Our Fair Share

January 19, 2020

by Steve Stofka

The holidays are over. This week our city picked up Christmas trees set by the curb. The sun set after 5 PM, the first time since the time change in the first week of November. The sun is returning to the Northern Hemisphere. Despite the variations in the amount of sunshine throughout the year, we all get the same amount of sunshine over the course of a year. Not so with our tax bills.

Estimated taxes were due this week. The self-employed, retired people and others who earn income with no taxes withheld must pay estimated taxes every quarter. This past year the IRS audited less than ½% of returns, a lifetime low. That sounds great because none of us wants to endure an audit. The very word strikes fear in the hearts of many taxpayers, but most of us have a small chance of being audited regardless. We don’t pay enough in taxes for the IRS to do much more than a paper audit, a request for supporting documentation.

The IRS is not a popular agency and became less popular when the agency discriminated against Tea Party and progressive groups during the 2010 election (Farhi, 2017). House Republicans repeatedly cut the agency’s budget, but that retribution has had serious budget consequences. The National Bureau of Economic Research estimated that the government could raise an additional $1 trillion in tax revenue – that’s about 20% of total revenue – with stricter enforcement of existing law (Heeb, 2019). In 2019, the Federal deficit, or budget shortfall, was $1.1 trillion (BPC, 2020). Stricter enforcement would have effectively erased that deficit.

The race for the Democratic Party’s nomination for President promises to center around several themes. The first is the horse race against President Trump, whose incumbency gives him a distinct advantage when running for re-election. The press often seems more concerned with the contest than the underlying issues of a campaign. Taxation is a recurring discussion in each election. More or less? What is a fair share? More, more, more social programs, taxation and regulation, or less, less, less social programs and taxation and more defense spending and power for large corporations?

What is fair? As children we have a keen sense of fairness – our “monkey brain.” We are social creatures who feel scorned at what we perceive as unequal treatment. Equal and fair are not the same thing. A fair share is not the same as an equal share. If I can afford to buy $50,000 worth of goods in a year, why should I have to pay more sales tax than someone who only buys $30,000? We make equal use of a city’s public services. Why should we be treated unequally? Well, we have become accustomed to paying an equal percentage of what we buy in the stores as a sales tax.

Why don’t we follow that same approach for income taxes? States like Colorado do charge the same rate of state income tax regardless of income. Is that fair? Some cities like Denver charge a head tax, a flat fee income tax for anyone who works within the district. Should we follow the same approach throughout the nation? Warren Buffett and I would pay the same amount in income taxes. Is that fair?

Should prices for public utilities be adjusted based on income? If my neighbor makes twice what I do, should they pay twice for the same amount of water? Currently, we are charged the same rate. The income and property taxes of those over 65 are often given a discount. In some districts, a person who reaches 65 finds that they can lower their property tax by 50%. Is that fair?

Elizabeth Warren, a candidate for the Democratic Party’s presidential nomination, proposed that all student debt be eliminated. Should students who went to more expensive private schools be rewarded more than students who borrowed less because they went to a state college? Should students who borrowed less because they worked part time while going to school be penalized? Is that fair?

In Matthew 20:1–16, Jesus tells a parable of the workers in the vineyard. Workers who came to work in the morning agreed to an amount of money for a day’s work. Workers who came to work later in the day were also promised the same amount of money for working the rest of the day. Jesus was making a point that each person will be rewarded equally in the kingdom of heaven no matter when in their lifetime they come to God’s love. No matter what your religious orientation, is that fair?

Each election we get to vote on what’s fair. Some people don’t vote because they say that their opinion doesn’t matter. It certainly doesn’t if they don’t vote so they have proved their case. If I vote and my neighbor doesn’t, my vote effectively counts double. In a few weeks, the Democratic primaries will start. The first two are in Iowa and New Hampshire, states with small populations and an even smaller number of people who participate in the caucus system. The votes of a few thousand people can make or break a candidate’s campaign. In a democratic nation of 320 million people, is that fair?

