The Homa Files

Summary: Tell your rich relatives to check out in 2010. 

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Under the Bush Tax Plan, estate taxes were cleverly rebranded “death taxes” and have been phasing towards full repeal (zero federal estate taxes) in 2010. 

But after 2010, estate taxes get automatically reset to 2000-2001 levels ($675,000 exclusion, 55% rate) unless Congress extends the provisions.

click table to make it bigger

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Some Numbers

Based on 2004 IRS data (the latest available, full table below):

2.34 million adults died (a remarkably constant number over the past decade)

19,294 taxable estate returns were filed (less than 1% of adult deaths)

$5.3 million average taxable estate

22% average tax rate on taxable estates

$22.2 billion aggregate estate taxes collected (down from $24 billion in 2000)

click table to make it bigger

Source: http://www.irs.gov/pub/irs-soi/08es01hi.xls

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Candidates’ Plans

Obama proposes a $3.5 million exclusion ($7 million for a married couple) with a top rate at 45%.

McCain proposes raising the exclusion to $5 million per person (which is thought by many to be the appropriate size to help small-business owners avoid cash-flow difficulties upon the death of a family member). and cutting the top federal estate-tax rate to 15% (linking the death tax with the current capital-gains tax rate … so that ” Americans will not be forced to pay more in death than they would if they had sold property prior to their death)”

Both Obama & McCain support retaining the current system for valuing stocks, mutual-fund shares and other inherited property whose value has increased over the years. at the time of the death (versus the original cost basis). This “stepped-up basis”  is important to many heirs because it can affect how much they eventually owe in capital-gains tax, if anything at all, when they sell inherited property.

Source: http://online.wsj.com/article_print/SB121495543483521281.html

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Observations

1. Under either plan, very few estates — less than 1 in a hundred — would pay Federal Estate taxes. 

2. I’m surprised that the stepped-up cost basis doesn’t get more attention.  Strikes me that eliminating it makes more sense than raising capital gains rates across the board.

3. These are only FEDERAL estate taxes.  States impose their own estate taxes  — and they vary widely (e.g. NY and NJ are high; FL and NV are low). For state rates check out  http://www.finance.cch.com/text/c50s15d170.asp

4. Charities will benefit (versus complete repeal).  The super-rich can direct mega-gifts to charities and foundations to at least keep the money out of the government’s hands.

5.  Heirs may benefit by getting an early distribution of estates via gifts … which are limited to $12,000 per giftor / giftee combo … meaning that a married couple can give $24,000 to an individual, tax free, each year

6. Bottom line, for all but the uber-rich, this doesn’t seem like a big issue — as long as the candidates follow through on their promises (ok, call me cynical).

7. I say, since Warren Buffet is parading his tax guilt so publicly these days, set up a separate provision to tax all of his estate 100%.  (Note: Buffet announced plans to give much of his estate  to the Gates Foundation.  That’s a worthy cause, but diverts money from the government coffers — where he wants everybody else’s money to go. Gotta ask: huh?)  

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Summary: In prior posts, I set-up the following issue …

Some policy analysts (typically left-leaning) such as  Robert Reich, Bill Clinton’s former Secretary of Labor argue that “Most Americans pay more in payroll taxes than in income taxes … payroll taxes take a much bigger portion of the paychecks of lower-income Americans than of higher-income … Viewed as a whole, the current tax system is quite regressive.”
http://economistsview.typepad.com/economistsview/2007/10/robert-reichs-p.html

Other analysts such as the Urban Institute clarify  “The payroll tax is very regressive with respect to current income: The average tax rate falls as income rises …  (But) the regressivity of the payroll tax is mitigated to a substantial extent when Social Security and Medicare benefits are considered as well.
http://www.urban.org/publications/1001065.html

But analysts generally “punt” the question “what is the effect when both payroll taxes and their benefits are considered ? ”  Why ? In part, I suspect, because they know the  answer doesn’t fit their politics … and, in part, because the analysis is challenging — with many nuances and moving parts.

In this post, I take a shot at the “combined effect” question by applying some fundamental financial analysis tools. 

