Born Weird

I should know better than to get into a political debate on Twitter. Particularly when I’m very busy working on deadline and don’t have time to be in a debate, in any medium, on any topic. But of course, that’s exactly what I managed to do today, with local friends/web geeks Chris and Gabe.

It all started when @skyhawk133 tweeted the following:

I’m not sure what the big complaint is about tax day… over 50% of the country won’t pay a single penny in federal income tax for 2009.

Yes, 50% of the country won’t have to pay ANYTHING in to the system. Some will even MAKE money.

You may be getting a refund, but how much did you ACTUALLY pay in taxes for the other 50% of the country to live off you for another year?

Eventually this triggered discussion that covered a variety of tax-related topics that involved a few other folks (mostly @signalnine and @danielmclark). I think pretty much everyone involved at some point made a statement that was true (or that I agreed with) as well as something that was ridiculous or false (myself included). Rather than give you a play-by-play and try to respond to every point made or intimated, I’m just going to ramble on about some of what we touched on.

Tax Fairness…

The AP article Chris referenced makes several startling points, including: about 47 percent of U.S. households will pay no federal income taxes at all for 2009; the top 10 percent of earners — households making an average of $366,400 in 2006 — pay about 73 percent of the income taxes collected by the Feds; and that the bottom 40 percent, on average, make a profit from the federal income tax, receiving more in credits and deductions than they’re owed.

Of course, as the article points out, “The vast majority of people who escape federal income taxes still pay other taxes, including federal payroll taxes that fund Social Security and Medicare, and excise taxes on gasoline, aviation, alcohol and cigarettes. Many also pay state or local taxes on sales, income and property.” Leaving aside the point (briefly) that many of these are regressive and not trivial taxes in terms of amount collected — which is important — I’m with Chris that it’s rather disturbing that so many pay so little of this one particularly visible tax.

But that got me thinking: The top 10% may be bearing 73% of the income tax load, but what percentage of the wealth in America do they control? Turns out that in terms of net worth distribution, the top 10% possess about… wait for it… 73% of the wealth in America! Hmmm… maybe the federal income tax isn’t so skewed after all.

Of course the picture gets a lot different if you do take into account all the other taxes paid. Remember that pretty much any tax (or fee, for that matter) not tied to your paycheck is actually regressive. If well-to-do guy A and lower-middle-class dude B buy the same car (long story) and drive it the same distance to work every day, at the end of the year they’ll have paid the same amount in sales+gas tax, say $1000. But guy A makes $80k/year so the effective tax rate he paid was 1.25%, whereas dude B only makes $30k/year so his effective tax rate was 3.33%.  Dude B’s tax rate is over twice as high! This is one reason we have a progressive income tax: to help balance out all the regressive taxation we’re subject to.

…and the Flat Tax

In case you don’t know (or remember) here’s how the progressive income tax works: the more income you have, the higher tax rate you incur.  It scales up in steps currently ranging officially from 10% to 35%, and the “progressive” part only applies to income beyond the given threshold. In other words, if a tier cutoff is at, say, $50,000 and you make $75,000, you pay the lower rate on income below $50k and the higher rate just on the $25k you made above 50k. It’s a bit complicated but it works this way for a reason — if it didn’t, anyone with income near a cutoff point would have incentive to keep their income below the cutoff to avoid having the higher tax rate apply to all their income… thereby creating weird circumstances where the person making $49,999 might get to keep more than the person making $50,001. And that would suck.

The idea of a “flat tax” is that we’d eliminate the (currently 6) progressive tax brackets and just collect the same official rate from everyone, say, 15%. This would certainly simplify the progressive part of calculating one’s taxes, but it doesn’t do anything to address all the loopholes, safe havens, credits, incentives, shell games, capital gains income and so on that both rich and poor exploit, and are really responsible for making doing one’s taxes some damn complicated. A flat tax does almost nothing useful short of deprive the government of money, particularly from the high earners.

