Senate Income Inequality in the U.S.: Causes, Effects, Solutions

Very interesting article highlighting problems with our tax system:

http://finance.yahoo.com/news/102-tax-rate-takes-cake-160010322.html

It states what I've long argued:

?The best way to have everyone pay their fair share is to tax all income (whether earned or unearned) at the same rates,? his accountant, Jeffrey Rosenthal, said.

Still, it discusses how some 'rich' people still pay a ridiculous tax rate because of their occupation, where they live, etcetera. In other words, the tax code favors certain professions over others.

It makes me think federal rates should stay as they are, eliminate some deductions and tax all income the same.

It's a good read and would be interested to hear everyone's thoughts...KK I'm looking at you in particular.

 

It's an interesting article, and it shows some very real issues with our tax code.

Ultimately, the goal should be to simplify the code as much as possible, so that issues like these can be better anticipated and avoided.

It all depends on how it is structured.

The first question that has to be asked, though, is how do you define what a "fair" tax rate is? For that, we can look to the dictionary:

6 a : marked by impartiality and honesty : free from self-interest, prejudice, or favoritism <a very fair person to do business with>
b (1) : conforming with the established rules : allowed (2) : consonant with merit or importance : due <a fair share>
c : open to legitimate pursuit, attack, or ridicule <fair game>

According to definition 6a, a fair tax rate would be one free from self-interest, prejudice, or favoritism. In practice, that means that you treat everyone the same.

So, how do you do that? The two simplest answers would be to either charge everyone the same amount (essentially a flat fee structure or a capitation tax), or to charge everyone the same rate (essentially a flat tax).

You could also try to apply definition 6b(1) "conforming with the established rules", but I'm not sure that it helps much. After all, you could set a rule that the government confiscates everything over $500,000 in income and apply that to everyone, but does anyone actually think that such a system would be "fair"?

Ultimately, I believe that a progressive tax structure is inherently unfair, because it decides that some people should have to pay more than others, and that some people shouldn't have to pay anything at all. When you start facing a system where approximately half of all "taxpayers" don't actually pay taxes, you can create a self-destructive cycle where those who don't pay taxes vote to raise the burden of those who do pay taxes. It then becomes a case of three wolves and a lamb voting on what's for dinner.

The problem is then compounded by payroll taxes (Social Security, Medicare, etc) that are ultimately treated as general revenue taxes by the government.

Personally, I would propose a personal flat tax (on the order of 15%, exact numbers would have to be calculated once other details are worked out) that replaces the current income and payroll taxes (including the employer-provided portion). I would include a standard deduction, and very limited additional deductions (specifically only in the areas of housing, medical, and education expenses).

The general effect of such a change would be relatively minor on low-income earners. For example, if someone pays no income tax now, they would still only take home 92.235% of their paycheck (because of the Social Security + Medicare employee contribution). Under my proposal, they would take home 91.5025% of their current income (tax rate of 15% on 107.65% of current income, to add in the employer portion of payroll taxes). That's a difference of 0.8475% between the two programs, without any change in deductions.

Overall, that's a minor change in a person's tax burden, no matter what tax level you are at.

On a philosophical level, I think it is important that everyone pay taxes and feel the sting of having to do so. It's a question of shared sacrifice, and locking everyone's rates together means that you can't raise my rates without also raising your own. That should ac

 

Out of my entire post, that was the only line you though worthy of discussion? Repeating a point that I had already addressed in two different ways?

1) I've already explicitly called for a generous standard deduction, with limited deductions for housing, medical, and education. The entire point of a standard deduction is to lessen the overall sting of taxation, exempting at least part of the basic necessities. That has the effect of making a flat tax more "progressive".

For example (all numbers are for illustration only), let's assume a $10k standard deduction with $5k for each additional dependent, and a 10% flat tax rate.