Specifically, I treat Social Security benefits as an annuity stream to individual retiring workers and I treat annual  payroll taxes over a worker’s career as periodic “premiums” that get applied to the “purchase” of the annuity.”contract”.  After adjusting for inflation, the difference between the present value of the expected benefits stream and the present value of the “premiums” paid over the years is, in essence, the real tax that a plan participant pays.

The answer: low wage earners pay practically nothing for their benefits — their contributions are simply a forced saving for their retirement benefits.  High earners get relatively little of their contributions back —  in effect, paying a tax rate over 60%

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Analytical Details

Regarding Social Security, a Congressional Joint Economic Committee reports:

“The rapid growth in payroll taxes over the past 40 years has imposed a large burden on working Americans. This burden has fallen disproportionately on low-income workers.

However, in the context of a comprehensive tax policy, it is misleading to focus on the short-term burden imposed by payroll taxes without accounting for the future benefits they provide through the Social Security program.

Social Security benefits are paid according to a progressive formula that gives low-wage workers a better rate of return on their contributions than it gives high-wage workers. The progressivity of the benefit formula outweighs the disproportionate burden imposed by the tax.

As a result, low-wage workers can expect to receive benefits that exceed the sum of their and their employers’ payroll tax contributions. Middle- and high-wage workers, on the other hand, can expect to pay substantially more into the system than they will receive in benefits.

Overall, middle- and high-wage workers subsidize the income and payroll tax liabilities of low-wage workers, leaving most low-wage workers with net negative tax liabilities throughout their lifetimes.”
http://www.house.gov/jec/fiscal/tx-grwth/payroll/payroll.htm

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Here’s what the Joint Economic Committee is talking about:

The amount employees have deducted from their paychecks is determined by the Social Security tax rate and annual income “caps” – the maximum amount of wages subject to the tax.  The Social Security tax rate has been flat for almost 20 years; and the income cap has consistently increased over the years.

Currently. an employee’s Social Security tax rate is 6.2% on annual wages up to $102,000.  For high earners, the rate drops to zero for any wages over $102,000 in a given year.

For example, somebody earning $50,000 has $3,100 deducted from their paychecks [6.2% times $50,000].  Somebody earning $102,000 has $6,324 deducted [the same 6.2% times $102,000].  Somebody earning $200,000 has $6,324 deducted [6.2% times the $102,000 income “cap”; 0% on wages over $102,000] — so their effective rate drops to 3.2%.  The more somebody earns over the $102,000 income cap, the lower their effective rate.. By definition, that’s a regressive tax, right?

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Not so fast.  There’s more to the story.

First, the 6.2% tax rate is literally only half of the story.  Employer’s are legally obligated to pay a matching amount to the Social Security fund (similar to a company matching 401-K contributions — but certainly not voluntary).  So, the applicable rate is really 12.4% (2 times 6.2%) — up to $102,000 in earnings. 

• Note: Most economists argue that, in the final analysis, employees bears the full burden of the employer’s matching amounts since employers probably cover the tax by reducing wages – or viewed conversely, employers would raise wages if they weren’t stuck paying the Social Security taxes.  That conclusion is debatable, but we’ll accept it and treat the full.12.4% as a charge incurred by the employee).  
• Note: Employers can deduct their share of the contribution for income tax purposes, but workers’ shares are not tax deductible.  For simplicity, we’ll ignore that taxing distinction. 

Obviously, doubling the rate ups the ante, but it doesn’t make this payroll tax any more (or less) regressive or progressive.

Second, while Social Security payroll deductions fit the technical definition of a tax  —  i.e.  a “levy” imposed on an individual or a legal entity by a government — they don’t act like most taxes. 

Most taxes are collected to fund a common interest (say, defending the country or building a bridge).  The amount that a taxpayer gets charged, is de-coupled from the benefits they (the tax payers) may receive. That is, the taxpayer may or may not actually receive a direct (or indirect) benefit, and any benefits that they do receive are almost always non-monetary (e.g. riding on a freshly paved highway, calling for an EMT crew)..

Social Security is different – it is both monetary and coupled. With Social Security, the benefits are strictly monetary – monthly retirement income checks – and are based on a  formula that is explicitly coupled to the beneficiary’s career income and corresponding contributions to the Social Security fund.

