May 17, 2006

More on How the “Evil Rich” Are Carrying Us

Filed under: Economy,Taxes & Government — Tom @ 9:56 am

At the urging of a commenter, I answered an objection he made at this previous post that my review only focused on federal income taxes, and didn’t consider the impact, which he appeared to assume was either regressive or at least “unfair” to low- and middle-income earners, of the other taxes that people must pay.

Fair enough. Here is the substance, with some enhancements, of the comment I left in response last night, which will serve as good marker for future arguments about whether the evil rich are pulling their weight in the tax system.

Keep in mind that at this other comment at the previous post, I noted that in 2003, the most recent year for which comprehensive IRS data is available, the bottom half of all individual income tax filers not only as a group paid no net income tax, but actually, thanks to the Earned Income Credit and other credits, had (again as a group) a negative tax liability.

So, here goes:

State income tax — Most state taxes are “progressive” and allow for very few deductions after federal AGI. The evil rich pay a much higher percentage of their income in most states than than those in the middle class. A particularly egregious example is California, where the top rate is currently 9.3% (10.3% on income over $1 million); that could go to roughly 11%-12% if Meathead Rob Reiner gets his way on his pre-school tax. The state’s tax rate starts at 1% for lower earners.
A convenient table of state taxes showing that the vast majority are “progressive” is here. Of the few states that have “flat” taxes, most have exemption amounts that make them mildly “progressive.”

Local income tax — In Ohio, it’s a straight percentage of income. It’s flat — neither regressive nor “progressive.”

Sales tax — In Ohio, sales tax is charged on everything except groceries and take-out food. That makes it progressive in the sense that those categories constitute a higher pecentage of a less well-off person’s or family’s budget. I can’t speak for other states, but a table of strictly the rates without identifying exempted items is here.

Medicare tax — 2.90% (employer and employee portions combined) of ALL earned income. It sounds like it’s neither regressive or progressive, but the fact is that there should be some sort of correlation between what’s paid in and the benefits received. The fact is that the evil rich are plunking almost 3% of their gross earned income (no deductions) into a system where they will never get anything even resembling proportional benefits in return, while low earners pay in very little and get much more than that back in terms of medical benefits. The least the rest of us could do is say “thank you.”

Social Security — 12.40% (employer and employee portions combined) of all earned income up to about $94,000). This looks regressive, but is actually progressive based on the way benefits are calculated. Assuming no inflation, someone making $25,000 a year during their entire working career will get a benefit of about half that, or $12,500 per year. Again with no inflation, a person making $75,000 a year during their entire career will get a benefit of about 25% of that, or about $19,000. (Earnings above the earnings limit aren’t taxed, but no additional benefits are earned either.) This means, in a point that I similarly made in my maiden post over a year ago, that the person who paid THREE times as much into SocSec is getting a benefit that’s only about 50% higher. On top of that, upper-middle and higher-income taxpayers usually have to pay federal income tax on 50%-85% of their SocSec benefits, while a lower-middle income person doesn’t. You can call Social Security a lot of things, but regressive is NOT one of them.

Real estate tax — This is essentially a “flat asset tax” based on property value. The decision to own a home is voluntary one based hopefully on an evaluation of what a person or family can afford. My take on this is that people tend to live in homes with values proportional to their income, so I would rate this tax as flat (though renters tend to pay proportionally less in property taxes that are inherently included in rents).

Personal property tax (usually on cars) — If there’s a regressive tax, this might be it. While the evil rich tend to drive more expensive cars and pay higher vehicle property taxes, those taxes as a percentage of their income will usually be lower. In the grand scheme of things, these taxes are not a big item.

