Who Does Trump’s Tax Plan Benefit?


Who does the Republican tax proposal aim to benefit ?  Let’s examine its intentions, then look at an approach that extends some of its features and is progressive.

Clear intent:  Give more to the heirs of the very wealthy, e.g., President Trump.  The estate tax is eliminated entirely in six years, which greatly benefits the wealthiest 0.2% of the population.

Clear intent:  Continue to take less from wealthy hedge fund managers and private equity executives who will continue to be taxed at capital gains rates that are about half the ordinary income tax rate on profits they pay themselves via the carried interest loophole.

Clear intent:  Give more to the owners of partnerships, S corporations, and sole proprietorships, which are overwhelmingly owned by rich individuals like President Trump.  Income from them that is returned to the companies’ owners is now taxed at the same rates as wages and salaries but it would be taxed at a new 25% rate.   The Tax Policy Center (TPC) finds that the top 1% would receive 88% of the benefit with the 400 households with the highest incomes getting an average annual tax cut of $3.7 million.

Clear intent:  Give all those with high incomes more by eliminating the alternative minimum tax and raising the threshold for the 39.6% top rate on income (which was 70% in 1980) to $1 million for couples, up from $470,700 today.

Clear expectation with unclear intent:  Add at least $1.5 trillion to the federal debt over a decade (many economists think it will be more) by cutting the corporate tax rate from 35% to 20% without raising other taxes.  The cost of this debt will grow as interest rates rise so the intent could be to “starve the federal government of revenues, setting the stage for a frontal attack on core social programs such as Social Security and Medicare.”

Unclear intent:  The corporate tax rate is cut from 35% to 20%, which will save US corporations $2 trillion over the next ten years.  The great majority of economists believe shareholders would be the primary beneficiaries but Republicans say employee salaries would rise.

Treasury Secretary Mnuchin claims: “many, many economic studies show that more than 70% of the burden of corporate taxes are passed on to the workers.”  Congress’s non-partisan scorekeepers — the Congressional Budget Office and Joint Committee on Taxation — as well as Treasury’s Office of Tax Analysis have all assessed the empirical research as showing that only about a quarter or less of corporate taxes fall on workers, meaning that they would receive a quarter or less of the benefit of corporate tax cuts.

The Tax Policy Center estimates that over a third of the benefit would go to the top 1% and 70% to the top fifth.  By 2027, low- and moderate-income families with children would receive little or no tax cuts, and many would see tax increases while 80% of benefits would go to the top 1% of households and after-tax incomes of the bottom 80% would rise by less than half of one percent.

Unclear expectation:  The effect on middle and lower income families.  The plan roughly doubles the standard tax deduction but it repeals or reduces current tax deductions that chiefly benefit workers and middle-class people, including mortgage interest, state and local taxes, student loans, medical expenses, moving costs, and tax credits for retired and disabled people.

  • The standard deduction will be raised to $24,000 for couples and $12,000 for individuals but the $4,050 personal exemption  is eliminated
  • The mortgage interest deduction is unchanged for current homeowners, but is capped at $500,000, down from $1 million, for all future mortgages.
  • The deduction for state and local income/sales taxes would be eliminated.
  • The deduction for state and local property taxes would be capped at $10,000.

The Tax Policy Center (TPC) analyzed the change in after-tax income for the poor, middle class and rich and found the middle class would get a 1.2% boost to their after-tax income and the bottom 40% would get almost no benefit.  Their taxes would actually increase $10 to $20, on average, by 2027.

The Center for Budget and Policy Priorities assessed the intent of the plan in its original form when the top tax rate would have been 35%.  They estimated the overall results of that plan would be:

  • The top 1 percent, who make above $733,000 annually, would see average tax cuts of $90,000 in 2018, increasing their after-tax incomes by 5.9%.  They would receive about 45 percent of the total net tax cut.
  • The top one-tenth of 1 percent, who make over $3.4 million, would receive average tax cuts of $507,000 in 2018, raising their after-tax incomes by 7.2%.
  • This average increase in after-tax income for those in the middle fifth of the income spectrum would be 1.2%.
  • The bottom fifth would gain less than 0.5%.
  • People with annual incomes over $1 million would receive average tax cuts of $138,000 in 2018, compared to average tax cuts of $270 for households making below $75,000. Millionaires’ after-tax incomes would rise 6.4 percent in 2018, compared to a 0.9 percent increase for those making less than $75,000.