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Let’s illustrate Social Security math using a hypothetical retiree.  We’ll call him Harry the High-earner — for shorthand referencing, just plain old Harry. 

Assume that Harry – an unmarried guy — turns 66 on January 1, 2008 and decides to retire — claiming his full Social Security benefits.

• Note: if Harry had retired at an earlier age, say 62, he would have started receiving scaled down benefits a few years earlier. 

Also assume that Harry has been working since age 25, that he earned precisely the maximum taxable base earnings each year (i.e. the year-by-year equivalent of 2008’s $102,000 wage cap), and that he and his employer both paid the applicable Social Security rates each year on those earnings. 

Applying historical Social Security rates and income caps, during the 41 year period (since age 25), Harry would have had $190,595 deducted from his paychecks.  His employer would have matched that amount  dollar-for-dollar.   

Again, economists usually argue that employee’s bear the burden of their employer’s contributions since they are  simply a diversion of higher  wages that might have been paid to the employee.  So, Harry’s total contributions – including his employers’ portions — are $381,189. 

The $381,189 is a “nominal” amount since it doesn’t reflect the impact of inflation over the years.  Using government-provided inflation indexing factors, the $381,189 has a “real” worth — in 2008 dollars – equal to $872,096.  That’s how much Harry and his employer paid into the Social Security fund, adjusted for inflation.

http://www.ssa.gov/pubs/10070.html#a

Conceptually, when he retires and starts drawing benefits, Harry is taking the $872,096 in accumulated contributions (stated in 2008 dollars) and investing the whole amount in an annuity —  a steam of checks that he’ll be receiving from the government.

How much is the annuity worth to Harry?  That is, what’s Harry getting for his $872,096 ?

The annuity valuation has two main components: the amount of the periodic payments and the duration of the payment stream.

Social Security benefits are based  on a relatively complex formula that factors historical earnings against a sharply dropping scale of payouts. 

Specifically, the Social Security  formula “looks back” over an employee’s career, picking the 35 years in which the employee earned the highest taxable wages (up to each year’s income cap).   The employee’s top 35 years of taxed earnings are then indexed to reflect inflation – i.e. “inflated” to current day dollars — and then averaged. .

Then, the qualified earnings (i.e. the 35 year average) are plugged into the sliding scale formula to determine the initial annual amount to be received in Social Security benefits.  90% of the first $8,532 counts; 32% of the next $42,924 (up to $51,456) counts; and only 15% of any excess over $51,456 counts.

Since we’re assuming that Harry earned the maximum taxable income in each year, his top 35 years are the last 35 years (since the income cap has been consistently going up).  His inflation adjusted average income over that period is $87,114.

Plugging the $87,114 into the Social Security benefits formula, Harry’s initial annual Social Security benefit will be $26,763 — 31% of his inflation adjusted average annual wages for his highest 35 years’ earnings.

How long will Harry  be getting the payments?

That’s conceptually easy to answer: Until he dies.  

• Note: If Harry had been married, payments would come until both Harry and his wife die  — since she would have survivor rights to his benefits).  

Currently, the average life expectancy in the U.S. is 78 years.  For simplicity assume that Harry is actuarially average, so he will get the $26,763 in annual benefits for 13 years — until age 78.  

Harry’s total  “annuity benefits” are $347,922 — 13 years times $26,763.  Assuming that the $26,763 gets inflation adjusted in future years (i.e. the Social Security Administration boosts the benefit each year to relect inflation), then the  $347,922 is — by definition — expressed in real 2008 dollars.

Pulling the parts together: stated in 2008 dollars,  Harry (and his employer) paid $872,096 to get annuity benefits worth $347,922. 

The $524,174 difference is the real Social Security tax that Harry paid — a whopping 60%

For comparison, let’s apply the same analytical logic and run the numbers for two other retirees who have  exactly the same profiles as Harry (the high-earner), except that they earned less during their best 35 years.

Low-earning Louie earned an inflation adjusted average of $30,000 and mid-earning Milt earned an inflation adjusted average of $50,000.   So, their respective calculated initial annual benefits are $14,549 (which works out to be 48% of $30,000) and $20,949 (42% of $50,000). High-earning Harry only got 31% of his inflation adjusted average wages in annual benefits.