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Notes:

Bipartisan Policy Center (BPC). (2020, January 9). Deficit Tracker. [Web page]. Retrieved from https://bipartisanpolicy.org/report/deficit-tracker/

Farhi, P. (2017, October 5). Four years later, the IRS tea party scandal looks very different. It may not even be a scandal. Washington Post. [Web page]. https://www.washingtonpost.com/lifestyle/style/four-years-later-the-irs-tea-party-scandal-looks-very-different-it-may-not-even-be-a-scandal/2017/10/05/4e90c7ec-a9f7-11e7-850e-2bdd1236be5d_story.html

Heeb, G. (2019, November 19). The US could raise $1 trillion more in taxes through stricter IRS enforcement, according to a new study. Markets Insider. [Web page]. Retrieved from https://markets.businessinsider.com/news/stocks/us-could-raise-1-trillion-more-tighter-irs-enforcement-study-2019-11-1028700145

Photo by Maria Molinero on Unsplash

A Proposal

May 28, 2017

The Republican led Congress has promised tax reform in the coming year.  This week I’ll introduce an income tax program that I think will clarify the debate.

Let me begin with those on the left side of the political aisle who talk about the rich paying their fair share.  The kernel of the Democratic social plan is a promise to take care of the poor by giving them benefits. Even if I don’t get any of those benefits, I like voting for politicians who help out the poor because I’m a good person.

If I ask House Minority Leader Nancy Pelosi or Senate Minority Leader Chuck Schumer “Where should the money come from?” they answer “People with too much money.” Nancy and Chuck know which people have enough money and which ones have too much.

BBLR has long been a rallying cry for those on the right. The acronym means “broaden the base, lower the rate.” As Majority Leader in the House and as Vice-Presidential candidate, Paul Ryan has espoused this philosophy. Here is a PolitiFact article on the issue during the 2012 presidential race. Tax reform champion Grover Norquist has advocated for the same principle.

The term “broaden the base” means to have more people paying at least some income tax so that they have skin in the game, so to speak. In a very progressive tax system, people who pay little or no taxes will vote for politicians who promise them benefits. After all, it is OPM, or other people’s money. In Democratic circles, BBLR stands for a mean tax system. Here’s the debate between Nancy and Chuck on the political left, and Paul and Grover on the right:

Paul and Grover: A minority of people are being forced to pay for federal programs that benefit other people who pay almost nothing into the system.  Those people will vote for more programs because it costs them nothing.

Nancy and Chuck: Republicans are bad people because they want to tax poor people. Poor people already pay Social Security and Medicare taxes so they are paying into the system.

Paul and Grover: Medicare and Social Security taxes are essentially forced saving programs that will return that money to the taxpayer in the future. Payroll taxes do not support the other functions and expenses of government like defense and the justice system.

Nancy and Chuck: Those taxes all go into the same pot.

Paul and Grover: Democrats have always been careful to separate Social Security and Medicare programs in their rhetoric. You champion the preservation of these programs as though they are separate. You can’t have it both ways. Either they are separate or they are not.

Nancy and Chuck: You Republicans are really mean and you are pawns of rich people.

These debates usually end in name calling, particularly during election season.  Some of the rhetoric is political branding but each side remains convinced that their way is the best way.

Let’s turn to recent history and take the chance that facts might get in our way. The non-partisan Congressional Budget Office (CBO) routinely analyzes proposed House and Senate laws for their estimated impact on the budget. In this report the CBO separated income, government transfers and taxes paid into income quintiles. (Click here if you want to know more about a quintile).

CBOIncTaxQuintile2013

In the table above, the lowest and highest quintiles received the least amount of money in government transfer payments like Social Security. The highest quintile had ten times more before-tax income than the lowest quintile but paid 87 times more tax than the lowest quintile. Notice that the CBO analysis includes all taxes paid to the federal government, including Social Security and Medicare.