Taxes on dividends and capital gains — The money used to invest in stocks, bonds, etc. is usually after-tax income that was already taxed when it was earned. A real good argument could be made that dividends and capital gains shouldn’t be taxed at all on that basis. It should also be noted that the tax collections from capital gains have skyrocketed since the rates were lowered in 2003, because the evil rich have been more willing to move their money around to better investments, even if it means having to pay the capital gains tax as a result. This not only raises more revenue, but moves money in the economy into better-quality investments as opposed to keeping it locked into lesser-quality ones.
Also don’t forget that all dividends in 401(k) are tax-deferred, and all cap gains are tax deferred, and those investment plans are more available in proportion to income to the middle class than they are to the upper class because of contribution limits, so-called discrimination testing, and the like.
On balance, I believe the lower taxation of dividends and capital gains outside of retirement plans compared to their tax-deferred nature inside of retirement plans is probably a wash, and that there’s no significant “progressiveness” or regressiveness here. Anyone who is aware of a study on this matter should let me know.

The Death tax — This is an asset-based tax. The only other asset-based taxes in the list above are the real estate and property taxes, which at least have some correlation with the services rendered by the state, county, city, and/or school district involved. There is no such correlation with the death tax — it is simply government-sanctioned theft of wealth that takes place only because a person happened to die, and then only because the person did not employ estate-tax avoidance strategies. Its impact on those who fail to do that is certainly “progressive.”
As discussed over a year ago, I believe that the death tax should be eliminated, because the money involved in building the estate was already taxed at least once, and perhaps as many as four times (income tax, dividends tax, capital gains tax, and/or property taxes on homes and farms); because eliminating it would eliminate the entire tax-avoidance side of the estate planning industry and put those people to work doing more productive things; and because assets wouldn’t remain locked in place as a strategy to avoid the tax, improving capital flows in the economy and the economy’s performance.

So, let’s review:

  • State income taxes — “progressive.”
  • Local income taxes — flat.
  • State sales taxes — flat to mildly “progressive.”
  • Medicare tax — flat, but VERY “progressive” when benefits to be received are compared to money put in are compared.
  • Social Security — flat up to the earnings limit, but VERY “progressive” when benefits received are compared to money put in are compared, and when the federal income taxation of benefits on higher earners is considered.
  • Real estate tax — flat to mildly progressive, if renters are included.
  • Personal property tax — somewhat regressive.
  • Dividends and cap gains — on balance, flat, IF the non-rich person is wise enough to be saving in tax-deferred retirement plans (more info on this from elsewhere would be welcome).
  • Death tax — when it happens, “progressive.”

So, despite concerns expressed by the commenter about items besides federal income taxes, it’s hard not to conclude that the tax system as a whole is still very “progressive.” The evil rich certainly pay a much higher percentage of their incomes in taxes than those in the lower and middle classes. In fact, one of the last things we need to worry about is whether the evil rich are paying their “fair share” — it’s pretty clear they’re doing quite a bit more than that.

My commenter appears to resent the fact that the evil rich may still have more money and wealth left than the rest of us even after paying their exorbitant taxes. Thank goodness for that; if they knew they would end up with the same amount as everyone else, they’d stop working so hard (or smart), and would also stop generating all those taxes that carry us.
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UPDATE: Steve makes some great points in his first comment, and picks up a few taxes I missed, and I think I covered his concerns in the comment that follows.

UPDATE 2, May 20: Here’s an update on the one remaining piece above that was a guesstimate, the cost of government regulation (link requires subscription):

Federal regulations now cost the U.S. economy about $1 trillion in lost output a year, or about $8,000 per household, according to a 2005 study by the Small Business Administration.

That is probably as regressive a “tax” as you’ll ever see. The regulatory burden on a richer person may be higher than it is for a poor person, but it certainly doesn’t increase in proportion to income.

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9 Comments

  1. Taxes are inherently UNFAIR as the government takes money it did not earn so let me dispene with this “fair share” argument. Taxes, like government, are a necessary evil.

    I propose to you that unless the government raises rates to confiscatory levels, taxes hurt poor people MORE than they do rich.

    As such:

    Local income tax, Sales tax, Medicare tax and such hurt the poor worse as they are less able to afford it. The government takes from the poor money that they can not afford to pay — giving back little.

    Social Security: the rich can afford to set aside their own money above SS, the poor have less disposable income, making them more dependent on a system that everybody agrees needs to be fix. If SS is so good, why the need to fix it?

