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Income Inequality and Taxation

September 21st, 2017 · No Comments · Economics, General, Politics, Populism, Taxes

by Joseph O’Shaughnessy

What is income inequality and what does it mean to the average person? Does it matter to you or me if someone makes 20 billion dollars a year? Most average people, going through their daily routines, never think about how much someone else makes, only what they themselves earn. So let’s examine the concept of “income inequality” and see whether or not it has any influence on your life. Here’s a video that you may have seen. If you haven’t, it is a reality check on income in America. You may be astonished at what you learn.

Before we go further, let’s make a couple of assumptions. Can we just agree at the outset that no one should be concerned by large  fortunes or how they were earned (or even if inherited )…so long as it was legal? Nor should one worry about how the rich spend their money. The long, relatively proud history of the United States has rewarded independence and initiative and has always considered wealth–if not without envy by some–to be a sign of innovation, persistence and hard work. There is no reason to change those ideals. Let’s concede that we would all like to make a lot of money .

But the term “inequality” does have some inherent implications. It implies unfairness. Does it not imply that there are super-rich but also homeless and foodless among us. What about the idea of enough income among everyone to establish a fully functioning society, equitable to all who live in it?

The famous Austrian political scientist, Frederick Von Hayek would say that there is basically no such thing as being fair when it comes to the economics of large societies. The economic circumstances determine a great deal about who makes how much. If you try to change the economic formula, from free markets to controls–Socialism, for example–the evidence, he maintained, with some validity is that it simply won’t work. Economics dictates income. How much of that income each person should pay in taxes to maintain a working society is the question.

And it is always an extremely difficult personal judgment. In fact, Hayek says, it can’t be done. But he does offer a solution.

People and companies intrinsically have a need to make as much money as they can. They inherently seek to optimize the efficient output of the organization. If you tamper with the economy to try to make it fair, Hayek said, you end up with inefficient economies and no one benefits. His pretty strong argument says that Socialism is evidence of that.

But Hayek had a solution to unfairness or “inequality” and to the Conservative bugaboo…redistribution. Redistribution is the idea that to make something work, society must take something from one group and deliver the equivalent good to another group. Rush Limbaugh would say, for example, that because we tax his annual $40 million salary for berating the Democrats on the radio, we are “redistributing” part of his income to others.

Hayek says that democratic societies do have the right to tax at levels they feel appropriate, if that right is given to them by society in a democratic majority vote. Taxes are necessary to maintain a viable society he says. Therefore, society, having been given the “power” to tax, as he calls it, can then decide what levels of taxation are right for the maintenance of government.

Is it equitable? No. Hayek maintains that  you cannot make it fair. No one has ever been able to determine what is the fairest tax system. No matter how hard you try, you cannot make a system that says that this is right for Citizen A and this much is right for Citizen B. A society, however, can vote to give government the power to tax. Based on the explicit will of the people, Hayek says, government has the power to make those arbitrary decisions. Hayek was the founder of modern Neoliberal economics, as followed by all Conservative economists, including Milton Friedman and the so-called Chicago School.

So that brings us to taxation. Where are we on taxation?

In 1961, the government took a look at the top 400 tax returns. Not the 400 richest people (because some of the richest do not file income taxes) but the 400 highest tax returns. Those individuals paid about 42% of their incomes in taxes. By comparison, the bottom 90% of tax returns that year paid about 20%. By 2011, those 400 taxpayers paid only 16.5% of their incomes in taxes and they averaged about a million dollars a day in income. The 90% also paid a little less, but because their payroll taxes were a higher part of their incomes, their taxes only went down less than a percentage point under 20%. Their average income for 2011? $33,000

As you saw from the inequality chart, one of our problems is that so much of our income, over 25% now, goes to the top 1% of taxpayers…or people in that bracket who may not be paying taxes. Yes. there are 35,000 people in the top 2% of incomes in this country who pay no taxes because of one or another loophole.

So how much money do we need to run our government? To find out we need to go to authoritative sources, like the Treasury department. I point that out because there are all kinds of tax institutes and foundations and other websites made to look like government sources but are, in fact, propaganda web sites published for the handful of Right Wing billionaires who–rightly or wrongly, and who is to say they are wrong–use them to persuade the rest of us that we pay too much in taxes.

Do we pay too much? It is no easier a question than the one that Professor Hayek said was virtually impossible to answer on individual taxes. But the group of 33 countries of which we are a member, the OECD, which includes Canada and the Western and Eastern European and Scandinavian countries, says that we are 4th from lowest in the rate of taxation of our citizens and corporations. Now, it is true, however, that for their taxes, almost all of them get free medical care, cradle to grave, free education as high as they can go, if their grades qualify, (Finland has the #1 educational system in the world), longer and higher unemployment, double the length of our paid vacations and maternity leaves and higher retirement income. But they pay more. And they don’t have the huge military budget because we have accepted that responsibility. That is not unimportant. Even American immigrants can attend university in some Eastern European countries and pay no tuition.

We pay about 17.5% of GDP in taxes and we have for some time. Those are Treasury statistics, not Koch brothers statistics. And before that, for about the last 40 years, since Reagan, we have paid something like 18.4% of GDP. But, for example, in 2016, a year of not only full recovery but strong economic activity, we had a GDP of $18.8 trillion and government revenues of $3.45 trillion. This is a ratio of 17.7% of GDP. We had a deficit of $587 billion dollars.