Pretend you are a reporter. Ask House Minority leader Nancy Pelosi “How much more should the rich pay than the poor, Ms. Pelosi? If 87 times is not fair, what is fair? 100 times? 200 times?” Each of us is an expert on what “fair” means.

In the past 35 years, despite all the rhetoric, state and federal policies have had only a small effect on income inequality. The GINI index is a standardized measure of the inequality in a data set. The scale runs from zero, perfect equality, to one, or perfect inequality. The CBO report showed a 35 year history of the separate effects of benefit and tax policies on inequality. In 1980, tax policy reduced inequality by 10%. 35 years later, the reduction was 9%. Despite major tax reform in 1986, the tax increases of the early 1990s and the tax decreases of the early 2000s, tax policy has had little to no effect on inequality.

CBOGiniIndexChange

Changes in social policy that directs government transfer payments have helped ease inequality in the past 35 years, but the CBO analysis finds the combined change from tax and benefit policies negligible. They reduced inequality by 25% in 1979. 35 years later the total reduction was 26%. The difference could be a measuring error.

Tax reform is tough because it involves contentious issues. We argue about tax rates and the income brackets for those rates. We argue about deductions and tax credits. Like pornography, we may not be able to define “fair” but each of us knows it when we see it. We can agree on what “cat” means but not “fair.”

I propose something different, something that will give us less to argue about. Let’s recognize that there are socio-economic classes and assign a portion of federal tax revenues to each income quintile. Using the CBO’s analysis, the 1st and lowest quintile paid 8/10ths of 1% into the kitty. It is such an insignificant amount that we might has well make it zero. What this means is that poor people would pay no income tax and no payroll tax. Paul Ryan led the effort on last year’s Better Way tax proposal which included the same concept:  poor people should pay nothing.

If we can agree on that, we have four things left to argue about: the percentages that each of the remaining four quintiles would pay. Let’s begin the discussion by looking at the CBO analysis of the federal revenue “pie” in 2013.. The second lowest income quintile #2 paid 4% of total individual federal income and payroll taxes, the middle quintile paid 9%, quintile #4 paid 17-1/2%, and the top #5 quintile paid 69-1/2%. I rounded the percentages.

There will be a fight over these percentages but we will be fighting over four concrete numbers, not 100 million interpretations of what the word “fair” means as it relates to thousands of pages of tax code. Once that portioning is settled, a bipartisan committee representing each quintile can argue over the details of how they raise their portion of the anticipated revenue.

Taxpayers in the highest quintile may want tax breaks for angel investors who invest in early startup companies. Sounds like a worthy cause. The members of that quintile’s committee can argue amongst themselves as to whether they can afford to carve out tax breaks for that subgroup and still raise the required revenues. Should some of the income of hedge fund managers be taxed at a lower rate like capital gains? Under the current tax system, that is an emotional issue. Why should those guys get a special interest tax break? Under this proposal, I don’t care because I’m not in that quintile. A hot button issue turns into a yawner for most Americans.

A majority of taxpayers in the middle quintile might want the mortgage interest deduction. Those people can put political pressure on that quintile’s committee members to include that carve out. The majority in the next lower quintile might prefer tax breaks on child care. Should capital gains be taxed at a lower rate? This group has little in the way of capital gains so they might prefer that all income be taxed the same. Those in the lowest three quintiles who pay small tax percentages might be attracted to the simple grade school arithmetic used by some states to calculate their state income tax. Adjusted gross Income x 10% = $tax, as an example. Tax filing made simple.

Could this proposal make the tax code more complicated than it already is? Yes, but most of the complications won’t affect each person. Under the current system, my tax software asks me questions about tax credits and situations that have nothing to do with me or my family. Why? Because all of the tax code applies in theory to all of us. Under this proposal, my tax software would know what quintile I was in and the tax rules that applied to me and my family.