For analytical simplicity, let’s assume that Louie and Milt earned a constant percentage of the Social Security income cap each year.  Applying that assumption, their $30,000 and $50,000 wage bases translate to 34% and 57% of each year’s income cap.  (Trust me and Excel Solver on the percentages).

Let’s assume that  Louie and Milt – like Harry — have been working and contributing to Social Security since age 25.  Then, we can multiply Louie and Milt’s income  cap percentages (34%, and 57%) times each year’s income cap (keeping in mind that it has increased in most years) — multiply that number (annual taxable wages) times the Social Security tax rate in each year (the total of the employees’ and employers’ contributions) – and then sum across the years (from age 25 to age 65).

The answer: Louie and Milt kicked in a total of $131,272 and $218,276, respectively.  Again, those are “nominal” totals, unadjusted for inflations. 

Applying the Social Security Administration’s inflation  factors –  the same ones used for the benefits calculation —   the nominal totals “inflate”  to $300,328 and $500,547 in 2008 dollars.

The rest of the analysis  is simply arithmetic: Louie kicked in $300,328 to secure an annuity with a present value (at retirement) of  $189,131.  The difference ($111,197) is, in essence, the implicit  net Social Security tax that Louie paid —  37% of his inflation adjusted contributions. 

Milt put in $500,547 to get $272,331 in benefits – an implicit tax of $228,215 – 46% of Milt’s inflation adjusted contributions. And trust me, below Louie’s qualifying income level, the rate drops further —  very quickly.

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The Bottom Line:

Social Security “payroll taxes” are fundamentally different from other types of taxes because they represent a future payment back to the contributor. 

Thus. payroll taxes cannot be viewed in isolation, but must instead be viewed in the lifetime context of tax payments and retirement benefits. http://www.house.gov/jec/fiscal/tx-grwth/payroll/payroll.htm

When both the taxes on current wages and the eventual benefits realized are both considered, real tax rates increase with income and Social Security is then – by definition – a  very progressive plan. 

Case closed !

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Some politicos and pundits say that payroll taxes — the paycheck deductions that fund Medicare and Social Security are regressive taxes — with high earners paying lower rates than low earners. 

For Medicare, they point out that that the same tax rate is applied to both high and low wages — the definition of a regressive tax. 

First, no it isn’t.  It’s a neutral of proportional tax.  A regressive tax rate goes down as income increases.  This one stays the same.

More important, though, the benefits eventually received are identical — whether a taxpayer contributed a little or a lot. 

When the Medicare program is considered in its totality — contributions and benefits — it’s clearly progressive — with high earners paying way more for the same benefits that low earners get.

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The Details

The Medicare Program was introduced in 1966.  It is  primarily “our country’s health insurance program for people age 65 or older” — “helping” to pay (i.e. not paying all) for hospital services & stays, doctors, medical supplies, and prescription drugs.  The latter is courtesy of the Bush administration.

Generally, people who qualify for Social Security benefits qualify for Medicare.  Importantly, everyone who’s on Medicare gets exactly the same benefits package — regardless of how much they paid into the program over the years through payroll deductions.

Medicare isn’t a free program. 

First, plan participants (i.e. retirees)  have to pay monthly premiums.  Most folks pay about $100 per month ($1,200 annually), but higher income participants pay more, scaled to their retirement incomes.  Folks with super-sized retirement benefits pay $2,860 per year — 2.4 times the low-earners premium.  That’s progressive, not regressive — but since about 95% of plan participants pay the minimum monthly benefit, it’s not a big deal.

click table to make it bigger

What are a big deal are the contibutions that people pay during their working years.

The bulk of Medicare funding (roughly 75%) comes from paycheck deductions over a wage earners career.  While these are deductions are popularly referred to as “payroll taxes”, they are called “contributions” on the Social Security web site — indicating that they are more akin to prepaid insurance premiums that general taxes.

The contribution rates have increased over the years (see chart below).  These days, employees have 1.45% of their wages deducted from their paychecks — with  no income limits.  So, a person earning $25,000 pays $362.50 to the government dor safe-keeping; a person earning $150,000 pays $2,175.  Though the amounts are way different, the rate is the same — 1.45%.  Some people consider the constant rate to be regressive.  In fact, : it’s neither regressive nor progressive — it’s proportional and, thus, income neutral. 

