The Fraudulent Flat Tax Pitch – A Rich and Powerful Tactic

Power and riches go together. But nowadays, they need political spin. Throughout history the very rich have usually also been the very powerful.  And usually the very rich use that power to both protect themselves from the less well-off and to figure out ways to further enrich themselves.  Often the enrichment comes at the expense of the less well-off.  When you’re powerful, redistribution of income away from the poor towards yourself is often a lot easier and more lucrative than trying to be productive and creative.  It’s been this way largely since the start of history.  But getting the poor and middle classes to go along it can be a challenge.  Of course blatant power, threats, and coercion were the means of choice for centuries.  The pure power dynamic gave way over the centuries to class, the idea that somehow the rich were different people, better people. The poor and middling classes were taught that it was the natural way of things.

Then the American and French revolutions brought out that dangerous idea: people really are fundamentally the same and they should have the same political rights.  It was a very dangerous idea for the rich and powerful classes. It leads to questioning why the rich are rich and the poor aren’t.  More importantly, this equality idea gave rise to a democratic governments.  Democracy is a challenge for the rich and powerful.  As historian William Hogeland has powerfully explained, the U.S. Constitution was actually created as a reaction by the rich and powerful against democratic finance well after the American Revolution.

So how do the rich and powerful today attempt to overcome democratic impulses and further enrich themselves at the expense of the others?  In other words, how do the rich and powerful get the poor and middle classes to go along with proposals that ultimately are only in the interest of the rich and powerful? 

One tactic is to simultaneously promote the idea that anybody can get rich and that success is purely a function of individual merit and effort.  One blatant example of this is Republican presidential candidate Herman Cain’s statements that “If you don’t have a job and you’re not rich, blame yourself.”   The unstated, but necessary assumptions behind such a statement are that sufficient opportunities exist instead of an economy where there is only 1 job opening for every 4+ job seekers.  It also assumes that all power is benign and that the rules are truly fair and balanced.  There’s a pernicious micro-economic theory called marginal resource productivity pricing (the MRP=MRC idea) that falsely provides a patina of cover for such ideas.  I won’t deal with that here but I hope to in a future post.

A second tactic is political spin.  Proposals that are really attempts to use the government to further entrench the rich and powerful at the expense of the 99% are dressed up in language that is carefully chosen to sound like it’s fair and populist.  But it’s a faux populism.  It’s an attempt to fool voters. Flat tax proposals are just such attempts to fool voters into supporting proposals that will hurt them. Let’s look at how and why flat tax proposals are neither “fair” nor beneficial to the majority of voters, workers, or taxpayers.

Inevitably, all flat tax proposals represent an attempt to raise taxes on the poor and middle classes while reducing taxes on the extreme rich, the top 1%. I’ve already analyzed and explained just how much Herman Cain’s “flat tax” proposal, the “9-9-9” plan would raise taxes on at least the 80% while providing a huge tax cut for the top 1% and even more for the top 0.1%.  If there were truth in political advertising, Cain’s plan should be described as the “9+9+9=27% tax plan”.

Why are all flat tax proposals some kind of tax increase on the poor & middle class while providing tax cuts for the rich?  It’s because we already have a mildly progressive tax system.  Progressive means that the higher your income is, the higher your tax rate is.  In other words, under a progressive system, the rich pay higher rates and the poor lower rates.  Under a regressive system, the poor pay higher rates than the rich.  In the U.S., the federal income tax system is moderately progressive, although it’s been flattened a lot in the last the 33 years.  The progressiveness of the federal income tax system is offset partially by the regressive nature of a lot of other taxes like Social Security and Medicare payroll taxes, state and local sales taxes, and some property taxes.  The net effect is a mildly progressive tax system.  I quote from a post I made about this topic last spring:

 the folks at  Citizens for Tax Justice  used 2008 data for all federal, state and local taxes combined to do the analysis.  Here’s their analysis (via New York Times – warning paywall):

It found that the average effective tax rate is 29.8 percent, and that including state and local taxes makes the tax curve look much  less steep:

INSERT DESCRIPTION
Source: Citizens for Tax Justice Horizontal axis shows the income group. Vertical axis shows the percentage of income that the average member of that group pays in taxes. Taxes include all federal, state and local taxes (personal and corporate income, payroll, property, sales, excise, estate, etc.). Incomes include cash income, employer-paid FICA taxes and corporate profits net of taxable dividends.