International Perspective

But discussing whether the tax burden is being distributed reasonably misses a larger question: is the burden itself reasonable? Government is rife with waste, excess, inefficiencies, thievery and more. Corruption is around every turn, whether it’s posh DoD contracts or Nancy Pelosi blowing tax dollars on booze. Knowing the government is taking money just to waste it makes paying taxes that much harder.

Of course, none of this is new, nor is it unique. Every government in human history has suffered from these same problems — and really, every human organization of any significance. And the problems tend to get worse as the organization gets larger, making the federal government a particularly bad offender due to its size. The issue isn’t whether or not there are problems, but whether those problems are intolerably rampant and creating a disproportionately large tax burden.

And really, despite how huge and inefficient our government is, it stacks up pretty well with the other industrialized democracies of the world. As this chart on Wikipedia shows, our individual income tax rate is lower that most. But I take that chart with a grain of salt since it doesn’t really indicate if that’s the rate actually being paid or just the rate that’s on the books, doesn’t account for non-income-tax taxation, etc. Probably a more meaningful metric is tax revenue by percent of GDP, where again we come in near the bottom compared with most other industrialized countries.

Does this mean we should just sit back and let our politicians spend us into bankruptcy, lavishing dollars everywhere and leaving the bill for future generations? Well no, of course not. But it’s important to recognize that our current system isn’t off-the-charts ridiculous.

Where the Money Goes

Our current setup is, however, unsustainable. Every year (except for a few under Clinton, I believe), the federal government spends more than it takes in. Eventually our tax rate is going to need to catch up — but we also need to curtail spending. Government spending in the U.S. is creeping up near 45% of the GDP, which is more or less in line with western European spending but still an awful lot (and way more than it was just a few years ago).

A lot of us I think still have the impression that a lot of our wasted spending is going to entitlement programs that help those 47% of households not paying any income tax. And to be sure, those sorts of programs eat up a good chunk of our expenditures, but low-income assistance is still a small portion of federal spending. If you looking at entitlement programs specifically for low-income (e.g. Medicaid), rather than those that target a different audience that may include low-income individuals (e.g. Medicare), the numbers aren’t that big (relatively)… maybe 15% or so.

Much was made during the welfare reform debate in the 1990’s of the “welfare queen,” often stereotyped as the single urban black mother pumping out kids to accrue more and more tax credits and milking the system without contributing anything. While I’m sure there are people doing that, there’s no evidence that that sort of situation is endemic. First of all, it doesn’t make any economic sense. Sure there are tax credits for having kids, health care services for low-income families, etc., but those government benefits aren’t so awesome that being poorer actually makes you better off. Trust me, I have a baby: the tax credit you get for having a child doesn’t come anywhere close to covering the cost of raising that kid.

If you check the numbers on welfare recipients, it’s not filled with single black moms on welfare for years and years. And countless studies have shown that welfare does not typically reduce the incentive to work. If you really dive deep into statistics on welfare, poverty and the like, you’ll find that a lot of your preconceived notions about who is poor and/or taking advantage of government entitlement programs isn’t who you thought (at least, that’s what I found. The numbers on persistently poor rural areas are particularly surprising).

So Who to Blame?

If you’re looking for scapegoats for all your hard-earned dollars going to Uncle Sam, you can look at the poor for a decent chunk, sure. You can look at earmarks and other pet projects, too, if you want — but they eat up a just fraction of the budget (maybe 1%, depending on what you count as an earmark) and are going down. Not that we should turn a blind eye to such waste, but these areas aren’t where the action really is.

You can start with looking at the Defense budget, which is huge and grossly out of whack with other industrialized democracies — by sheer dollars the U.S. accounts for over 40% of all military spending in the world. By GDP we fare a bit better, but not if you consider how large we are compared to the countries spending a higher percentage.

But if you really want to know who’s getting your tax dollars, look at senior citizens.

The numbers are just silly, really. Nearly 32% of the federal budget goes to Social Security and Medicare. That dwarfs any other entitlement programs, defense spending, or servicing the debt. While right now servicing debt is less than 10% of the federal budget, things look pretty ugly if we’re going to keep pumping this kind of money into stuff for senior citizens. If you want to trim the federal budget, senior entitlements are an excellent place to start.