Employers are obligated to match employees’ Medicare contributions dollar-for-dollar.  So, the combined Medicare contribution is 2.9% — half paid by employees and half paid by employers.  Since self-employed folks are both employers and employees, that get docked for the full 2.9%

• Note: Most economists say that the employer contribution is an employee burden.  They argue that if employers didn’t have to make the matching contribution, then employee wages would be higher by that amount. 

The big deal is that the cumulative “insurance premiums” paid by a high earner are SUBSTANTIALLY higher than low-earners’ contributions.

For example, take 5 individuals who have been earning wages since 1966 (the uear Medicare was introduced).  A relatively low-earner — with average earnings of about $20,000 over the period 1966 to 2007 — would have paid about $10,700  in Medicare premiums during that period.  Inflation indexing each year’s “current year” dollars (i.e. the “nominal amounts”), the premium are worth over $23,000 in 2007 dollars (i.e. “real amounts”).  A relatively high-earner — raking in average wages of about $80,000  — would have contibuted about $43,000 in current year dollars — inflated up to about $92,000 in 2007 dollars.  Middle-earners pay between those low and high amounts; uber-earners pay, and pay, and pay.

click table to make it bigger

• Note: The employer contributions don’t impact the degree to which the Medicare program is regressive or progressive — but, when conbined with the employee contributions and inflated up to 2007 dollars, might raise some questions about the program’s fundamental economics.

Again, keep in mind that Medicare benefits are identical for all — regardless of how much was paid into the program over the course of a wage earner’s career. 

So, high-earners pay substantially more than low-earners for exactly the same benefits.  And, high-earners who get high pension benefits or IRA payouts — a very likely correlation —  get even less in program benefits since their premiums are higher (than low-earning retirees).

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The bottom line:

Curent year Medicare paycheck deductions are income neutral since the same rate applies to all wage earners, with no cap on the income level.

The premiums paid by high-earners are literally multiplles of the premiums paid by low-earners.

Benefits are identical, regardless of whether a person is a high- or low- wage earner.  Arguably, the benefits are slightly progressive since high retirement earners have to pay higher Medicare premiums.

There’s no way that anybody can say with a straight face that the Medicare portion of “payroll taxes” is regressive?  It’s progressive — in fact, very progressive.  PERIOD ! 

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Next up: So, what about Social Security — regressive or progressive ?

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More re: Medicare from the goverbment web site:
http://www.ssa.gov/pubs/10043.html#part2

Medicare is our country’s health insurance program for people age 65 or older. Certain people younger than age 65 can qualify for Medicare, too, including those who have disabilities and those who have permanent kidney failure or amyotrophic lateral sclerosis (Lou Gehrig’s disease). The program helps with the cost of health care, but it does not cover all medical expenses or the cost of most long-term care.

Medicare has four parts

• Hospital insurance (Part A) that helps pay for inpatient care in a hospital or skilled nursing facility (following a hospital stay), some home health care and hospice care.
• Medical insurance (Part B) that helps pay for doctors’ services and many other medical services and supplies that are not covered by hospital insurance.
• Medicare Advantage (Part C) plans are available in many areas. People with Medicare Parts A and B can choose to receive all of their health care services through one of these provider organizations under Part C.
• Prescription drug coverage (Part D) that helps pay for medications doctors prescribe for treatment.

For most beneficiaries, the government pays a substantial portion—75 percent—of the Part B standard premium and the beneficiary pays the remaining 25 percent.

Beginning in 2007, the government portion was reduced for higher income beneficiaries who began paying a larger percentage of the premium based on income …  In 2008, higher income beneficiaries will be responsible for 67 percent of their income-related adjustment. By 2009, the end of the transition period, these higher income beneficiaries will pay a monthly premium equal to 35, 50, 65, or 80 percent of the total Part B cost, depending on their income level.   However, the law is expected to affect only about 4 to 5 percent of Medicare beneficiaries, so most people will continue to pay the standard premium, without an income-related adjustment.

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In a prior post, I hypothesized that Warren Buffett’s guilt-ridden 17.7% effective Federal tax rate is most likely a consequence (unintended ?)  of the capital gains tax rate cut and  the functional failure of the AMT to do its job.

