Monday, January 30, 2012

With a Little Help from My Friends

What is your fair share?

We all know that a key to the President's success in the upcoming election is to convince the electorate that those on the upper end of the income ladder do not pay their "fair share" of federal taxes.  Further, the media has spent an amazing amount of time focusing on Mitt Romney's tax returns mainly to see if he paid a "fair share".  Beyond the fact that "fair share" conveniently has no quantifiable definition, I still think we can look at some key indicators to make a more informed decision as to which direction we think tax policy should head.  

1) Proportionality - I lifted this little nugget right out of the President's latest state of the union address: "Now, you can call this class warfare all you want. But asking a billionaire to pay at least as much as his secretary in taxes? Most Americans would call that common sense."

I do not know what the average billionaire's secretary earns, but lets call her middle class at $50k per year.  Even if she pays the full 25% (unlikely), she pays $12.5k in taxes.  Now, look at Mitt Romney's famous tax returns, he paid around 15% in personal income taxes on $20M and thus about $3M in taxes.  $3 MILLION vs. $12.5k.  If my math is right here, Romney paid at least as much as 200 secretaries combined.  Gasp, that bastard.  He paid for as much national defense, medicaid, and government warmth as 200 other Americans combined.  So, no Mr. President, I would not call your statement common sense, I would call it bad math.

We have come to a place where we equate the percentage of taxes to the absolute amount of taxes.  If we turn that concept around and equate the percentage of government spending to the absolute amount of taxes paid, then shouldn't Romney get 200 times the amount of national defense and medicaid and such.  Of course not.  Seems odd to me that someone who is footing the bill of 200 other people is accused of not paying their "fair share."

I have actually come to accept that proportional taxation is the best practical immediate solution to our problems.  However, even there, the amount paid by different income groups is extremely skewed.  Take a look at the graph in one of my favorite blogs that shows the share of federal taxes vs. the share of income:

The conclusion here is simple, In 2010, top earners made 30% of the income pie and paid 40% of the federal taxes.  Low end earners took home 25% of the income and pay 13% of federal taxes.  If your definition of 'fair' says people should pay proportionally to what they earn, then you should be advocating a flatter tax structure, NOT asking for a surtax on millionaires.

(So how does the rest of the world charge their top earners, no other country leans on the top 10% of tax payers like the U.S. does.)

2) Dividend Taxes & Capital Gains - So owners of corporations (stockholders) get taxed on the earning of the company at a top rate of 35% and then the same owners of those corporations get taxed AGAIN on the earnings when received as a dividend.  Would you say double taxation on the same income is fair?  Do you think raising this tax will increase or reduce business investment (a supposed common goal of all elected officials).  Again, use the Mitt Romney example here, his personal income taxes say he paid 15%, but he actually paid close to 50% on that money in taxes due to this double taxation.  

3) The Death Tax - Seriously, the most egregious overreach of government confiscation I can think of.  So two people: one invests, produces and saves enough money to be very wealthy at the time of his death.  His reward for such prudent activity, a 35% tax on his entire estate of which EVERY DOLLAR HAS ALREADY BEEN TAXED, with no option as to how he could choose to pass that on to his family, charities, and community.  The second person produced very little, spent every nickel the second it hit his hand, and passed on with just the clothes on his back.  The government says, kudos, you have achieved the American dream, you owe nothing, rest in peace.  Is it fair to tax this income yet again?   

4) Deductions - Mortgage Interest, Child Tax Credits, Child Care Deductions, Property / Sales / State Tax Deductions, and Making Work Pay Credits greatly raise the threshold before individuals actually start paying taxes.  Don't get me wrong, I benefit from these deductions as much as the next guy, but it greatly reduces the effective tax rates on a subset of individuals.  Somehow we are suggesting that people who make the personal choices to buy a house, have a baby, buy cars and boats, live in states with ridiculously high taxes, or work very little do not consume as much of the bloated government bureaucracy as those who don't make these choices.  Would you say it is fair to tax different groups of people based on their personal choices?   

(Side note: A lot of the argument I have seen for why lower income Americans pay more taxes do not hold much water.  Seriously, do not blame the federal government for how much your state and municipality charge in income, property, and sales taxes.  If you have issues with your state and local taxes, talk to your local representatives.  Its a different issue.)

In the end, I agree with the President, I believe the federal tax system is wholly "unfair."  I believe you should tax people based on the cost of protecting their rights and freedoms as Americans, and since all citizens have the same rights and freedoms, they should be taxed the same amount.

In lieu of that ever happening, I would just take a system where we all pay proportional rates to our earnings, do not get penalized by double taxation, and eliminate preferential treatment for individual choices.

Whether you agree with each point above is irrelevant, your "fair share" is not a quantity that can be readily calculated, but the more we let the government decide how society should spend its money, the less freedom society will have.


