The Unfair Tax

[From my backlog of interesting topics. It's not particularly newsworthy now, but it's still a worthwhile topic, so I finally finished it.]

What is the Fair Tax?

It's the politically expedient label for a consumption tax. It's also a misleading label because nothing about this tax makes it 'fairer' than other forms of taxes. However, that's not the first thing that comes to mind when you hear the term. No, the first thing you're likely to think is that you want a taxation system that is 'fair' and especially one that is fairer than what we have now.

When you look beyond the branding, what is clear is that it is a tax designed to change our economic fundamentals. It taxes consumption, but leaves labor, investment, savings, and business untaxed. This means that the tax falls heaviest on those who consume the most. Unless basics are exempted, this means it will be a heavy burden on those who just barely scrape by. This doesn't sound particularly 'fair' to me.

However, it's a good exercise to ask why we tax what we tax. Is it a historical fluke, or maybe a reasonable system that evolved by trial and error? This prompted me to think about the nature of taxation. In pre-modern times, the taxing authority would take a share of your goods, or would demand a share of your labor, or might take one of your children. In the 1800's, liquor taxes and custom taxes were the biggest share of federal taxes.

I can see certain advantages to taxing income. It is a monetary exchange, so money is changing hands anyway. That's a convenient place to exercise a tax. Work payrolls are less cyclical than consumer spending, so tax revenue will be less affected in recessions. Perhaps there are other good reasons to tax income. However, the point is that the so-called "fair tax" isn't obviously a good tax. To make a determination of whether it's a good tax, you have to look beyond the label, and see how the tax functions. You also have to compare it to the alternatives. When I do that, the 'fair tax' has a lot of problems. We need to take a good, hard look at it, not just jump on the bandwagon.

This one (and a bunch more) for the tax collector

Image: scoop.it

What the rich owe us

Yes, you rich person, who either made a fortune or inherited one, you owe society. As Elizabeth Warren and President Obama have pointed out, you owe something to the society in which these riches were made.

That shouldn't be denied, though some people strenuously deny that society, or specifically government, provides much benefit to those who are trying to make a living. That's hogwash, of course. The rich are not self-sufficient. They rely on the commercial marketplace, public roads and utilities, customers, property rights enforced by police and courts, etc.

Fear Factor

Nonetheless, an unqualified statement that rich people owe society is frightening. The world has seen the rich plundered (along with the poor or the average), the rich guillotined, the rich sent to reeducation camps, etc. Even in this country we've had 90% income tax rates for the rich, which amounts to confiscation for those who aren't adept at tax avoidance.

It would be good if those who say that 'the rich owe society' show that they aren't planning to go down that slippery slope, because that is what will pop into the heads of a lot of people if they don't address the issue.

Reassurance Rates

What is effective reassurance? Giving a maximum tax rate would be somewhat reassuring, but it's not the best political optics. For people who know their effective tax rate or their tax bracket, the highest tax bracket of almost 40% sounds damn high. Besides, I think that tax bracket will break over the 40% threshold when the Obamacare taxes start being collected.

Perhaps it would be more palatable to talk in multiples of the usual payroll tax. I personally think that having highest earners paying income tax at a rate of 5 times the usual payroll tax doesn't sound terrible, especially if you quantify the other brackets too: 1.5 times the payroll tax, 2 times the payroll tax, 3 times the payroll tax, etc. (Note: I say the usual payroll tax to account for the Social Security tax rate cut we're currently having. Any tax holidays for payroll taxes shouldn't apply to the income tax rates.)

Reform

The best way to reassure taxpayers that you aren't out to soak the rich is to support a broad, fairly flat income tax structure. But that means committing to tax reform because our current tax structure isn't very flat and contains all sorts of loopholes for the wealthy and not-wealthy to reduce their tax burden. It also means being committed to finding ways to rein in spending, including entitlements. Because if you don't rein in spending (and growth in entitlements are the largest automatic spending hikes), then the US taxpayers know that you're going to be soaking the rich sooner or later.