Another group of low capital gains tax rate benificiaries shows no Buffett-like remorse: private equity partnerships, and their close cousins, the hedge funds.

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In brief, hedge funds are partnerships and are legally positioned to benefit from favorable capital gains tax treatment.  But, hedge funds cavalierly push the law to the limits with some contested schemes.

Specifically, hedge funds have made an art form of “carried interest” — a claim that current operating income should be classified as returns on their invested capital and then taxed at capital gains rates (which are, of course, much lower than regular income rates.

Many (most? all?) disinterested observers smell a rat — a Enron-like loophole that you can drive a truck through.

Why doesn’t the loophole get closed?  Simple politics.  Sen. Shumer (NY) keeps blocking action because he fears hedgers will head off-shore, and — some cynics reckon — stop their super-sized contributions to the Democratoric Senatorial Re-election Committee — which, coincidentally, Shumer runs.

The likely fix: raising everybody’s capital gains rates — to avoid the appearance of singling out a prized political support group. 

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For details re: carried interest, below are summaries and links to a couple of good sources.

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Carried Interest – The Issue

From : Senate Testimony: “The Taxation of Carried Interest”
by Peter R. Orszag, CBO Director
July 11, 2007

“A growing amount of financial intermediation is occurring through private equity and hedge funds, which are typically organized as partnerships or limited liability companies and … are growing rapidly for many reasons, including their tax advantages over traditional financial services corporations.

A general partner of a private equity or hedge fund typically receives two types of compensation: a management fee tied to some percentage of assets under management and “carried interest” tied to some percentage of the profits generated by those assets.

The management fee is taxed as ordinary income to the general partner. Taxation on the carried interest is deferred until profits are realized on the fund’s underlying assets, and any resulting profits to the general partner are taxed at the capital gains tax rate …

Most economists, however, would view at least part and perhaps all of the carried interest as performance-based compensation for management services provided by the general partner rather than a return on financial capital invested by that partner … and suggest taxing at least some component of the carried interest as ordinary income, as most other performance-based compensation is currently treated …

Much of the complexity associated with the taxation of carried interest arises because of the differential between the capital gains tax rate and the ordinary income tax rate, which creates an incentive to shift income into a form classified as capital gains. Further widening of the differential between the taxation of ordinary income and of capital gains would create even stronger incentives to shift income into the tax-preferred capital form.

Full testimony (worth reading):
http://www.cbo.gov/ftpdocs/83xx/doc8306/07-11-CarriedInterest_Testimony.pdf

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Carried Interest – The Politics

According to Bloomberg:

Democratic Senator Charles Schumer of New York is fighting a plan to raise taxes on hedge funds and buyout firms with his own legislative poison pill …  saying that he would agree to the proposals only if taxes were also raised on oil-and-gas, venture-capital and real-estate partnerships.

Schumer may be trying to shield both his Wall Street constituents [i.e. keeping jobs in NYC] and his party’s electoral war chest … based on federal filings, contributions from employees of private-equity firms and hedge funds to the Democratic Senatorial Campaign Committee, which Schumer heads ,,, far exceed the industry’s contributions to the Republican Senate committee.

http://www.bloomberg.com/apps/news?pid=20601103&sid=a9DpYagBpVIo&refer=us

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A few years ago I stumbled on a Dogbert cartoon.  At the time it made me smile. 

Today, the cartoon makes me nervous — very nervous.

Of course, the source of my angst is the Obama tax plan.  But, my specific concerns aren’t the ones that most pundits dwell on.

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Buying Votes

True, Obama did hijack Dogbert’s campaign strategy and plans to raise tax rates on the top 3% of income earners (individuals and  couples earning over $250,000 annually) and to redistribute the “savings” via a new tax credit of $500 per person, or $1,000 per working family.  

Cynics point out that in the good old days, Mayor Daley’s Chicago political machine could deliver a  vote for a the price of a pack of cigarettes.  Apparently the price of a vote has gone up more than the price of gasoline.  At least votes are now  “marked to market”.  The Obama plan clearly sets the price at $500 (cash) per vote, with a perpetuity value of about $10,000 @ 5%.