Brian Scott said...

Hi Andy,
First off, thank you for starting an intelligent conversation about the question “what is fair?” Even though I have fundamental disagreements with you on this issue, I think there are “common sense” approaches that we can all agree on. So, let’s go through your points:
1) Your proportionality argument for a flat tax completely ignores the most salient aspect of economics – wealth is non-linear. How can you apply a linear model to a system with disparate step changes as you increase wealth? Let’s assume a federal flat tax of 15% - I hear this number tossed around as a flat tax rate by advocates. The median cost of living in the U.S. is approx. $50k. So that leaves $42.5k. The median mortgage payment per year (on a median priced home of $205k at 4% with 1.75% property tax and $1200/year insurance policy) is approx. $16.5k. So that leaves $26k. BTW, I think a family rental would be about the same. So, now the family has $26k for the following: food, clothes, transportation, communication, etc. I’m not going to dig up all the numbers, but I’m willing to bet that even the most frugal households would be hard-pressed to stay under $1k/month or 12k/year. So that leaves $14k to save per year. At a generous return rate of 10% APR, it will take this household almost 19 years to save $821.5k, of which a household making $1million a year saves in only 1 year. With all the benefits that being rich affords (political influence, worker exploitation, etc.), I think a progressive tax system is the only choice to keep things fair. Warren Buffet (someone who knows what it is like to be rich) advocates taxing all millionaires at a 30% minimum; this is also known as the “Buffet Rule”. This way people can still be rich; in my example the millionaires would only save $671.5k per year. However, that money would go to social services and education that will allow people a chance to make a better life – maybe become millionaires themselves.
2) Double taxation happens all the time (e.g. Sales Tax), so I don’t think you can call a tax illegitimate for that reason alone. Also, Mitt Romney’s effective tax rate on his total income was 15% - where are you getting this 50% number?
3) The death tax typically impacts households with an estate of over $10million. So, going back to point #1, I don’t see a big problem with this.
4) I agree with you 100% on this. We need to take a look at the deductions – they are ridiculous and very unfair. Why should someone who decides to buy a big house and have 10 kids get a bigger tax break than someone who behaves, in my opinion, much more responsibly with a modest house and 2 kids.
I know that it is easy to oversimplify the scenarios to determine what is fair. For me it comes down to making sure there is money going into the pot to make this country a great place to live – nice parks, clean roads, community centers, educated people, and seed money for innovation. I personally think our government is good at those things.

Andrew Blankenship said...

Hey Brian, thanks for the thoughts:

1) While it is difficult to split hairs on some of these issues (i.e. the rich can afford "just a little more" taxation). We can look at this from the 2 extremes to illustrate what direction each path takes us.

a) One could easily say the rich can "afford" a much higher tax increase than just 30% right? Why not cap it so they can only make 10 times as much as the median earner? That is plenty right? They would still be rich and grow their wealth disproportionately high. Problem is that now they will stop working after they make that 10x median salary. Why bother? So you would then collect 10x the taxes.

b) Or you could let them pay as much % salary as the average worker with no cap. Per your example they would still pay 20x as much in taxes.

In the second scenario they get to keep more but also pay more in taxes because they are motivated to earn more. Is your goal to just extract vengeance on those that make money, or is it to grow the governments revenue pie? Also, lets not forget someone actually earned that money while someone else is plotting how to spend it.

Also, suggesting on the whole that job creators are exploiting workers is unfounded. Employers are under no law to hire that worker and that worker is under no law to take that job. Can workers take no responsibility for themselves?

2) Sales tax is not double taxation. Double taxation requires that the same money gets taxed by the same entity twice. The Federal govt does not charge a sales tax.

Double taxation occurs in Mitt Romney's case because his ownership in companies dictates he pay the corporate taxes of 35% on earnings (remember a corporation is just a collection of owners), then these post-tax earnings get given to him as a dividend where he pays a personal rate of 15%. That is near 50% tax rate on the same dollars. It is frustrating that the tax system is so complicated that this is not readily understood.

3) This is just a basic freedom argument. Who do you believe is entitled to the money people earn and save? Money that has already been taxed no less. Also, do you want to encourage risk taking, saving, and investment in our country, or just encourage spending.

To your last point, I too want to see enough money go into the pot to do essential work without incurring debt. I personally think the federal government does a lousy job directing funds. As an example, what percentage of the federal govts funds go to things you think are important (from above "nice parks, clean roads, community centers, educated people, and seed money for innovation")? 85% of the spending goes to entitlements, defense, interest, fed pensions, etc.) Only 15% has any chance of being invested in the future, which are things you are advocating.

Why not let states and localities and private organizations determine how best to optimize these issues. Let the federal government keep us safe and free and then get the hell out of the way.

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