The Joint Committee on Taxation estimated the results of every detail of the plan but we do not need more detail to confirm that its purpose is to benefit the wealthy.

So let’s move on.  Is there a way to build on some of the Republican ideas to start reversing our society’s dangerously high inequality?

We use tax revenue to pay for services we want from our government.  The “we” who want those services is, to coin a phrase, “we the people” not also “we the legal entities such as corporations” so it would be more straightforward to tax the income and wealth only of people.

We could then focus just on the relative contribution each economic subset of people should contribute to the cost of government services that benefit us all.  We would still have vigorous disputes about relative contributions but we could better understand each others belief about what is fair.

Making that change might also encourage us to pay more attention to how much our government spends on each of its services.

We know what Social Security and Medicare cost us because we pay for those with dedicated taxes.  But most of us do not know that what we spend on our military activities dwarfs every other discretionary service and includes having our troops in 53 out of the 54 nations in Africa.

A better program might look like this:

  • Entirely eliminate taxes on businesses and tax only the income their owners derive from them.  Replace the lost revenue by:
  • Making income tax rates steeply more progressive, perhaps returning to the 1980 70% rate
  • Entirely eliminating preferred subcategories of income such as capital gains, pass-through and carried interest.  We would tax all income above, say, $12,000 per person, from all sources at the same rates.
  • Making the estate tax very steeply progressive on amounts above, say, $5 million (which my grandfather’s generation did to end the stranglehold of Britain’s aristocracy).

Some other things we could consider:  If we wanted to accelerate cutting the influence of our financial oligarchy we could also establish a wealth tax, similar to property tax but applied to all wealth.

We could also build on the Republican idea of cutting tax deductions that benefit some people over others. and entirely eliminate tax preferences, including mortgage interest, state and local taxes, student loans, medical expenses, moving costs, and tax credits for retired and disabled people.

We could raise the minimum wage if we believe the Republican theory that eliminating the tax on businesses would cause wages to rise.  We might raise them to the level where a head of household could support their family as they did before America needed to be made great again.

We could also explore new taxes such as this one and use those revenues to fund maintenance of the transportation and other infrastructure that we all depend on.

Summing up:  The Republican tax proposal contains some good ideas but the way they are structured would greatly benefit the very wealthy and do little or nothing for everyone else.  It would also greatly expand our debt whose cost will be born by us and future generations.

The promises made to sell the plan are spurious.  It can not be supported by anyone who understands it and is not wealthy and selfish.

But we do need a better tax system.  What do you think of the progressive approach above?  Don’t worry if it seems impossible.  If we are clear on what we want, we can figure out how to get there.

We the Easily Bamboozled – Tax Reform


We do need to change how we fund our government’s activities and how our economy distributes the wealth it creates.  But the tax plan now being revealed is not what we need.

Our President and Republican leaders keep telling us it is urgently necessary to lower corporate tax rates so companies can stay competitive.  It has become the party line.  As my Republican Senator Toomey’s website says:

“Our country’s current corporate tax rate of 35 percent is one of the highest in the developed world, far higher than the average 25 percent rate of our economic competitors. Without a significant reduction in business tax rates, the U.S. will never be the best place to invest and create jobs … The best economic stimulus for the middle class, who have seen their wages stagnate and tax bills rise over the last decade, is a well-paying job. Tax reform will help deliver on this goal with its focus on lower rates, investment, and growth.”

Really?  The 20 US companies that accounted for 20% of US GDP last year, meaning all our economic activity, paid taxes totaling only 0.6% of GDP and only 3.6% of all federal taxes (Source: Forbes).

Businesses pay taxes on profits not revenues, of course, but my point is that our theoretical corporate tax rate is not making our businesses less competitive or stifling their job creation.   That is not the motive behind this tax plan.

But before we get to that, what would this budget cost?  The fiscally conservative Committee for a Responsible Federal Budget estimates $2.2 trillion in lost revenue over a decade.  The tax cuts would total $5.8 trillion.  New revenues totaling $3.6 trillion resulting from “base broadening” would allegedly reduce the net loss to $2.2 trillion.