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Buying Old Folk’s Votes

And, Obama promises zero Federal taxes for seniors over 65 on income up to $50,000 . 

Mark Penn, Hillary Clinton’s former chief strategist says: “The Obama camp hit a bull’s-eye with this proposal, which has little economic justification but is great politics.” http://www.politico.com/news/stories/0708/12117.html

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Upping High Bracket Marginal Rates

In a WSJ op-ed, Stanford economics professor Michael Boskin opines that despite the rhetoric to the contrary,  Obama’s increases don’t just hit “rich” individuals.  They also impact lot of small businesses and two-earner households in high cost-of-living areas.

Specifically, Obama would raise the top marginal rates from 35% to 39.6%,  increase the tax rate on capital gains and dividends, and uncap Social Security taxes (which currently are levied on the first $102,000 of earnings).

When payroll and state income taxes are thrown in, Boskin estimates that the high bracket marginal rate goes to over 60% —  with almost $2 of every $3 earned at the margin, going to the government for services and redistribution.

click to make table bigger

http://online.wsj.com/article/SB121728762442091427.html?mod=opinion_main_commentaries

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Redistributing $131 Billion Annually

An analysis done by the Tax Foundation — a self-proclaimed non-partisan think tank —  indicates that Obama’s plan — as proposed — would redistribute about $131 billion each year.  Taking money from the undeserving rich, and giving it directly to the financially besieged middle (and lower) class). 

“Hard Numbers on Obama’s Tax Redistribution Plan
http://www.taxfoundation.org/publications/show/23319.html

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My POV

1.  On a philosophical level, I agree that the grossly uneven distribution of earning power in the US is a serious problem that needs to be fixed. 

2. But, I don’t think that the problem of income inequality should be fixed via a tax system — which was originally intended to “tax & spend” efficiently on necessary common services — not to “grab and redistribute”.  Direct transfers from one citizen’s pockets to another’s (e.g. refundable tax credits) are certainly the latter.

3. Except for the impact on small businesses, I can’t get too riled over marginal rate increases that start at $350,000; but I do think a “doughnut hole” payroll tax schedule is wacky and I think raising capital gains taxes during an economic slowdown is dangerous.

4 . My real  issue:  The numbers say that in Obama World, a minority of voting age Americans will be paying income taxes.  That scares me. What’s to stop an income tax-free majority from continually voting  to  raise taxes on the tax-paying minority to fund an ever increasing potpourri of benefits or add to the redistribution pot.

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Next Up: The numbers are conclusive … taxpayers will be a minority.

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Summary: To load you with some interesting factoids for cocktail party conversations and to provide background for the next couple of analytical posts — here are some highlights from the 2006 IRS data pile (the latest year available) , and the link to the complete IRS data set (which is a treasure trove of info).

Some Highlights

138.4 million returns filed … reporting almost $8 trillion in AGI
           … up 8.4% from 2005 …  $57,670 average AGI

23%  reported dividend income … averaging $5,897

10.5%  reported capital gains … averaging $4,275

 63%  took the standard deduction … averaging $7,043

 37%  itemized deductions … averaging $24,122

 30%  reported charitable deductions … totaling $173 billion

2.9%  were assessed Alternative Minimum Tax
              … averaging $4,769

 19%  claimed child tax credits … averaging $1,233

 17%  claimed earned income tax credits … averaging $1,939

 67%  paid income taxes … averaging $11,064

   33%  paid zero taxes (or received a refundable tax credit) 
                … up from 20% in 1990 and 25% in 2000 

     
 * A deeper dig on this point is coming in subsequent posts *

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Summary Table:

click table to make it bigger

Source: IRS
http://www.irs.gov/pub/irs-soi/06in01fg.xls

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Next up: Taxpayers –  A Dwindling Majority

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The 2008 presidential campaign is loaded with tax rhetoric.  The GOP says that the Bush tax cuts have worked and it would be crazy to raise taxes during an economic slowdown. 

The Dems say that the Bush tax plan “gave tax breaks to the rich, who didn’t even want them” — as evidenced by Warren Buffet repeatedly saying that he pays less taxes than his secretary — and that uber-earning people — e,g, greedy CEOs and hedge fund managers — aren’t paying their fair share.