But what if people move from one quintile to another? How will they plan? Incomes do change. A person gets a raise, a better job, goes to school, loses a job or retires. A simple rule would help: a person’s quintile this tax year is based on their income the previous year.

The setting of the quintile brackets could be done by another simple rule. The IRS can not provide summaries and analysis of tax data for a particular tax year till about two years have passed. Each year we could adjust the income brackets of each quintile by the annual inflation rate based on the most recent tax year data available.  Families with fairly predictable income will know in advance what their tax expense will be in the coming year.

What about the Earned Income Tax Credit (EITC) program for poor people? This program largely offsets the payroll taxes that poor people pay with tax credits paid directly by a person’s employer. The program is fraught with abuse. Under this proposal, payroll taxes for the lowest income workers are eliminated so the offsetting tax credits aren’t needed.

Will those workers in the lowest quintile still be eligible for Social Security?  Sure.  There is still a record of their labor income, which is the basis for determining Social Security payment amounts.

Tax reform has come infrequently because the tax code tries to be all things to all people. The top 40% pay most of the individual income taxes so naturally they lobby for special interest tax breaks which are slipped quietly into the tax code.  Under this proposal, those special interests can lobby all they like, just as long as they meet their revenue targets.

Is it fair that someone making a half a million dollars gets a tax break on their vacation home on the Outer Banks in North Carolina? Of course not. Under the current system, I get angry about that. Under this proposal, I simply don’t care. If that person is getting a break, some other equally rich person is having to pay for that tax break. None of my business.

As it is now, we struggle to understand the various tax proposals. Politicians talk in non-specific terms about what is fair, or they speak in slogan tax talk like BBLR. Tax reform rhetoric has become a rallying cry to get out the vote.

This proposal will not stop the political fights. We will continue to debate the amount of  federal spending, the role of government and what tax revenues should be spent on. We will fight bitterly about the percentages of tax revenue expected from each quintile. But this proposal will direct the debate to specific percentages that most of us can understand. So let’s put on our debating gloves and get into it!

 

 

January Employment and Economic Production

February 9th, 2014

The ISM manufacturing report for January reported a severe decline from the robust readings of past months.  New orders suffered the most, dropping from a strong reading of almost 65 in December to just a bit above the neutral reading of 50.  Prices jumped significantly.  Manufacturing’s drop off in new orders comes on the heels of a similar decline in the service sector in December.  This is the third report in the past thirty days that came in below even low estimates, the other two being pending home sales and December’s employment gains.  At mid week, ISM released their January estimate of the health of the service sector which is the bulk of the economy.  Happily, this showed continued growth, helping to offset concerns about a broad slowdown in the economy.

The CWI that I have been tracking continues to show an overall strength, declining slightly to 58 from the rather vigorous reading of 60 last month.  As I noted a few weeks, this index anticipated a winter lull before picking up energy again in early spring.

A reader had difficulty understanding the wave like graph of the CWI.  I indexed it to a starting base then indexed that to the SP500 average in 1997.  Perhaps this will help visualizing the long term response of the SP500 to underlying economic activity.

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ADP reported a gain of 175,000 private jobs in January, below the strong 227,000 job gains of December.  There was only a slight revision to ADP’s previous report, confirming the suspicion of some that the greater flaw lies in the BLS figures for December.

On Friday, the Bureau of Labor Statistics (BLS) released their estimate of 113,000 job gains in January, far below the consensus of about 180,000.  Here’s a story from the Atlantic that captures some of the highlights.  Forgive some of the misspellings, if they are still there by the time you read it.

As I did last month, I’ll show the average of monthly job gains estimated by the BLS and ADP.  ADP does not report government jobs so I’ve just added those in from the BLS report.

The decline below the replacement level of 150,000 may be a temporary response to severe weather conditions in the populous east coast and Chicago region.

The market responded quite favorably to this labor report. A slackening labor market prompted hopes that the Federal Reserve will not accelerate their easing of bond buying.  A large revision of job gains in November was a big positive in the report.  Another positive was the half a million increase in the core work force, those aged 25 – 54.  Men accounted for most of this increase.