    Real estate tax: Somebody has to pay those property taxes and let me tell you — it ain’t the property owner. I read that rents in Ohio are among the highest in the nation for this very reason. We’re not a New York yet, but it is hard.

    Personal property tax: In Ohio, the poor are not as much effected by these taxes, but a sudden increase in income can be quickly gobbled up.

    Taxes on dividends and capital gains: Trying to get ahead? The tax man is waiting. I have only owned stock once, but when I cashed in — so did the tax man.

    OK, now let’s count the cost of the taxes that you did not cover:

    Taxes hiding as “fees”: Driver’s liscense, tags etc… Don’t tell me they are fees, they are taxes and the poor are hurt more as they can less afford it.

    Corporate taxes: yes, the poor pay these as well. While some are absorbed by the company, most are passed on to the consumer, poor ones again being less able to pay.

    “Other”: gas taxes, the Gore telephone tax, the telephone tax still “paying” for the Spanish/American War (yep, true), damn…there’s too many to name!

    The “hidden hand” of big government: The federal regulation on selling lettuce contains a half of a million words to it. Every mandate to a corporation, whatever it’s purpose, increases the cost of doing business, thus raising prices.

    Bottom Line? Taxes suck — cut them!

    Comment by Steven J. Kelso Sr. — May 17, 2006 @ 1:12 pm

  2. #1 — You make some excellent points that I will get to tonight.

    Comment by TBlumer — May 17, 2006 @ 1:52 pm

  3. #1, the general acceptance of the idea that taxes taken from low-income folks hurt a lot more than those taken from high-income folks is why the federal income tax system operates as it does, exempting essentially half the population from paying anything, and “progressively” taxing ever-higher percentages of incremental income. It is also why most state income taxes operate similarly, but with unfortunately much lower thresholds for where the pain begins.

    And of course I acknowledge that a flat tax that starts at the first dollar hurts a poor person much more than a rich one.

    Other points on taxes, and perhaps how to change them to accommodate your point that the poor sometimes get the shaft:

    - Local income taxes are flat and probably “shouldn’t” be. You would think they shouldn’t kick in until maybe $10,000 or so of income, but in the name of simplicity (i.e., not having to fill out yet another complex tax form) that probably won’t change.

    - Sales tax — I think the Ohio exemption for food and takeaway food does a half-decent job of exempting more spending by the poor as a percentage of their income vs. the rich. But in an ideal setting, maybe the first few thousand dollars of other purchases might be exempt too, and could carry through as a credit (refundable if necessary) in a line on the state income tax return form.

    - On real estate taxes, you misunderstood my point. Of course I know they’re built into rents, but the amount built in as a percentage of a renter’s income is probably lower than the percentage of income a typical homeowner pays in real estate taxes.

    - Personal property IS a regressive tax, no way around it. What’s ironic is that one of the biggest contributors to the recall of Davis in California was the Democrats increasing this regressive tax, hurting “their” constituency more, and sealing the deal on Davis’s departure. Democrats in other states where reducing or eliminating car taxes has been proposed have usually been opposed to them as well. Go figure.

    - Fees. I’m less troubled by this. Shouldn’t everyone have to pay $40 or so to be able to drive their car? Do we really want to means test that? We could take that to absurd levels and means test things like national park admissions, etc., or even go into private items like means-testing car insurance, etc.

    - Gas Tax — to the extent that there’s a correlation between road repair and maintenance needs and gas taxes paid, it seems that it’s fair that it should be paid regardless of your income. To the extent that gas taxes fund other things, it’s definitely a regressive tax, and gas taxes should be reduced to only what’s needed to repair and maintain existing roads and build clearly required new ones.

    - The other nuisance taxes (telephone, cable, etc.) – they are clearly regressive and I believe have no correlation with any specific government service rendered. I would support ditching them all.

