Saturday, September 24, 2011

Conservative Chicanery

There are lies, damned lies, and statistics. In the current debate on the "Buffett Tax", some conservatives are perpetrating a statistic more mendacious than Mephistopheles himself. A great example is John Steele Gordon, writing a pompous editorial with the attitude of a pedant.

Mr. Gordon is playing at Mythbusters, but he's neither entertaining nor enlightening. He writes to correct five misconceptions, some of which are more germane than others. The Mephistophelean "myth" is that "Millionaires pay proportionately less income tax than poorer people." What's so insidious about this "myth" is that it is, in fact, a myth: Millionaires pay proportionately more income tax than the rest of us, and - in fact - some 50% of all taxpayers pay no Federal Income Tax. Note the qualifiers.

Left out of this narrow definition of income tax are the FICA ("payroll") taxes that supposedly fund Social Security and Medicare*. These usually amount to 15.3%** (13.3% in 2011 with the stimulus tax break) of all income earned up to $102,800. According to Gordon, families with incomes above $1 million payed 23.3% in income tax. Adding in FICA, they would have paid at most 24.8%. Families earning between $50,000 and $100,000 would see their average tax rate jump from 8.9% (if Mr. Gordon is to be trusted) to 24.2%, which is very, very similar. Those earning less than $50,000 pay substantially less.

Now, President Obama is still wrong in saying that millionaires pay "less taxes than the rest of us". He's also wrong in defining earners who make $250,000 a year or more as "millionaires", a puzzling stretch of nomenclature. A family earning $250,000 in straight earned income (say, a successful doctor) might be chipping in about 35% of their income to the Federal till. That's a lot.

Mr. Gordon goes on to perpetrate another fallacy: he says that "dividends are paid out of corporate profits that have already been taxed. So Buffet's [sic] equity earnings are doubly taxed: He pays 35 percent at the corporate level and 15 percent on his own return." This is also specious. First, it applies only to dividends, not capital gains, and the latter amount to 70% of taxed income on investments***. A back-of-the-envelope calculation tells us that the total tax on investment profits might be about 15% + 0.3*35% = 25.5%. That's a marginal difference at best. Taking into account that high-rolling investors are likely to do a lot more trading and earn from capital gains, while dividends go disproportionately to cautious folks with retirement accounts, the "dividends are taxed twice" argument is a poor defense of the very rich.

Second, few companies pay the full 35% rate; they have tax shelters, rebates, and gimmicks just like wage earners. Third, the corporate profits tax is taken into account by investors when they purchase stocks. They decrease their investment in American firms concomitantly, lowering the marginal product and thus the wage of American workers. So workers suffer (although somewhat less) from the high corporate profits tax too.

In summary, let's look at the average tax rates we've calculated.
  • Millionaires pay less than 24.8% of all income on average
  • Middle-class families pay about 24.2% of all income on average
  • Investments by the affluent are taxed at something less than 25.5%, taking corporate profits tax into account.
This tax structure looks pretty flat, but only on its surface. The myriad loopholes, breaks, progressivities and regressivities make it a moonscape of craters and ridges. More important than raising or lowering taxes on any large, average group is true tax reform: making the code transparent and boring. Whether the tax code is flat or progressive, it ought to be smooth. Could somebody in Washington pick up that phrase?

* FICA taxes were instituted to fund Medicare and Social Security, but in practice are tossed into the same Federal till out of which all the government's obligations are paid. It makes no sense to consider these separately from income taxes.
** Half of this 15.3% comes out of workers' paychecks, half comes from their employer. As my Intro to Econ students can tell you, this doesn't make a dime's worth of difference: no matter who writes the checks, relative elasticities determine who bears the cost of the tax.
*** Calculated from IRS data for tax years 1980-2005, from this IRS spreadsheet.


Carol L. Douglas said...

Social Security was designed as an insurance scheme, and should be considered as such. To flop it into general taxation and general revenues just plays into the hands of those who want to turn it into another entitlement.

While Social Security taxes are without a doubt regressive, so too is the payout for Social Security. No matter how rich I am, I can never take out more than the maximum—something like $ 2,162 a month right now—just as I never can pay in any more than the maximum, which I think is $14204.40 a year (the actual amount is the same whether you or your employer write the check for the other half; it’s still part of your compensation package).

One more quibble—most people who make their living trading end up with a combination of long- and short-term capital gains taxes. It would be a rare duck who sat on every investment for more than a year. So the whole argument is specious, since that’s simply not how investments work. Rather than look at potential rates, it makes far more sense to look at what is actually paid by each income cohort—and there, the evidence is irrefutable. The rich indeed do pay more tax than the rest of us.

Chops said...

Carol -
That's a noble ideal, and might be implementable sometime in the future. But it doesn't describe the FICA system now, or at any point during your lifetime.

Reality is, those retiring now get 2 or 3 times what they put into the system, regardless of their income level. Likewise, the future payout for my generation is expected to be much less than what we pay in, unless some reform is made.

Under the current system, FICA contributions are indistinguishable from taxes, and should be treated as such. If a massive FICA reform comes along finally, then it might be different. But for now, the relationship between contribution and benefit is mostly notional.

Carol L. Douglas said...

If the money I’d contributed to Social Security had been bunged into even a very mediocre Fidelity fund, I’d have realized far better than 2-3X times my investment over the 49 years of my working life (age 16-65).

All you’re saying is that the Federal government is a lousy, lousy steward, and in that we’re in agreement.

Carol L. Douglas said...

Chops, I just read this on a friend's wall. Haven't checked the math, but I believe the overall gist is correct:

"Remember, not only did you contribute to Social Security but your employer did too. It totaled 15% of your income before taxes. If you averaged only 30K over your 49 year working life, that is close to $220,500. If you calculate the future value of $4,500 per year (yours & your employer’s contribution) at a simple 5% (less than what the govt. pays on the money that it borrows), after 49 years of working, you would have $892,919.98. If you took out only 3% per year, you would receive $26,787.60 per year and it would last better than 30 years, and that is with no interest paid on that final amount on deposit!

"If you bought an annuity and it paid 4% per year, you would have a lifetime income of $2,976.40 per month. The folks in Washington have pulled off a bigger Ponzi scheme than Bernie Madhoff ever had."

Chops said...

Carol -
The only obvious problem with that math is the 5% per year return. It's possible to get that kind of real (i.e. after-inflation) return on investment, but only with fairly high risk.

Carol L. Douglas said...

Chops, the CAGR of the weighted S&P since 1988 has been 8.8%. That means such a return is not impossible, assuming the investor just plunks his money in an index fund.