning (CR) Questions

Between 1977 and 1989, the percentage of income paid to

Prep Toolkit

615 to 715 in 15 Days (Ria's Strategies)

More than Quant/Verbal Abilities: Speed vs. Accuracy

745 with Only Self-Prep and GMAT Club

From 555 to 765: 210-point Improvement

Perfect 805 Score Debrief by Julia

My Rewards