Here’s what happened. I decided to propose my own individual income tax plan with the intention of closing two-thirds of the federal deficit. Later, I would propose changes to the business income tax system designed to close the other third of the gap. I put a lot of thought and effort into the individual tax plan and while double-checking one fact, I discovered that I had started with an errant assumption.
If you’ve been reading this blog for a while, you’ll know that I have spent a fair amount of time on the federal tax system and presidential candidates’ proposed changes to it. In those earlier posts, I used the before-tax and after-tax income for each quintile (20%) of tax filers from 2014. For example, the top 20% earners in 2014 had an average total income of $306,320 before taxes and $229,360 after federal taxes.
While cross referencing sources for my proposals, I discovered a discrepancy so I went back to look at the original data. I missed two important points in that original source from the Bookings Institute:
1. The before tax income includes employer provided benefits such as health insurance and retirement plan contributions, and
2. The after tax income counts each quintile’s share of corporate taxes in addition to individual income taxes and the employee portion of payroll taxes.
Why Does This Matter?
1. Employer provided benefits can be substantial for higher earning individuals, and very low for low income individuals. For example, the maximum contribution to an employee’s 401(k) retirement savings plan in 2016 (employer + employee contributions) is $53,000 ($59,000 for 50 years old and over). In a partnership, the $18,000 employee contribution simply comes out of the employee’s quarterly or annual bonuses. The $6,000 “catch-up” contribution for age 50 and over is taken out of the employee’s wages or bonuses, if the employee chooses to do so. The entire $53,000 to $59,000 annual contribution per employee is exempt from federal income and business taxes.
Similarly, low income earners are generally not offered an employer-sponsored health plan, while middle income earners may be offered a plan with limited benefits. Of course, this depends on the employer. For small business owners, doctors and lawyers, the health plans are often very generous and may cost the employer $25,000 or more per year for a married employee with dependents. This amount is also not subject to federal tax.
2. My two-thirds from individual & one-third from business plan won’t work if the business taxes are already included in the individual numbers. Some additional business tax income could be generated from a reworked tax code, but the majority of the increased taxes would likely come from individual taxpayers. Of course, if the economy were to strengthen, there would be more taxpayers to share the burden.
A Review of the Problems
1. The federal government does not collect enough money to support its spending (many think of it as the other way around – the federal government spends too much money and outlays should be restricted to the amount of income);
2. The income tax code is overly complex which means:
a. ordinary taxpayers waste money hiring professionals to prepare their returns, &
b. many wealthy people take advantage of targeted tax breaks to pay lower tax rates than most taxpayers;
3. the IRS is universally disliked, but necessary in the current complicated tax system.
Where the Revenue Comes From Now (okay, in fiscal year 2014)
1. 63.1% ($1.907 trillion) from individual tax payers (46.2% income tax & 16.9% employee portion of Social Security & Medicare taxes);
2. 27.6% ($833 billion) from businesses (10.6% from business income tax & 17.0% from employer portion of Social Security & Medicare, plus unemployment insurance taxes);
3. 3.1% ($93 billion) from excise taxes
4. 0.6% ($19 billion) from estate & gift taxes;
5. 1.1% ($34 billion) from customs duties;
6. 4.5% ($135 billion) in miscellaneous receipts.
2014 Federal Budget Deficit = $513 billion
To close the federal budget deficit, income needs to increase by 17.0% if spending is to remain the same. That is a very difficult task.
My Previously Findings
1. Tax increases and decreases for the top 10% earners has statistically no effect on job creation or loss in the following two year period;
2. In the two years following a change, tax increases and decreases for the bottom 90% earners generates about 5% job growth or loss for a tax change of 1% of state GDP;
3. Similarly, a 1% of state GDP change in tax burden for the bottom 50% earners generates about 9% job growth or loss.
Put more simply, tax changes for top earners have little or no affect on job creation or loss, while tax changes on the less financially successful have a large affect on jobs. High income Americans save much more of their money than low income Americans, and savings do not generate economic activity until the money is spent at a later date.
4. When I managed a tax preparation office four years ago, there were two low-income, high refund cases which stuck in my mind. In one, the recipient of a $7,000 refund paid about $650 in tax preparation and refund loan fees in order to get the money right away. She wanted it before she left on a Caribbean cruise. In the other case, one of the franchise owners’ tenants used the entire federal tax refund to pre-pay her rent for the upcoming year. She did that every year. These high refunds consisted almost entirely of refundable tax credits designed to encourage employment of single parents.