For a family of 4, you would get the following table:

Income----Tax---Effective Rate
$25000 -- $0 ---- 0.00%
$30000 -- $500 -- 1.67%
$40000 -- $1500 - 3.75%
$50000 -- $2500 - 5.00%
$75000 -- $5000 - 6.67%
$100000 - $7500 - 7.50%

And it would continue. No one would ever actually pay the full 10% rate, because everyone would have that standard deduction (effectively making the top rate 9.999999%).

Again, these numbers are for illustration purposes only.

2) My position has no problem with that family that $25k family receiving $10k in government assistance benefits, even if they are only paying $2500 in taxes. The point of it is that they should be paying something. You should not have half of the population paying no income taxes.

Finally, how exactly do you measure what is an unjust "sting" from taxes? How do you define what a person's "fair" share of taxes is? Because taxes are necessarily quantitative in nature, you cannot define it in a qualitative manner. You need to be able to say that X% is a fair tax rate for person Y, and justify it.

Moreover, because we are dealing with an entire spectrum of income earners, can we really say that it is fair for a person making $X should pay Y% in taxes, but a person making $X+1 should pay Z% in taxes? How do you determine what X, Y, and Z should be? It becomes even more complicated when you consider that there are different costs of living in different parts of the country, and yet federal tax rates are the same for everyone. (For example, I live in the DC area, and the Obama administration recently defined that in my area making less than $80k qualifies you as "near poor", a category that my wife and I fall into. And yet, we own a comfortable home with a reasonable mortgage, and the only other debt we have is a small car loan and a few thousand dollars in student loans.)

Now, do you want to respond to the rest of what I wrote, or are you going to just repeat your already-addressed complaint again?

Kimball Kinnison

 

No, I didn't say that the taxes are progressive. I said that the net effect is still "progressive". The taxes are the same on all taxable income. A progressive tax rate increases as the taxable income increases.

Then answer me this: how do you quantitatively determine what is a fair tax rate on a national level?

If you want to talk about making people pay a "fair" tax rate, then you need to define the criteria that would constitute a "fair" rate. And I'm not talking about extreme comparisons of one person making $25k and the other $250k. I'm talking about criteria that defines how you know if it's fair at any point in between.

On the most basic level, I would say that a fair tax rate has several properties: it treats everyone the same, it is no higher than is needed to supply the necessary revenue, and the taxpayer keeps more than he pays (i.e. total tax rate below 50%).

How about you? How do you define a "fair" rate?

Kimball Kinnison

 

KK

It's an interesting article, and it shows some very real issues with our tax code.

Ultimately, the goal should be to simplify the code as much as possible, so that issues like these can be better anticipated and avoided.

Agreed, although I disagree with a flat tax, I do think our progressive tax structure is very problematic. I also agree that SS/Medicare should be out of the general fund.

For example, calls to raise taxes on $250,000+ means that we will treat those that make $250k and $10 mil the same. Even at our current rates, 33% kicks in between $178k and $388k, and is bumped up to 35% thereafter. In other words, its as if once you make $178k, your income is treated the same as everyone else?s above that. If we are going to have a progressive tax system, that seems strange. If one lives in any of the NY, LA, DC, SF metropolitan areas (where I bet a large number of those making $178k+ do indeed live), earning a solid but modest six-figure salary doesn?t make you ?rich? due to the cost of living. And especially in Cali and NYC, local taxes are very high.

I also strongly agree with the article that all income should be treated the same. I don?t see how someone who earns $350k in wages should pay more in tax than someone who earns $350k in capital gains.

So I would like to see a progressive tax structure something like:

0 - $50k at 10%
$50 - 100k at 15%
$100 - 200k at 20%
$200 - 300k at 25%
$300 - 500k at 30%
$500k - $1m at 32.5%
$1m -$5m at 35%
$5m - $10m at 37.5%
$10m + at 39%

I agree with deductions for medical expenses*, housing and particularly education, an issue you and have agreed on IIRC since I joined these forums. I think a deduction for private school expenses is acceptable.

*I prefer an overhaul of our health care system to the Bennett-Wyden plan, but that?s a seperate issue.

 

I actually find KK's "proposal" to be worthy of consideration, as it is "simple" with progressive effects. (For the record, I'm socially liberal, fiscally conservative.)