So here's my declaration: I believe in the rich paying their fair share, and everyone else paying theirs too. And I'm not afraid to quantify what I mean by 'fair share.'

 My proposed tax rates

Image: travel-images.com

Short: Editorial spin

You don't have to make up magnificent lies and conspiracy theories to be a biased commenter. In fact, a bit of subtlety can make the spin more believable. Here is the Wall Street Journal, writing about the extension of the payroll tax holiday:

"...then Messrs. Boehner and McConnell were gulled into going behind closed doors with the President, who dragged out negotiations and later emerged to sandbag them with his blame-the-GOP and soak-the-rich re-election strategy. Any difference between the parties on taxes and spending has been blurred in the interim."

Obama sounds like a political Svengali, gulling less wily, less experienced politicians into compromising positions. How evil of Obama, we are led to think.

If you bother to question the WSJ's version, you might wonder how two politicians experienced enough to rise to the offices of House Speaker and Senate Minority Leader could be lured into negotiations and then sandbagged. Could it be that they entered the negotiations with a terrible weak position? Why, yes indeed, that's a possibility. Maybe they also overplayed their hand, and their bluff was called, and they lost their shirts.

A Speaker of the House and a Minority Leader of the Senate should know their way around a political negotiation. So should the editors of the Wall Street Journal. Try this spin on someone else.

Diabolical!

  Photo credit: Salon.com

Tax Fairness

Oh God, is this a sticky topic. Maybe I'll just throw some major threads against the wall:

• Everyone should be paying some tax because it represents skin in the game.
• Everyone should pay the same percentage of taxes because then they're all contributing the same relative amount.
• People who earn less struggle so much already, they don't have the means to pay as much tax as the well-off, higher earners, or rich.

Each of these views sounds good and reasonable, so it will be hard to choose between them.

Everyone should pay some tax.

• Pro: Having a stake in government, at both the paying and receiving ends, is most likely to make people care what government does, educate themselves, and vote wisely.
• Con: It's hard to determine what the minimum tax should be, particularly for low wage workers with children who barely scrape by as is.

Everyone should pay the same percentage of taxes. 

• Pro: This makes scapegoating impossible, so no particular group gets soaked. Everyone has the same stake in good government.
• Con: This country has wide disparity in incomes, with a lot of people living at or near subsistence levels. A tax rate that is easily shouldered by higher-income folks is a burden to the poor.

People who earn more should pay a higher percentage.

• Pro: The tax burden is put on those most able to afford it.
• Con: People who don't pay taxes but receive services have no stake in efficient government, because the burden falls on other people. Burden-shifting epitomizes what's terrible about the current tax code.

Not surprisingly, there still isn't a clear winner. However, when I look at our tax system, I see elements that fit these categories.

Our payroll taxes are flat taxes, and they seem to work pretty well. Everyone who works pays them, and everyone benefits (or expects to benefit) from the services they provide. They are also relatively easy to collect. The burden is low enough that most people pay without trying to weasel out. These look like good taxes to me.

In comparison, our income taxes are a train wreck. We have so many groups lobbying for particular deductions and credits that the tax code is like a subterranean cavern, or a hoarder's attic, or a junkyard, or an even more arcane, disjoint, jury-rigged, unstable, unbelievable metaphor. We have separate rates for different kinds of income: dividends, wages, short-term capital gains, long-term capital gains, rents, maybe farm income, business partnerships, etc. to infinity. The whole thing is a crazy mess.

I can't believe it, but I just talked myself into supporting a flat tax!!!!??!!

That stills leaves the problem of too much burden on those who can't afford it. The best way to handle this is to give realistic exemptions for living expenses. Allow exemptions per category: adult, child, elder, and maybe a few other special cases, but not many and as clear as possible.