    - The corporate income tax, dividends, cap gains — To the extent that companies price the corporate income tax into their products, which of course they have to, it’s a very regressive tax. In an ideal world, owners would pay pass-through tax on their share of corporate income, just like Sub-S’s and partnerships do now, and there would be no corporate income tax. That would also mean that taxation of dividends would end, as companies would normally have to issue big “distributions” instead of “dividends” to enable their shareholders to pay the pro rata income tax I just described. As a nice side benefit, companies would also have to justify why they are keeping their profits and not distributing them in their entirety, perhaps forcing more shareholder interest and activism than exists today. Cap gains would still get taxed, though at the curent lower rates, to encourage capital flows to the best investment opportunities, and as we have seen with previous lower cap gains rates, to generate more revenue to the treasury in the process.

    Regulation is fairly seen as a regressive, virtually flat-dollar tax on everyone. I looked around for some reliable figures for the costs companies and people assume as a result of regulation, but couldn’t find anything right away. I believe it works out to several thousand dollars per either person or family per year. Another irony — The people who complain most about how “unfair” the current tax system to the poor tend not to be in the camp that wants to radically cut back regulations that hurt poorer people didproportionately by adding to the cost of everything they buy, most of which as you noted, are needs and not wants.

    I disagree with you on Social Security and Medicare, as I think their fairness has to be evaluated in terms of what a person gets in return for the taxes they pay in. The poor do very well by Medicare, while a person earning $1 million pays $29,000 a year into the system and will only in rare instances get anything resembling that level of benefit from it. For all practical purposes, that 2.9% should be seen an as additional income tax on the rich, and as an inadequate user fee paid by the poor.

    On Social Security, the argument is simlar — lower earners get a huge payback relative to what they put into the system vs. upper middle-income earners (plus the federal income taxation of most benefits that upper-income earners receive).

    As to the ability to save for retirement, which I believe is your sole remaining objection, I think the way that Social Security is skewed towards lower incomes makes up for a lot of that, but doesn’t solve the problem by any stretch, especially given that the SocSec system as it currently operates isn’t sustainable.

    Comment by TBlumer — May 17, 2006 @ 6:46 pm

  4. Thoughts:
    Columbus is considering requiring filing (they want more money!) You are correct though, I wouldn’t expect “progressivism.”

    If I remember correctly, half of the money we make goes to food and housing? That leaves well over half taxed, though I understand your point. Income taxes AND sales taxes? How about one or the other?

    Fees & gas tax: We agree quite a bit. Stop hiding them. Make them a true tax and stop playing around. Eliminate most trips to the BMV, standing in line to “renew” my plate when I haven’t moved in over a decade! Also, we have a state gas tax, a federal gas tax, title transfer fees, liscense renewals, plate renewals. How much money do they need? I don’t know about where you live, but Columbus’ roads suck. (I’d eliminate the property tax except at the point of sale and create a seperate tax for what is needed: schools, etc…it’s more up front and honest)

    As for Social Security and Medicare, I see your points and will go back to the drawing board. In the mean time, I’ll fall back on my “default” position — it’s my money! :)

    Comment by Steven J. Kelso Sr. — May 17, 2006 @ 8:42 pm

  5. PS: The Republicans would get more votes from poorer people if they did a better job of articulating what you’ve discussed and fighting for the little guy. IMUHO

    Comment by Steven J. Kelso Sr. — May 17, 2006 @ 8:44 pm

  6. I looked at some stats on this last year during the Bankruptcy debate; it seems like your 50% for housing and food is hign, except for those who have REALLY maxed out on their house payment.

    I think the property tax is something that needs to be worked on so that people better understand its components and have a separate say on each one.

    I like your default position. :–>

    Comment by TBlumer — May 17, 2006 @ 8:52 pm

  7. #5, I would tend to agree with that.

    Comment by TBlumer — May 17, 2006 @ 8:54 pm

  8. $1 trillion in lost output a year, or about $8,000 per household … it’s worse than I thought.

    What angers me most is that the people who are holier than us are the ones placing this burden on those who can least afford it.

    PS: Thanks for the update!

    Comment by Steven J. Kelso Sr. — May 20, 2006 @ 6:14 pm

  9. #8 that is exactly correct.

    Comment by TBlumer — May 20, 2006 @ 6:20 pm

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