Has such a proposal ever been broached, let alone debated, amongst politicians?

I'd like to hear more "pro" and "con" or suggestions on how revisions might improve it.

 

Do you consider that to be a "fair" tax rate? If so, how are you defining "fair" in a measurable manner?

That question really gets to the core of the debate over tax rates, but I've rarely seen anyone who supports a progressive tax rate even try to answer it. (And I've yet to find anyone who could provide an answer more concrete than "rich people should pay more". That doesn't actually answer the question, though. The question is how do you determine what a "fair" rate is.)

Kimball Kinnison

 

KK, "fair" is in the eye of the beholder.

Fair is like statistics, it can mean anything.

Tax everyone a flat % - that's fair because it's all the same for everyone,while it's unfair because it affects everyone differently.

Set up a progressive tax and the tax rates are unequal.

So I'm not sure there really is an answer, except our own definition.

(I haven't defined mine because I'm not even sure what is "more" fair.)

 

The NYT today features one of the most depressing articles I've read in a while.

Education Gap Grows Between Rich and Poor, Studies Say

?We have moved from a society in the 1950s and 1960s, in which race was more consequential than family income, to one today in which family income appears more determinative of educational success than race,? said Sean F. Reardon, a Stanford University sociologist. Professor Reardon is the author of a study that found that the gap in standardized test scores between affluent and low-income students had grown by about 40 percent since the 1960s, and is now double the testing gap between blacks and whites.

This seems fairly clear. Increasingly regressive tax policies over the last 30 years have dramatically increased income inequality in the U.S.

Income inequality has dramatically increased educational inequality.

Which will probably affect American global economic competitiveness and undermine income equality even more.

Every single Republican candidate supports more tax cuts for the wealthy. Not only is the vicious income inequality circle self-reinforcing, but Romney, Gingritch and Santorum all want to add more fuel to the fire.

A flat tax will be an absolute nightmare for America as will any additional tax cuts for the rich. If Romney is elected and is able to push through the tax proposals in his campaign platform, it will be a social and economic catastrophe above and beyond the income/educational inequality tragedy we're already facing.

 

KK

I had an answer typed out, and I lost it. I do agree with what VS said, but I think my proposal is fair. Even then, I'd certainly be open to negotiation on the exact numbers.

I do know what you are getting at though, with the use of the term 'fair'. I don't like the use of the term 'fair' when politicians say 'the rich should pay their fair share', since it is a somewhat arbitrary term, and the rich do pay a majority of the income taxes. Even though a major reason of this is because more and more of the income is being concentrated at the top, it still seems like a bad use of the term 'fair', just as when some keep insisting on saying the rich pay the majority of taxes without clarifying that it is income taxes, that everyone pays an assortment of taxes. Point being obviously that the way the political class discusses taxes is beyond stupid.

Anyway, IMO our economy is more complicated than everyone earns whatever they can get. It's true to a large extent and a progressive tax structure still certainly allows people to get very wealthy, but I think it also is a way of preventing power from being concentrated in too few hands or because they work in a particular industry, without creating an equality of outcomes.

What do you think of taxing capital gains income and wage income? Do you think they should be taxed at the same rate?

Jabba

I saw that. I wonder though if the study goes into the make-up and progress of middle and lower income schools. Based on my experience growing up, most public schools were solid. Now, here in SoCal at least, unless you live in the wealthiest areas, the public schools are absolutely terrible.

 

My big issue with people calling a progressive tax structure "fair" is mostly because by any measure, on average the rich pay more in income taxes than anyone else. It doesn't matter if it is the tax rate, the total number of dollars, the total percentage of income, or the total percentage of the overall tax burden (especially when compared to the percentage of the total income). By any reasonable measure, the tax system is designed to make the rich pay more in a larger proportion than anyone else. That simply doesn't match any definition of "fair" that I can find.

In fact, the claim that the rich don't pay their "fair" share in taxes is an emotional one meant to play on envy and mistrust. It is designed to make people think that the rich got that way by cheating others, and so they don't actually deserve their wealth. This becomes even more clear when people can't define what they mean by "fair" other than "I think they should pay more".