So what do we learn from this?  It shows us that if we look at the overall tax system in the U.S., the complex patchwork system of federal-state-local income taxes, payroll taxes, property taxes, sales taxes, etc., we are pretty close to having a flat tax system.  The poorest, lowest income folks pay 18.7% of income as some type of tax while the the richest 5% do pay more, but they only pay 32.2%.

What is really stunning is how the top 1%, the really-really rich multi-millionaires actually pay less average tax rate than the those who are only rich enough to make the top 5%.  It must really be nice to be so rich that Congress tweaks the tax code just for you.

So the system is very, very mildly progressive.

Flat tax advocates don’t make this “tax increase on the poor/middle class with tax cut for rich” aspect clear.  They try to hide it and obfuscate it.  They use terms like “flat” and “fair”.  They are really trying to tap into our collective memories of childhood when the idea of everybody getting the same percentage of the birthday cake seemed like an obvious “fair” solution.  They don’t want us to pay attention to the actual numbers.

But even a “flat” tax rate isn’t really fair. There’s a phenomenon that’s described in economics as the “diminishing marginal utility of money”.  In plainer English, it simply means that the richer you are, the more income you have, the less valuable any particular increase in income is to you.  The reverse is also true, when you’re poor and don’t have much money, the value or utility of money is very, very high.  An obvious example is to consider two extremes and look at the value or utility of having an additional dollar bill.  To an unemployed person with no assets and no money, a dollar bill is very, very valuable.  It may well represent eating vs. not-eating today. Life is dependent upon it.  Now contrast that to a hedge-fund manager who has a tens of millions of dollars in income each year and even more cash in the bank.  A single additional dollar doesn’t mean much.  If a strong wind blows the dollar out of the hand of the unemployed, they will no doubt chase it.  If it blows it out of the hand the hedge-fund manager, they’re much less likely to chase it.

But some critics may point out that my example is using dollar amounts not percentages.  Surely percentages would be the same.  Not really.  This time let’s consider someone working full-time at minimum wage.  They earn $296 per week – gross. But after payroll taxes they’re closer to $275.  That’s close to $1100 per month. One percent of that is $11.  That one percent could easily represent the difference between bus fare or gasoline and not having it.  In other words, that 1% represents the very ability to get to work and earn their income.  It’s extremely valuable.  It can be the difference between making it and not making it.  For many seniors on social security, 1% is the difference between life-maintaining prescriptions and not. But let’s look at that hedge-fund manager again.  The one with the $16 million dollar a year income.  The monthly income is $1.33 million.Now yes, 1% for our hedge fund manager is $13,333 each month. It seems like a huge amount of money to us (I’m assuming not many of the 1% read my blog), is how big of a sacrifice will it mean to the hedge fund manager?  Would paying an additional $13,333 per month really change the hedge fund manager’s life much?  Not likely.  It’s not likely to change the choice of first or second house.  I’ll grant it might affect the choice of whether to have a third home or how big it would be. The point is that the sacrifice represented by 1% of income is greatly different depending upon your income.  A flat tax does not represent equal sacrifice.  

The flat tax advocates also make much of the idea that a flat tax would simplify the tax code. Again the reason for claiming simplification is to get middle class voters to support  something that isn’t  It won’t.  First, while some flat tax proposals start out as recommending the elimination of all deductions, exemptions, and tax credits, they rarely do in practice.  Even Herman Cain has backtracked from his original proposal of eliminating all exemptions.  It’s the personal exemption that gives the current federal income tax system much of it’s progressiveness.  When push comes to shove, the political pressures and special interests that pushed for the deductions and credits originally rise up and force some kind of inclusion in the new proposal.  Herman Cain, I understand has now already backtracked and decided to add back personal exemptions.  That ends the “flatness” of his flat tax.  Now it’s just a tax cut for the rich proposal. In the real world of politics and special interests, no flat tax proposal will stay that way.  There are too many legitimate reasons why we don’t have a flat system now and they will inevitably reassert themselves.  Charitable deductions (think churches and universities, not homeless shelters) and home mortgage deductions have powerful interests behind them. Besides, much of the complexity in tax forms comes from simply trying to determine what’s income and what isn’t.  That won’t change.  Simplicity is just false promise to make flat tax proposals attractive to the middle class.