Treasury Secretary Mnuchin told us “The plan will pay for itself with growth”.  But we have seen over and over again, most recently in a multi-year “experiment” in the state of Kansas which its governor trumpeted as a “shot of adrenaline” to the state, that a tax cut plan that will pay for itself is a fantasy.

That fantasy cannot and will not ever come to pass.

So, what motivates this plan?   Who would benefit?  The Tax Policy Center estimates that 80% of the $5.8 trillion in tax cuts would benefit the richest 1 percent.

And who would lose?  55 million Americans would lose their tax deductions on what they save in tax-deferred 401k plans and what they pay in state and local taxes.   They are our middle class.

Those who earn less would be hit harder, losing government services eliminated to pay for the tax cut, which look to include about $1.5 billion in Medicare and Medicaid.

Would anyone other than those with very high incomes benefit from this plan?  Yes — their heirs.

This is a good budget if you want your kids to live under an aristocracy of folks like President Trump whose inheritance installed him among the plutocrats who bought our political establishment.

We do not have the leaders we should want.  Their plan is very far from what we need.

Proposals for Healthcare and Tax Reform

A letter I recently sent to my Democratic Pennsylvania Senator and to Democratic Party leaders:

Dear Senator Casey:

I am growing more and more concerned about the future of our society and the Democratic Party.  We must change course.  I hope these proposals about healthcare and tax reform, top issues for you at this time, will be helpful.

Automation and artificial Intelligence are eliminating more and more jobs.  Making that worse, the profits are going only to the wealthiest of us, and many of our middle and lower income citizens are being impoverished by medical expenses.

We can eliminate that financial ruin with insurance for both the currently healthy and the sick.  Covering every American will also avert a looming Federal debt crisis because that system is much more efficient.

We can best do this is by extending Medicare.  It is an established and popular system that is far less complex and costly than other plans being proposed.

And we must finance it in a way that mitigates our fast growing disparity of wealth.  The very stability of our society is threatened if we allow that trend to continue.

Here’s how we can overcome both huge problems:

Replace Medicare’s 80/20 percent sharing of costs with a progressive Co-Pay amount based on income.  That is the only change for the already retired.

Authorize Medicare to negotiate drug prices with providers to cut costs.

Have working people: (1) continue to pay a progressive payroll tax to cover their Medicare participation when they retire, and (2) also pay a progressive payroll tax for their current medical care, with a progressive Co-Pay amount.

Note:  The tax for current medical care would be less than we pay now for private health insurance because (1) Medicare system costs are lower and (2) costs could be subsidized by other taxes described below.

Allow employers to  pay some or all of this tax to attract employees, but not require them to do so.  They would continue to pay their half of the tax for their employees’ retirement medical care.

Additional funding for this universal health care would come from tax system changes to reduce income and wealth disparity.

Specifically, tax all Personal Income including investment profits in the same way, and return marginal taxes on high incomes closer to where they were in President Eisenhower’s time, perhaps 50% for amounts between $5 million and $10 million, 60% between $10 million and $20 million, and 70% for amounts above that.  The bottom three brackets could be cut by 5% each.

Cut the top Business tax on profits to 25% to encourage re-investment in business instead of taking the money out for personal use where a much higher personal income tax would have to be paid.

Change the Estate tax so distributions are treated as ordinary income with an exclusion of up to $5 million from each person’s share of the estate.  This will reduce wealth disparity over time.

Tax Stock Transactions to reduce High Frequency Trading and increase government revenue.

Eliminate all Tax Expenditures (tax breaks/loopholes) after a five year period during which Congress could individually re-instate any believed to be beneficial with a 2/3 vote from each house.

Drastically cut government expenditures for so-called Regime Change and Nation Building.  We must stop trying to re-invent other nations in our image and destroying them in the process.

Under this Medicare-For-All plan, Medicaid would be eliminated because all citizens would have coverage regardless of their financial situation.  If they were out of work or working a low paid job, they would continue to receive coverage, but their payroll tax and co-pays, based on their income, would be low or possibly zero.