However, my biggest problem with progressive taxation comes from two parts of the Constitution: the Equal Protection clause and the Bill of Attainder clause. The basic principle of these two clauses suggests that the government shouldn't be able to single a person or group of people out for special treatment under the law (either good or bad). For example, a law that confiscated all personal wealth over $20 billion would only affect 11 people in the US (barely missing Michael Bloomberg, who is #12 on the list with only $19.5 billion). While on the surface that law would apply to everyone in the country, functionally it is the same as a bill of attainder against those 11 people.

I don't think that principle changes much if you are talking about raising taxes on only the top 1% (who made over $343927 in 2009). You are still singling out a small portion of the population for special treatment.

I would say that it depends on what the goal of capital gains taxes is. Is your primary goal to encourage investment, or to raise revenues?

For example, consider treasury bonds. They are exempt from capital gains taxes in order to encourage people to invest in the public debt. By the same reasoning, a low capital gains tax on other investments would similarly encourage people to invest more money in businesses or other enterprises. That would be a good thing, right (especially if those businesses would be taxed as they grow)?

On the other hand, if your primary goal is to raise revenues, it would then make sense for all capital gains to be taxes as if they were wage income. However (again considering treasury bonds), what effect would that have on investment? (For treasury bonds, it would reduce the overall ROI and therefore discourage investment. For private investment, it would encourage people to focus investment in riskier ventures to gain the higher rate of return.) If overall investment goes down, then the overall tax base for a capital gains tax will decrease, and you will see a drop in revenues.

I think that the answer lies in a balance between the two positions. You want to encourage investment, but you also

 

KK

I understand your points. But it's hard to reconcile your statements regarding fairness with your statements regarding taxing capital gains/investments.

Your first is all about fairness. Your second on is about economic theory, that taxing certain forms of income differently would result in a better revenues for the government.

Speaking purely about fairness, how is it NOT fair to tax the wealthiest more to increase revenues to pay down the debt, but it IS fair to tax wage income more than investment income because that may in theory be better for revenues? Is it ok to tax sources of income differently so long as it is better for revenues and economic investment? Because if that's the case, we're not talking about pure fairness, more about economic theory.

But, I also think that it's unfair to compare tax rates between income and capital gains, because the two taxes serve different purposes. Warren Buffett might pay a lower tax rate than his secretary, but that's because they are paying different taxes! Buffett's rate is lower because he is following the government's encouragement to invest in the economy

Buffett and his secretary are paying ?different taxes? only because that is the system we have set up. Again, setting theory aside, why is it fair to tax someone who earns $500,000 in wages (i.e. a doctor) more than someone who earns $500,000 through a capital gain? I think even Buffett himself agrees with this.

Or lets take for example...me. I earn a wage, and I recently sold some stock. I pay a higher tax on my wages. It's not like if I received, for example $2000 in wages and $2000 in capital gains, I'm going to say "I think I'll invest the $2000 in capital gains only". I'm not more 'encouraged' to invest only the income I receive from an investment. Income is income.

So not only do I disagree with that economic theory, I don't understand why it is unfair to have a progressive tax system that taxes income at a higher rate the more you earn, but it is fine to tax income at a higher rate depending on where that income comes from.

 

Bravo - but the question is HOW do we do so, when "helping" some is seen as "unfairly helping some at the expense of others" (sometimes called "reverse discrimination" when it comes to "race")?

Any time we offer a hand, we are not offering it to others and that always gets folks in an uproar with no consensus and no forward movement.

 

"Worthy of consideration", perhaps. But these flat tax numbers are, ahem, always a disaster budget-wise. Steve Forbes' old 15% tax would have the top 1% paying 20 points less than they paid at the time.

They look elegant on paper, but so does communism.