What do the numbers say?

Well, several pivotal conclusions can be drawn from a comparison of published IRS data for 2000 (the year immediately prior to the first wave of so-called “Bush Tax Cuts for the Wealthy”) to the data from 2005 (the last year of IRS data available):

1. The effective tax rate for the top 1% of tax filers — those reporting AGI greater than $365,000 — did go down 4.32 percentage points from 27.45% in 2000 to 23.13% in 2005 — a 16% reduction; the effective tax rate for the top 5% earners (which, of course, includes the top 1%) went down 3.64 percentage points from 24.42% in 2000 to 20.78% in 2005 — a 15% reduction. 

Note: “effective rate” is actual income taxes paid divided by income; “marginal rate” is the percentage of “last dollars earned” paid in taxes.  So-called “payroll taxes” for Social Security and Medicare are not included (see ana;ytical note below).

2. But — and it’s a big “but” — the effective tax rate for the bottom 50% of all tax filers (those reporting less than $28,875) also went down — from 4.62% in 2000 to 2.98% in 2005 — “only” 1.62 percentage points, but representing a whopping 36% cut from the 2000 rate.

Note: 32% of tax filers paid zero income taxes or received refundable credit checks from the government

3. And, the amount of taxes paid by the top 1% as a group was approximately the same in 2000 ($388.9 billion) and 2005 ($368.1 billion); ditto for the top 5% — $553.7 billion in 2000 and $557.8 billion in 2005. 

4. During the same time period, the tax proceeds from the bottom 50% of tax filers dropped almost 25% — from $38.3 billion in 2000 to $28.7 billion in 2005. 

5. So, the tax burden absorbed by the top 1%  increased by 2 percentage points from 37.4% of total income taxes paid in 2000 to 39.4% of total income taxes paid in 2005; the top 5% share of the tax burden increased by 3.2 percentage points from 56.5% of toal income taxes in 2000 to 59.7% in 2005; the bottom half’s share of total income taxes paid dropped from 3.9% in 2000 to 3.1% in 2005. 

6. Taking a longer run view, the share of the income tax burden shouldered by the top 1% has roughly doubled over the past 25 years — from about 20% of total income taxes paid to about 40% of all income taxes paid; the share of the income tax burden shouldered by the top 5% has has increased roughly 25 percentage points over the past 25 years — from about 35% of total income taxes paid to about 60% of all income taxes paid. 

7.  The share of income taxes borne by the bottom half of tax filers has fallen from over 7% to about 3%.

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Observations

I. The picture is certainly different when the focus shifts off marginal tax rates to the  amount of taxes paid or the share of the total income tax burden.

2. Broad based surveys indicate that people in general think the maximum percentage of a person’s income that SHOULD go to state, federal, and local taxes (in total) is 16%, with only 12% of respondents saying that the rate should be over 30%.

From a HarrisInterActive Poll:
Q 650: What is the maximum percentage of a person’s income that SHOULD go to taxes – that is, all taxes, state, federal, and local?

 
http://www.taxfoundation.org/files/topline-20050414.pdf

3. A tax burden of 60% of taxes paid by 5% strikes me as a pretty high number — especially since it’s 5% of tax filers not 5% of citizen-voters. Of course, “fair share” is in the eye of the beholder …

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Data deck: 02-irs-tax-quartiles-key-metrics
Primary data source: http://www.taxfoundation.org/news/show/250.html

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Analytical Note: This post, and a few follow-ons that I have in process, focus on individual federal income taxes.  That distinction excludes corporate taxes (an entirely different animal), state taxes (a crazy quilt of different programs), and so-called “FICA” or “payroll taxes” (for Social Security and Medicare).  The latter exclusion is admittedly dicey.  Employees’ paycheck deductions for Social Security and Medicare are a constant percentage of income (6.2% + 1.45% = 7.65%), up to $102,000 in earnings.  So, many people argue that the assessments are “regressive.”  Nonetheless, I consider these charges to be more akin to forced savings or deferred income plans since contributions are matched by employers and since the benefits received (e.g. retirement income and health insurance) are directly tied to the level of contributions.  So, I choose to outboard them from “tax and spend” analyses.  

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Next up: More on income, deductions, credits, and taxes.

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