Flat tax advocates also claim it would treat all taxpayers the same.  But the current system already does that. As Robert Reich points out:

The truth is the current tax code treats everyone the same. It’s organized around tax brackets. Everyone whose income reaches the same bracket is treated the same as everyone else whose income reaches that bracket (apart from various deductions, exemptions, and credits, of course).

For example, no one pays any income taxes on the first $20,000 or so of their income (the exact amount depends on whether the person is married and eligible for tax credits like the Earned Income Tax Credit of the Family Tax Credit.)

People in higher brackets pay a higher rate only on the portion of their income that hits that bracket — not on their entire incomes.

So when Barack Obama calls for ending the Bush tax cut on incomes over $250,000, he’s only talking about the portion peoples’ incomes that exceed $250,000. He’s not proposing to tax their entire incomes at the higher rate that prevailed under Bill Clinton.

Republicans have tried to sow confusion about this. They want Americans to believe, for example, that if the Bush tax cut ended, small business owners with incomes of $251,000 a year would suddenly have to pay 39 percent of their entire incomes in taxes rather than 35 percent. Wrong. They’d only have to pay the 39 percent rate on $1,000 – the portion of their incomes over $250,000.

Get it? We already have a flat tax – flat within each bracket.

Flat tax advocates also deceive by only focusing on federal income taxes.  Payroll taxes, the Social Security and Medicare taxes, are regressive.  People with incomes over $104,000 don’t pay any tax on the income above that threshold.  People whose income comes from capital gains and not wages don’t pay any Social Security or Medicare taxes.  Yet they are eligible for Medicare.  State sales taxes are highly regressive.  Flat tax advocates don’t want to change those systems because the real objective is to shift taxes to the poor and middle class and give tax cuts to the top 1%.

Finally, the biggest deception in most flat tax proposals is that capital gains, dividend income, and hedge fund management fees (called “carried interest”) are usually still provided special treatment.  Herman Cain does this.  He claims to want all income taxed at 9%, but in reality he proposes that capital gains and dividend income be totally exempt from taxes.  In other words, the way that the top 1% generally earns most of their money would be tax free.  How fair is that?  It’s the current loopholes about taxing capital gains, hedge fund managers, and dividends at lower rates that results in the top 1% paying less than anyone else in the top 10% (see graph at top).

Flat tax proposals aren’t about flattening tax rates. They’re about flattening the majority of taxpayers.  But that doesn’t sell politically so they have to be wrapped in political spin to be something they aren’t.

 

 

 

 

 

Millionaires Don’t Move to Avoid Taxes – Empty Threats

I’ve commented on this before, but it’s worth repeating.  Millionaires, despite all their bluster and threats to move when taxes are raised, simply don’t move.  It’s empty threats.  If income tax rates are raised on millionaires, they actually stay put.  This means it is indeed possible to improve state government finances by using a very mildly progressive income tax, a tax with a higher rate for very high incomes.  The evidence comes from academic studies of a near-perfect test case: New Jersey.

I’ll let Ezra Klein of the Washington Post explain:

When anyone brings up new taxes on the rich, the big objections is that such taxes end up being counterproductive because the rich simply flee to places that don’t tax them. This is, in theory, particularly true at the state level. It just doesn’t appear to be true in practice.

A few years ago, New Jersey instituted a tax that raised rates on those making more than $500,000. Predictably enough, some clever academics swooped in to test the prediction that all the rich folks would leave. So how’d it fare? Poorly:

The study found that the overall population of millionaires increased during the tax period. Some millionaires moved out, of course. But they were more than offset by the creation of new millionaires.