 

A quick note differing tax rates for capital gains. Another, fairly important argument in favor of the rates being lower is the treatment of wages v. dividends* at the corporate level. Wages are deducted before corporate taxes and then taxed at the individual level; dividends are paid after corporate taxes so dividends are taxed twice. Taxing corporate gains at a lower rate helps correct that imbalance. This structure also has a flaw in that interest payments on debt are deducted before taxes as well, leading to companies taking on relatively more debt than they should, relative to an undistorted marketplace. I believe the flaws in that overleveraged system have been made obvious in recent years.



*obviously a lot of capital gains is from appreciated stock prices, not dividends, but that implicitly factors in future dividend payments; the share is a claim on future earnings.

 

I had written the following yesterday, but I didn't hit "Post":

Except there are clear differences between capital gains and wage income. Just because both increase the amount of money you have doesn't mean that they are the same thing.

For example, wage income is more-or-less a guaranteed thing for someone who is employed (depending on how much they work). Capital gains, on the other hand, involve taking risks, and can easily result in losing money as well, and last I checked the government doesn't give you a tax credit for money you lose in the housing or stock markets. (In fact, they only let you deduct up to $3000 in capital losses each year.) Why should the government reap the reward of people's risks, but not bear the burden of those same risks?

Also, by your reasoning, why should a person's primary residence be exempt from capital gains taxes? Or Treasury bonds? (Both are currently exempt from capital gains taxes.) You could make an argument that since Treasury bonds are paid out by the government, it makes no sense to have the bondholder then turn around and give the money back to the government, but that doesn't really hold up. (If that were the case, then why should people pay income tax on military or government jobs? They are getting money from the government just to give some of it right back.)

If you don't think it is unfair to have a progressive tax system, then answer my question about how you quantify the term "fair". Taxes are a completely quantifiable subject, and if you can't quantify what is a "fair" tax, then how can you actually say whether or not something is or is not unfair?

You don't have to give specific values, but at least a model for how a progressive tax structure is fair. (For example, the basic equation of a line is Y = MX + B, with Y and X as the variables and M and B as constants. We might disagree on the values of M and B, but it still describes the relationship.)

Until you can define what you mean by "fair", you have no basis to claim that any tax structure is either fair or unfair.

Now for the new part:

No, I didn't ask you what you considered to be a fair tax rate. I asked you to define "fair" in the context of a tax rate. There is a big differ

 

KK

For example, wage income is more-or-less a guaranteed thing for someone who is employed (depending on how much they work).

Except wage income isn?t guaranteed because employment often isn?t guaranteed. A lot of careers are uncertain. If someone writes a book, maybe it will sell maybe it won?t, but the writer can?t deduct the royalties. If someone takes a job with a startup, that is a risk as well. Even if someone signs a contract guaranteeing a salary they risk losing out on a better offer during the duration of that contract.

Why should the government reap the reward of people's risks, but not bear the burden of those same risks?

Why should the government ?reap the reward? of people?s labor?

If you don't think it is unfair to have a progressive tax system, then answer my question about how you quantify the term "fair". Taxes are a completely quantifiable subject, and if you can't quantify what is a "fair" tax, then how can you actually say whether or not something is or is not unfair?

You don't have to give specific values, but at least a model for how a progressive tax structure is fair. (For example, the basic equation of a line is Y = MX + B, with Y and X as the variables and M and B as constants. We might disagree on the values of M and B, but it still describes the relationship.)

Are you trying to assign me homework? Don?t venture into patronizing-answer-on-my-terms KK.

But seriously, I don?t think my answer is the be-all, end-all of what is fair, mainly because pure fairness is impossible, which I alluded to earlier when I said I dislike the use of the term ?fair? as Obama and the Democrats use it. Should an exec at AIG receive the same tax treatment as say, Steve Jobs, even though AIG guy has taxpayers to thank whereas Steve Jobs is a true ?job creator? and innovator. Howabout many industries that receive government subsidies (i.e. energy, military, Michelle Bachmann) as opposed to the ones that do not? Shouldn?t someone who is wealthier and thus has more assets to protect pay more to protect those assets from foreign and domestic enemies (i.e. to fund police, courts, military spending)? Guy who works minimum wage job has a lot less to lose than the President of Bank of America. I also think it may not be ?fair? that certain professions earn more than others. The Navy SEALS that caught Bin Laden IMO are far more valuable than Joe-the-hedge-fund-manager who manages money his Dad?s friends gave him. But such is life. Likewise, I look at a progressive tax system as not necessarily ?fair?, more like the quote ?capitalism is the worst system, except for all of the others?. IMO we should try to make it as fair as possible, but since there are so many other variables, 'fair' shouldn't be the only consideration nor should it only apply to wage income.

