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On Class Warfare and Taxes: Part 2

In part 1, which you should read first, we discussed how the US has crossed a milestone where fewer than 50% of the taxpayers in this country pay about 100% of the personal income taxes. We also discussed how the recent tax cuts actually shifted personal income tax burden more onto the rich, rather than less.

However, John Kerry has cited the same CBO Report I used to make the points in the previous post to say just the opposite - i.e. that the recent tax cuts actually shifted the tax burden away from the rich to the middle class. Assuming he is reading the study correctly (which he is) how can this be?

The answer is in the difference between Federal income taxes and total federal taxes. The tables I used in part 1 were for income taxes only. It strikes me as reasonable to use income tax numbers for analyzing income tax changes. The total tax numbers Kerry uses includes not only income taxes but social security and Medicare taxes (including the employer contribution), federal excise taxes (such as the gasoline tax) and the corporate income tax. Lets look at who bears the brunt of these taxes.

1. Social security taxes are regressive. Very regressive. While your paycheck may show 6.2% FICA, the bill is really 12.4% because your employer matches this payment with funds they probably would otherwise pay you in wages. What makes this tax regressive is that it is a straight 12.4% of every dollar up to a limit, currently $87,900, after which the tax is zero. This kind of profile would never be tolerated in the income tax system. The reason for this is the carryover of the original idea that social security is not a tax and social benefit program but an insurance and retirement plan, a characterization that is becoming increasingly out of whack from reality. (If it was a private retirement plan, the managers would all be in jail right now for the terrible long term returns it pays out).

2. Gas and excise taxes are generally considered regressive as well, since gasoline is probably a much higher percentage of lower and middle class spending than for the rich (those rich who own Hummer H2's notwithstanding).

3. Its harder to pinpoint who pays corporate income taxes. The CBO report allocates corporate income taxes in proportion to dividends reported on income tax statements, which seems reasonable. Fifty years ago, one would have said that this meant the rich pay it, since we pictured the rich as owning all the stock. Today, in our mutual fund world, a lot is probably born by the middle class, particularly middle class retirees.

As a result, the sum of these non-income taxes are probably net regressive - i.e. they disproportionately hit the lower and middle classes. This means that an income neutral income tax cut, i.e. one that does not shift the tax burden but lowers it proportionately for everyone, will still shift the total tax burden to the middle class, because it reduces the amount paid in the progressive system (e.g. income taxes) in proportion to the amount paid in the regressive system (e.g. social security).

This leads me to a couple of thoughts. First, I think while he is quoting correct stats, Kerry is using the data a bit disingenuously. First, it implies to people that the middle class is paying more so the rich can pay less, which is untrue - everyone is paying less. Second, he is trying to use the data to show that personal income tax burden is shifting to the middle class, which we showed in post 1 that it is not - it is actually going the other way. Third, he uses it to justify a tax increase (or a tax cut rollback) on the richest Americans. We showed that already the Bush tax cuts shifted more of an already ridiculously high burden to the rich. This will shift even more.

However, there is a point here if Kerry wanted to latch on to it. Forget the class rhetoric about the income tax system - focus instead on social security. There are two good reasons for this: 1) Social Security is broken, and the financial reckoning is coming 2) unlike the income tax system, social security is truly indefensibly regressive. Yes, you can dig through Kerry's web site and find something on this, but he is for some reason so drawn to the income tax issue he never really hits it hard.

If John Kerry really wants to take up a populist tax banner, leave income taxes as they are (for all the fiscal deficit crisis talk, an economic recovery plus fewer new military invasions will bring the deficit back in line without tax increases). He should instead propose a reduction in the 12.4% FICA tax rate and then an elimination of the $87,900 wage cap. To make this palatable to Congressional Republicans (and me, if I were voting) it should be tied to a package of other reforms such as allowing some investment choice by individuals.

Of course, this is not going to happen. Politicians have used Social Security scare tactics with retired and older people so often that these folks have come to react negatively to any hint of change to Social Security. Reasonable discussion about the future of Social Security is just not possible in the last five weeks of an election, particularly with Florida in play.

Posted on October 8, 2004 at 08:53 AM | Permalink


It would also help if rich attorneys like John Edwards are prevented from avoiding social security and medicare taxes by the abusive and illegal use of Subchapter S corporations

Posted by: jeff | Oct 10, 2004 7:38:24 PM

Actually, consumers primarily pay the corporate income tax through higher prices. Its just a form of indirect taxation. Investors seek out rates of return, generally calculated after corporate tax - I am sure a few shareholders get stuck with the bill, but mostly consumers do.

Also, if you are looking to blend SS taxes, you'd have to net out the SS checks, and medicare benefits (much like the EITC) to get the true net tax burden/wealth reallocation. I have not seen this.

Finally, the Edwards S corp structure only sheltered medicare taxes (not SS taxes), as the salary he paid himself was in exess of the OASDI cap, and at the time it was legal.

Posted by: DH | Oct 12, 2004 3:06:03 PM

John Kerry speaks of tax cuts for the wealthy when really what is taxed is income. The only taxes on wealth are those under the Gift and Estate tax laws. These taxes can and are deferred almost indefinately by use of trusts, etc. That's how a billionaire couple like the Kerrys can get by with a low tax rate and little contribution to the Social Security system.

If you really want to raise taxes on the wealthy then you need to look at individual net worth in addition to income. That would definately shift the tax burden more towards the wealthy.

Next is the use of S corporations, LLCs, and partnerships in avoiding the Social Security taxes should the current income cap on those taxes be eliminated. It is a simple matter to reduce wage income through these entities to minimized exposure to the FICA and Medicare tax. If the wage cap was eliminated, I would expect to see a large reduction in wages paid through these entities and a large increase in non-wage income. Couldn't the IRS catch the abusers and reclassify the income? They could with a massive budget increase and improved efficiency but who expects that in the next 20 years?

The bottom line is that the Kerry campaign is trying to spin the numbers without a valid plan for the future of the tax system or Social Security.

Posted by: Mike Bahnmiller | Oct 13, 2004 7:47:39 AM

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