The study dug deeper to figure out whether the millionaires who were moving out did so because of the tax. As a control group, they used New Jersey residents who earned $200,000 to $500,000 — in other words, high-earners who weren’t subject to the tax. They found that the rate of out-migration among millionaires was in line with and rate of out-migration of submillionaires.  The tax rate, they concluded, had no measurable impact.

The study went on to conclude that “the policy effect is close to zero,” though if it exists for anyone, it’s for the over-65 crowd who live off their investments.

I Don’t Think Corporate Taxes Are Too Low

Ok, just a quickie about taxes with two more startling graphs.  Another proposal that’s making the rounds in Washington is to cut the corporate income tax rate.  This proposal is originally coming from the Republicans, but it looks like Obama has drunk the kool-aid too.  The argument goes that corporations in the U.S. are taxed too much and that’s why corporations don’t invest in the U.S. and therefore don’t grow jobs here.  The “evidence” cited is the fact that the U.S. statutory income tax rate for corporations (at least any with substantial income) is 35%, one of the two highest in the developed, industrialized world.

But it’s a deceptive piece of evidence because what matters is what corporations actually pay, not the statutory rate.  As I’ve noted before, U.S. corporations, particularly multinationals pay little in income tax.  GE, especially,is a welfare queen that pays no taxes despite taking huge contracts from the government. So what’s the trend been for corporate taxes as part of our GDP? The CBPP obliges with a graph:

Um, that doesn’t look to me like a severely burdensome corporate tax rate.  In fact, back in the 1950’s and 1960’s, back when corporate managements were focused on making products and opening markets instead of focused on spreadsheet tricks to gimmick-up this quarter’s earnings, the corporate tax rate was higher.

Tax Rates Are Historically Low

The  Difference Between Average and Marginal Taxes

U.S. average tax rates are at historical lows.  Yes, that’s right. Our taxes aren’t “high”, despite the Tea Party’s claim that we are “taxed enough already”.  The average family pays approximately 5% of gross income as U.S federal income tax.

How can that be you ask?  Well, the political rhetoric that quotes tax rates of 33% or 39% or 50% or the historical high of 91% are all marginal tax rates.  They tell us what percent of income above a certain threshold (typically in the $250,000 range) gets paid as tax.  For all taxpayers, even high income earners, the first money earned is taxed at the lower rates.  Indeed, the way personal exemptions work, the first thousands of dollars of income aren’t taxed at all.  In contrast the average tax rate is figured by taking the total dollars of taxes paid and dividing it by total income.  The average tax rate is the best measure of how burdensome or not-burdensome taxes really are.

In the U.S., for the median income family, the average tax rate is near 5% as shown in the graph. This is down dramatically from 12% in the late 1970’s. It’s even down significantly from the 6% we paid in 2006!  At a 5% average rate, this means that 95% of your gross income is available for other purposes. For many households, the rate is even lower if your income is below the median.

But what about the rich and the high income bracket folks?  Aren’t they being “taxed to death” with those supposedly awful, allegedly job-killing 35% marginal rates? No. Those are marginal rates.  A married filing jointly household will only pay that 35% on income after the first $379,150. (source: Tax Foundation).  Further, much of high income gets sheltered.  If the income came from capital gains, it’s taxed at a lower rate. Income paid to pay interest on mortgage doesn’t get taxed and neither do a host of other deductions.  So how much do these high-income people pay? Not as much as you think or they want you to believe.  Let’s look at another chart, also from CBPP.

So the millionaires, the folks with incomes over $1 million only pay an average rate of approx. 22%.  What’s really startling about this chart is how mere millionaires ought to be upset.  The really, really, ultra-rich, the top 400 households in America pay only 16-17% average tax rate.

So we’ve got the median household income, which is around $50,000 per year pays 5%.  A millionaire pays 22%.  And a real high multi-millionaire pays only 17%.  This is hardly highway-robbery style redistribution of income.