The number of people working part time because they can’t find a full time job dropped by a half million but there are still more than 7 million people in this situation.  A 232,000 decrease in the number of long term unemployed was heartening although many lost their unemployment benefits at the end of the year and may have had little choice but to take whatever job they could find.

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Doug Elmendorf is the head of the Congressional Budget Office (CBO) that advises the Congress in constructing the budget, making appropriations, and the anticipated or actual economic effects of policy.  In advance of his testimony before the House Budget Committee this past week, the CBO released the highlights of their report. Some talk show hosts and conservative media were trumpeting a loss of 2.3 million jobs due to Obamacare.  In his testimony, Mr. Elmendorf explained that the 2.3 million jobs mentioned in the CBO report are not lost jobs because the CBO does not estimate any reduction in the demand for employees because of Obamacare. The CBO estimated the number of hours that employees would voluntarily reduce their hours in order to meet qualifications for subsidies under Obamacare and divided those total hours by what a full time employee would work in a year.  Since there is a surplus of labor in this country, this voluntary reduction would help those who are either looking for a job or want to work more hours.  The CBO sees no impact on part time jobs that can be attributed to Obamacare.

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Republicans and some Independents have repeated the claim that the rich are paying most of the personal income taxes in this country. IRS 2010 data (Table 2 ) doesn’t seem to support that contention.  The top 5% of taxable returns with taxable incomes greater than $200K had taxable income of $1.9 trillion, or 36% of the total $5.3 trillion in taxable income.  On that income, the top 5% paid $513 billion in Federal income tax, 49% of the total.  In a flat tax system, the top 5% would have paid a bit more than $360 billion.

When Republicans use the code words “broaden the tax base” what they mean is that they want a flat tax so that rich people pay the same percentage of tax as poor people.  Several states have such a flat tax system.  To Democrats, a broadening of the tax base means making more of the income of rich taxpayers subject to progressive tax rates.

When Democrats use the code words “paying their fair share” they mean that the rich should pay proportionately more than the additional load of about 32% that they are currently paying.  To Republicans “fair share” means a flat tax.

What the IRS data shows is that the rich are not paying most of the income taxes in this country.  Often tax policy and social benefit programs are lumped together, confusing the issue in the minds of many.  The Tax Foundation did an analysis of the net benefit and expense of taxation and benefit programs.  They report that:

As a group, the bottom 60 percent of American families receive more back in total government spending than they pay in total taxes.

Government tax and spending policies combine to redistribute more than $2 trillion from the top 40 percent of families to the bottom 60 percent.

The methodology that the Tax Foundation uses presumes that everyone benefits equally from public spending like defense, police and the courts.  An alternative assumption that people benefit according to their income results in a $1.2 trillion redistribution, about 40% lower, according to the Tax Foundation.  (Kudos to the Tax Foundation for making both computations.)

What the report does not do – because it is just so hard to do – is calculate age and circumstance related movements of taxpayers from the top 40% to the bottom 60%.  Consider a taxpayer – I’ll call her Linda – making $100,000 who is in the top 40%.  She loses her job and starts collecting unemployment for several months.  Her income now puts her in the bottom 60%.  “Past Linda” was supporting the bottom 60% but “present Linda” is now part of the bottom 60%, according to the methodology used by the Tax Foundation.  Yet if we isolate this one taxpayer, we can say that “past Linda” was actually supporting “present Linda.”  When Linda was making $100K, she presumably paid a lot in income and other taxes, including unemployment taxes paid by her employer.  The Federal Government does not keep records that would allow this kind of inter-temporal analysis.  As a result, we get a distorted view of what is actually happening.