I would also keep the earned income tax credit (or its equivalent) because I know too many people who really need this. I don't think the earned income tax credit creates a new problem (no stake in efficient government). The working poor still have skin in the game with payroll taxes. They also usually aspire to move up the income scale to where they will be paying income taxes.

So, that's my unexpected conclusion. Yes to payroll taxes. Yes to a flat income tax with exemptions and the earned income tax credit. No to lots of deductions and credits and different types of income. Case closed. (Or is it?)

Still in shock

Addendum: I think that maybe we'll need two tax brackets, maybe one for earnings under something like $200,000, and then you pay 50% more on earnings above that.

Update: When I crunch some numbers, I ended up with two brackets at 18% and 28%, though they could be high or low. (It's hard for me to estimate the changes in taxable income when deductions are eliminated and exemptions increased.)

Update again: I think 18% is too high for a flat tax. It takes too much from low earners who don't have very much to spare. If the bottom fifth of workers are earning only 3% of income in the country, what should their tax burden be?

History for Amnesiacs: Our stolen Social Security taxes

In this lesson, I have to ease off my usual how-could-you-forget tone. I had to do a bunch of research to confirm, and in some cases correct, my own memory of events.

Social Security (SS) was born underfunded. Maybe I should have researched why the founders in 1935 thought 1% per year were adequate savings, but I didn't. However, as far back as I can remember, which goes into the 1960's, SS was in trouble and in need of rescue. The employee contribution rate went from 1% in 1935 to 7.65% since 1990.

(Click to enlarge)

I remember the series of SS crises, as collections failed to keep up with current and projected pension demands. The Greenspan Commission in 1983 was supposed to fix SS for good. I guess politicians and voters bought the story, or maybe just felt that the taxes were as high as Americans could stomach, because the rates haven't been raised since the commission set the rate at 7.65%.

One thing that didn't happen was isolating the surpluses and making sure the money was available when the bulge of retirements started to tax the SS fund in the 2020's. This is where my research went off the rails. I expected to find that because there was no "lockbox" for the surpluses, they had been frittered away through tax cuts and deficit spending during the Bush II years. That's the Democratic narrative, anyhow.

The Twist

What I found instead is that the SS trust fund never had a method of securing its surpluses. It always handed them over to the Treasury in return for IOU's. Unlike a normal pension plan, the SS trust fund not only didn't secure its surpluses, but it never invested them. It was always on the road to relying on US federal dollars for its own deficits when the baby boomers retired in droves.

The SS trust fund also funded most of our modest deficit spending for 3 decades. But starting in the 1980's, we ran significant extra deficits beyond that. So not only does the federal government owe the SS trust fund $2.6 trillion, but it owes non-government creditors nearly $10 trillion on top of that.

(Click to enlarge)

One part of the Democratic narrative is correct. The SS payroll taxes were increased and that provided the federal government with ready money to fund extra spending and tax cuts and buy up yearly deficits, so that money was frittered away.

A more important truth is that, despite creating these surpluses, neither party in the 1980's had a plan that allowed the SS trust fund to use these surpluses. When you think of pension funds losing billions in hedge fund collapses, it's reassuring to know the SS trust fund isn't being used that way. But to find out that the money isn't even being stuffed in a mattress, that none of our top economists have ever figured out how to stash or invest or isolate or protect that much money, that is maddening.

All that time that I was being taxed, I was one of the many baby boomers who said "I'm not going to count on Social Security because it's not going to be there when I retire." However, finding out more of the mechanics now, it really hurts. OUUUUCCHH.

Even when the commission declared that the tax increases would keep the SS trust fund solvent in perpetuity, and it increased taxes ON ME and EVERYBODY to create much larger surpluses, THEY NEVER HAD A PLAN. Those surpluses were just thrown down the same rabbit hole. What the hell was that commission for? Why the f**k didn't the commission work on that part of the problem? My respect for Greenspan, which started dropping after he retracted his "irrational exuberance" comment and kept pumping up the bubble, just hit a new low. It's now tunneling its way to China. How appropriate.