A Better Comparison – Let’s Add Payroll Taxes.

But if we are going to compare tax burdens by income brackets, we really need to look at more than just federal income tax.  We definitely need to add in payroll taxes – social security and medicare taxes.  These payroll taxes were payable on all income up to $106,800 in 2010.  The rate for Social Security tax and Medicare combined was 7.62% (not counting the employer’s share) (source: Payroll Experts.com).  Now it gets tricky.  The median household with an estimated $50,000 income paid 7.62% payroll tax on their entire income.  So the combined federal income and payroll tax bite on the median family income was approx. 12.6%.

Now let’s figure the millionaire.  Let’s suppose that someone with a million dollar income paid 22% in federal income tax. Actually it would likely be less since the 22% figure is from all incomes over million, many of them much over.  But for the sake of argument, we’ll say they paid 22%.  But they would have only paid the 7.62% payroll tax on the first $106,000 and none on the rest.  This means that the millionaire’s average payroll tax was 0.76%.  So the combined federal income and payroll average tax rate for the millionaire is no more than 22.76%.  The gap between the median and the millionaire is much smaller than widely believed.

For the Top 400 households, the payroll tax is insignificant, so their combined tax rate is around 16-17%.

Overall, the U.S. is not high tax burden country.  But, the tax burden is not fairly or progressively shared anymore.  The burden falls heaviest on those least able to pay.

Taxes and Unshared Sacrifice

It’s tax time so it’s appropriate to look at the fairness of the tax code.  One of the greatest beneficiaries of the Bush-era tax cuts were hedge fund managers.  Hedge fund managers are people on Wall Street who manage other people’s money, not primarily their own.  In return, they get paid fees for managing the money. The more money they make for clients/investors, they more they get paid.  Sounds like wages or income to me, and I suspect to you, too.  But not to Congress.  In 2001, they redefined things. The compensation these hedge fund managers is only taxed at less than half the rates other people pay for income.  This is despite these incomes being at astronomical levels.  Wonkroom puts things in perspective with a nice little graph.

CEO pay pales in comparison to that of hedge fund managers:

Last year was very lucrative for some of the biggest and best-performing hedge funds’ chiefs. Wealth was so concentrated that a mere 25 people pocketed a total of $22.07 billion, according to this year’s annual ranking by AR Magazine, which tracks the hedge fund industry. At $50,000 a year, it would take the salaries of 441,400 Americans to match that sum.

Making matters worse, hedge fund managers benefit from preferential tax treatment that middle-income Americans don’t. Due to what’s known as the carried-interest loophole, the income that hedge fund managers receive if their funds make money is treated as capital gains — rather than ordinary income — and gets taxed at the capital gains rate of 15 percent. Even though the pay is performance-based compensation (just like any other performance-based bonus made by any other worker), hedge fund managers receive a tax break on that income.

This results in hedge fund managers paying less in taxes on this income than middle-class workers, who are subject to a 25 percent top marginal tax rate:

Congress has debated closing this particular loophole over and over, but has never actually followed through. At a time when vital and popular programs are being placed on the altar of deficit reduction, removing this tax break for some of the richest people in the country seems prudent.

To be fair, the graph compares only the marginal tax rate each taxpayer faces.  The marginal tax rate is the tax rate on the next dollar of income earned after you’ve reached that level.  It is not the average tax rate paid. Average rate paid would be total taxes paid divided by income.  But, even if we went by average tax rates, these hedge fund managers pay a lesser tax rate than ordinary middle class or poor individuals.  Further, since this income is not considered by Congress to be wages or labor income, they don’t pay Social Security taxes on the additional income.  

BTW, there’s another way to look at the graph.  The firefighter, the teacher, the police officer, and the doctor all perform valuable services that improve the quality of our lives.  All four may occasionally screw up, but the damage done is isolated (although granted if it’s your home that burns or your body that’s hurt, you may feel differently).  Hedge fund managers, however, have been a key part of the Wall Street environment that sought more and more risky investments and complex financial schemes in the last decade.  The kind of stuff that blew up and created the Great Global Financial Crisis.