Let’s look at an older taxpayer – I’ll call him Sam – who retires.  Sam was making $80K before he retired and was in the top 40%.  With social Security income and income from savings, Sam now makes $36K in retirement, which puts him in the bottom 60%.  Is Sam being supported by the top 40%?  Statistically he is.  However, most of us would say that Sam is simply living off the benefits that he paid into during his working life.

I appreciate the exhaustive work that the Tax Foundation does but the problem is more complex than they present.  Furthermore, many people are not aware of the difficulties and complications of calculating who supports whom.  Some use this analysis to present the case that the majority of Americans are sucking on the teats of the few well off.  Presidential contender Mitt Romney’s unguarded comment about “the 47%” who are living off the efforts of others did not serve him well in the past election yet a sizeable percentage of voters believe this.

The 16th Amendment passed a century ago allowed the Federal government to tax the income of individuals directly and it was intended to be progressive.  Relatively few paid any income taxes in the first decades after the enactment of the income tax.  Whether one likes the progressivity of the tax code, one has to recognize that the law was intended to be that way when it was passed.

I would like to see the repeal of the 16th Amendment for two reasons: 1) protect individuals from the power of the Federal government; 2) slow the consolidation of money in Washington.  Money brings power and power begets patronage, if not downright graft.  We can never get rid of patronage, only retard the concentration of patronage. Studying 5000 years of history, we have learned that the concentration of power in any political institution ultimately leads to the downfall of that institution.  Only corporations can exist with such a concentration of power and even they sometimes fall when top leadership in a company becomes resistant to change.

Perhaps we could adopt a taxing system where the Federal government taxes the states based on the population in each state.  If a state has 10% of the country’s population, then they would owe 10% of any tax used to replace the current income tax.  Let the states determine how they will collect the money.  Racism has been a constant nemesis of this country and legal protections could be enacted which would prevent states from taxing citizens based on race or sex.  Head taxes have a tawdry reputation because they were often used to disenfranchise poorer voters.  If the population count of a state was simply used as an allotment mechanism and not applied directly to each citizen, I think that this could be a fairer and safer system of taxation.  Certainly, legislation could be passed preventing the denial of rights to a citizen based on a tax.

Could Doug Elmendorf and his cohorts at the CBO build a model based on such a system?

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Tidbit:

And we’re talking about nine million individuals who are eligible for both Medicare and Medicaid. They are responsible for a significant amount of spending in both programs — approximately 46% of Medicaid and close to a quarter of Medicare spending annually.  Estimates range that that is anywhere from 300 to $350 billion a year total that we’re [CMS] spending. 
Melanie Bella, Director of the Federal Healthcare Office at the Centers for Medicare and Medicaid Services, Federal Coordinated Healthcare Office Conference 11/1/2010

Tired Taxpayers

On 4/10/09, I blogged about recommendations for tax reform from Nina Olson, an IRS advocate. On 4/20/09, a CPA wrote a letter to the editor in which he suggested that “each senator and representative [should] prepare his or her federal income tax return personally and .. the IRS [should] audit 100% of those returns each year.”

We must have some reform. Alternatives include 1) a tax on spending, or VAT; 2) a flat tax on income; 3) a tax on savings through fees charged on all stock and bond trades.

Here is a review of flat tax proposals. Here is a proposal for an optional flat tax by Kansas senator Sam Brownback.

A fair tax is a modified VAT tax (value added tax as it is called in Europe) with no tax for those below a certain income level. The home page is here, and a page explaining the rates are here.

We all agree that the current system is broken. Where we disagree is the solution. Perhaps the best thing would be to put a version of the three alternatives and the current system on a ballot for this November and have all of us vote on it. Lawmakers have been disagreeing on reform since the last tax reform of 1986 and it is doubtful that they could ever agree on a radical change to the code.

The disadvantage of the current system is that it invites Congress to “tweak” the code to reach certain admirable goals, but this constant tweaking is confusing and treats taxpayers like we are donkeys responding to carrots dangled in front of our eyes.

Tell your Congressperson that you don’t want to treated like an ass anymore.