But let’s suppose that we were paying what we have averaged paying throughout the post-Reagan years, the 18.4% of GDP, rather than finding every possible excuse to cut taxes on everyone not in poverty. What would that look like? Well, it would amount to an increase of about $131 billion or a net deficit of $456 billion…still too much of a deficit. But what if we went back to the 20.4% of GDP of the Clinton years? We’d still be short by about $200 billion. So what can we do?

Here are a couple of important points. If you take the top in come earners who do submit tax returns, that is, just the readily available true numbers published by government on the facts, we collect something like $3.5 trillion. The amounts fluctuate but not by much, so let’s just say that this is an average of about 26.6% of everyone’s income. This is all taxes, and since we all pay them they are relevant. But the top 1% actually pay less than the top 5% or the top 10% who pay more as a percentage of income. And, everyone pays taxes. The idea that the bottom 47% of Americans pay no taxes is wrong. Even the poorest quintile, the bottom 20%, pays taxes, and those are paid immediately through payroll deduction and they pay some state an local taxes, which come to something like 16 to 17 percent. The mean household income for this group in 2016 was about $12,800. They paid a total of about 16% of that income in taxes. And the top 400 households (remember?) after all the Reagan and Bush tax cuts…dropped from 42% to just 16%.

What about the family making $150,000? They are in the 25% bracket. But if they have a house and a mortgage for let’s just say $2,000 per month, then they have some deductions. Rather than going into all of them, here is the basic idea. Your basic txx bill would be around $25,000. But if you had even $6,000 in deductions, which would be low, then your effective (married filing jointly) tax would end up somewhere around $21,000 or about 15% That is what you actually pay as a part of what you actually earn before taxes. That is federal income taxes. You keep about $10,000-$11,000 per month.

But this is nothing compared to what the very wealthy have been able to keep. Remember, Warren Buffett lives in the same house he bought in 1950. It is isn’t a mansion, but if it works for he richest man in the country, how big or how many big houses do people really need? Nothing wrong with having as many as you want. But there is also nothing wrong, according to arch-conservative Frederick Hayek, from the government saying…we think that a firm 25% of everything over $1,000,000 is justified. And nothing wrong with government saying that all corporations with sales of over $50 million will pay minimal income taxes of 10% so that no corporation can make $400 million in profits, like EXXON and yet pay zero in income tax.

Which brings us to reality. Last year we took in about, in round terms, $920 billion in Social Security taxes and we paid out a little more than that in Social Security…maybe another 20 billion. But the Social Security fund was raided long ago, mostly by the Republicans but partly by Democrats, and about $3.5 trilion was simply moved into the general funds of the Treasury. So, it will be a long time before we use up that surplus that was, some call it, stolen to pay for tax cuts. So, if we decide that we can raise the Social Security payroll deduction cap from people with $100,000 of income to those with $200,000 of income, we can solve the Social Security problem.

Medicare is another function of appropriate taxes and appropriate spending. If we continue with private health care plans, we will continue to add to the Medicare problem, which is that it costs us, in taxes, about $500 billion per year. By substituting a public option plan into a health care bill, we could reduce costs by as much as 20% ($100) the first year and probably 70% by the fifth year. So in five years, our costs bases on the same GDP, same numbers of recipients would go down from $500 billion to $150 billion…more than current costs. Medicare administration is simply a function of two things. One, taxing Americans for adding health care to social services for retirees. Even then, it is not free to retirees. For full coverage, it costs substantial amounts of Social Security income. But, by reducing administration costs on all health expenditures, we could bring Medicare costs down and thereby make it sustainable over the longer term, while lowering basic medical costs from what is now an average annual of about $18,000 down to a much more manageable $12,000. This would costs some jobs in the insurance industry but those jobs are probably the most easily transferable to other segments of the economic spectrum.

Finally, we have the issue of tax expenditures. And this is where, if we have the trust and dedication (and a Democratic Congress) we can fix our tax code once and for all. Your mortgage interest rate deduction is a tax expenditure. Business lunches are a tax expenditure and so are many many other tax deductions. But here are the two that will make the most difference. If we simply change the deduction for employers providing health care at a policy of, say, $10,000 and top out the deduction for home mortgage interest at a reasonable amount…say half a million dollars rather than a million…two things would happen simultaneously. First health care costs would come down almost immediately. Second, the number of people buying second homes over a million dollars would drop and that money would go into savings, or vacations.

There are other tax expenditures, huge ones in industry that people do not want to discuss that will make a huge difference. First of all, the inheritance tax is basically a tax expenditure overall because without tax it simply gives individuals money that they would otherwise not have as income without being taxed. So, since they are being given income without working for it, we should tax it as working income or tax it one time, with a large deduction and then about 50% of the balance going to the state. The person dying is gone. He or she is not the beneficiary. The one living is the one who is the recipient of unearned income. That person should be taxed, because, as Hayek said, society needs money to function.

If we were then to tax capital gains at 25% with no exceptions, leave the tax rates somewhere within a point above or below 30%, all taxes, and 22-25 percent income taxes, we would have surpluses within 7 or 8 years and long term surpluses with a much better functioning society than we currently experience.

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