Except there are clear differences between capital gains and wage income. Just because both increase the amount of money you have doesn't mean that they are the same thing.

In the end, they are the same thing to me. As I stated earlier, lots of things involve taking risk not just investing in the stock market. So at the end of the year, I have income from wages I earn at a job I could be fired for at any moment (merger, buyout, company folds for whatever reason, force majeure, etc.), and I receive income on the gains of investment. I don?t see why I should pay higher taxes on one income than the other.

Until you can define what you mean by "fair", you have no basis to claim that any tax structure is either fair or unfair.

Neither can you, nor am I claiming with 100% certainty that one is fair and another isn't. You talk on one hand about the goal of creating revenues and taxing capital at a different rate than labor, and the other on a strict definition of fairness. But in the end, you are the one who brought up and keeps talking about fairness, not me.

As President Lincoln said:

?Labor is prior to, and independent of, capital. Capital is only the fruit of labor, and

 

The difference is that wage income, once earned, is yours while you are employed. In that context, it is guaranteed. You may not be guaranteed employment, but you are guaranteed wages for the work performed. (Personally, I don't consider royalties to be the same as wages. They are actually closer to capital gains because they are a return on investment.) I've been in the position of working for a small business, and had to file complaints against them to finally get the paychecks that they owed me, but they still had the legal obligation to pay me what was owed.

Capital gains, on the other hand, are not guaranteed. With any investment, you run the risk of losing your initial investment from day to day. An investment worth $1000 today can be worth $500 tomorrow, or $1500. That doesn't happen with wages. It is a much higher form or risk, and very different in nature.

You know, I've never really understood this sort of argument, because it's really a straw man argument.

No one is saying that a person who makes $100 million should pay less than someone who makes $10000. However, if you are talking about who has more to lose, or more to protect, then a flat tax answers that better than a progressive tax. After all, if it costs roughly $0.10 per dollar to provide military protection, then the person making $100 million is paying 10% for that protection just like the person who is only making $10000. If everyone pays at the same rate, then the person who needs more protection because he makes more money is paying more for that protection. It doesn't logically follow that the person making $100 million needs to pay 15% while the person making $10000 only needs to pay 5% for the same protection.

Both sides in this discussion (every time it happens) throw around the word "fair", but what we should really look at is the terminology used in the Constitution: equal. Under the 14th Amendment, everyone is guaranteed equal protection of the law. At the same time, the Bill of Attainder clause essentially prohibits laws that single out individuals or groups of individuals for punishment or discriminatory treatment.

My core problem with progressive tax rates, especi

 

Bill Gates gets far more value out of his participation in U.S. infrastructure and its ability to create a nurturing business environment than someone at the bottom. His return on investment is huge. He makes greater use of the Federal highways, of communications regulations and aviation regulations and securities infrastructure. He benefits from the social stability provided by food stamps and other welfare programs to earn an immense killing. Your "similarity to bill of attainder" argument doesn't make it a bill of attainder. I'm not suggesting a special income tax rate of 90% for all people with net worths of $1 billion or higher, but a progressive tax structure reflects the relative benefits of American life that get returned to our richest citizens. A strong middle class if nothing else is a vast customer base for an endless array of products and services. And regressive taxation (a flat tax) will kill it off once and for all.

Meanwhile, regressive tax policies continue to undermine income equality in the U.S. and destroy the underyling social fabric of our country. As social stability unravels, the richest Americans will begin to miss the middle class that they successfully eradicated.