How Do Those Findings Apply?
1. Income taxes generated from top 10% earners should form the solid base of federal revenue;
2. Consequently, the tax rates for the top 10% should be fixed at an optimal level. While this group will likely pay higher income tax than they do now, high income earners can count on stability from one year to the next;
3. Tax increases and decreases for the bottom 90% should be used to regulate the economy – slight increase to slow things down a little & slight decrease to stimulate growth, when needed;
4. While savings for the top 10% do not stimulate the economy for perhaps generations, there is an advantage for promoting savings among the bottom 50%. Those people may increase federal government spending on Medicaid and other social welfare programs if they have not saved enough money to make it through unexpected situations, or for retirement.
What Can Be Done? – My Ideas, Plus One From Jeb Bush
1. Pass legislation which authorizes a small percent increase in the employee portion of payroll taxes for a short period of time in response to an interest rate increase from the Federal Reserve (This keeps the Fed independent, but before they agree to slow down the economy with an interest rate hike, they will consider the added data that come from the corresponding tax rate increase.);
2. Design this tax increase/decrease so it only applies to the bottom 90% so it will stimulate or curtail the economy as desired;
3. Designate all funds collected from idea #1 exclusively toward reducing the federal debt;
4. This economically stimulating/curtailing tax change does not burden businesses other than with a slightly increased or decreased Social Security and Medicare withholding rate which will be easy to administer. This provides stability to businesses and top 10% earners;
5. From Jeb Bush’s campaign website: Only capital that is used to start or run a business is eligible for the lower capital gains tax rate – capital gains from buying or selling stock is taxed as regular income.
These ideas are just that – ideas. I believe they can go a long way to closing the federal budget deficit, but it’s not a complete plan.
I like Jeb Bush’s idea about increasing the capital gains rate for stock market investment income. That money is not stimulating the economy. Some of my stock holdings go back to purchases I made in the 1990’s. I have multi-thousand percent gains on those stocks, and when I do eventually sell, I will pay a substantially reduced capital gains tax rate. Because I have held them so long, I also pay that reduced rate on the dividends I receive from the companies. This portion of the tax code only benefits the well-off and harms the country by acting as a deterrent to economic growth.
A change in that law, as Jeb Bush proposed, who likely mean that the top 10% earners would have a larger impact on economic growth and job creation.
Not to toot my own horn, but I also really like my idea for a law that uses slight increases or decreases in employee paid payroll taxes to regulate the economy. It provides stability to businesses of all sizes and to the top 10% earners, while also moderating interest rates and reducing the national debt.
Who Would Oppose These Suggestions?
1. The wealthy would balk at the tax rate increase on capital gains and qualified dividends (something similar has been proposed before – look up the Buffet Rule);
2. Retirees who rely on investment income for retirement expenses would balk at the lower interest rates that would naturally result from my payroll tax law idea.
We Have a Problem and an Opportunity
1. Since a tax increase on lower income individuals has a significant negative impact on the economy, we don’t want to take that action. The problem is that the bottom quintile has a negative federal tax rate – the receive more from the federal government in refundable tax credits than they pay in income and payroll tax. The republican presidential candidates’ tax plans all have a tax increase for the bottom quintile and likely for the second quintile. They would not have to pay any income tax under the proposed plans, but that is a substantial tax increase (remember the person who prepaid her rent for the year from her refund?).
2. The opportunity is, believe it or not, Donald Trump. He is very likely to be the republican nominee for president, much to the surprise of the political establishment and most political insiders. But, Mr. Trump promises to get things done because he’s a man who gets things done. While this sounds hollow to many who want details, this may actually be a self-fulfilling prophesy.
His supporters appear to swallow these prognostications hook, line & sinker, as the saying goes. But what if Mr. Trump can mobilize this force? What if he can get his supporters to shake up the establishment, to threaten their elected officials to do what Trump proposes or get recalled or voted out? Things could actually get done with such an insistent group of foot soldiers In Trump’s Army.
So all we have to do is sell these tax proposals to Donald Trump. Do you think he’ll go for it? If so, he could be the president who solved the country’s financial problems. Then, there would be few who would question his ability to get things done.