Non-citizens would have to buy their own coverage for the length of their stay, or the companies they work for would have to provide coverage, or there might be reciprocal coverage programs arranged between their country and the U.S.

Does all that sound too radical?  It’s not.  We must take a bold new approach.  Opposition to Trump and the Republicans is simply not enough.  We must win a mandate for sweeping positive change.

We must tell voters what big changes we will make so no American is bankrupted by medical costs.  We must show voters how we will reverse the flow of riches only to the very few.

I hope these ideas can begin to reinvigorate the Democratic Party to be not just a focus for unspecified hope or reflexive opposition, but the agent of great beneficial change.


Capitalism, the General Welfare and Education

I’m blessed to have friends whose beliefs I do not share.  They make it so much easier to see that if I believe this, I cannot also believe that.

My ideas were well tested in a discussion of this New York Times article about income inequality analyzed in the context of US economic expansions by Ms. Tcherneva, an economist at Bard College.

In the 1940s, ’50s and ’60s, most income gains from the bottom of one recession to the start of the next went to most people, i.e., the bottom 90% got a majority of the increase.  But in each expansion they got a smaller share while the top 10% got increasingly more.

From 2001 to 2007, an extraordinary 98% of income gains went to the top 10% of earners.

In the first three years of the current expansion, the incomes of the bottom 90% actually fell, which meant the top 10% got a seemingly impossible 116% of all income gains.

Inequality Increased with Expansions

The top 10% now gets almost half of all income.  Just the top 3% got almost a third (31%) in 2013 and the next 7% got 17%.  The remaining half (52%) is shared by the bottom 90%.

Making life harder for the bottom 20%, they got only 36% of federal transfer payments in 2010, down from 54% in 1979.

The short term result of rising inequality is weak economic demand.  The longer term impact is lack of progress in education.

The USA is the only high-income country whose 25-34 year olds are no better educated than its 55-64 year olds.  College graduation rates for the poorest increased only 4% from those born in the early 1960s to the early 1980s while the rate for the wealthiest increased by almost 20%.

Upward mobility is very limited without a college degree so high inequality in education results in children of prosperous families tending to stay well-off while children of poor families remain poor.

Ms. Tcherneva focuses on the short term issue, weak demand, and observes that our fiscal policy – lower interest rates to increase demand to create jobs – is not working.  She suggests the Federal government focus directly on employment:  “The manpower of the poor and the unemployed can be mobilized for the public purpose irrespective of their skill level, which in turn will be upgraded by the very work experience and educational programs that the program would offer.”

When the discussion began, a different version of the income distribution chart by Robert Reich was dismissed as “bull crap.”  By the end, we agreed that income distribution really is highly unequal in the US and is growing more so.  We further agreed that the trend is unsustainable.  We came close to a consensus that if it continues too long, there will be civil strife. 

And we ended up agreeing that our economy is undergoing structural change.  Off-shoring and automation are eliminating many lower paid jobs.  AI software is also replacing many higher paid jobs.  Perhaps there simply will not be enough jobs humans can do better/cheaper than intelligent machines and we will in the longer term need a new economic paradigm.

When we discussed solutions for today, we disagreed about whether government should try to alter income distribution, directly create jobs, or do more to govern behavior in markets e.g., with stricter bank regulations.  We disagreed about whether government should ever try to influence society in any way e.g., by tax incentives. 

And we disagreed if education should be primarily private or public. 

Seeking a philosophical basis for our beliefs, we discussed the Constitution’s: “We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, … promote the general Welfare …”, and its section 8, which gives the legislative branch the power “… To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the the common Defence and general Welfare of the United States.” 

What, we debated, is the Federal government’s responsibility for “the general welfare” in a capitalist society?

Characteristics of all forms of capitalism include capital accumulation, competitive markets and wage labor.  Piketty’s research suggests the rate of return on capital is inevitably higher than the rate of growth of wages.  What government action does that suggest?  To what extent should government constrain behavior in competitive markets?  And is the freedom that comes with wage labor sufficient?

What preceded capitalism was slavery where slaves could not seek a better owner, and feudalism which also kept those at the bottom in place.  Capitalism has no such iron-clad constraints.  In pursuit of higher wages, a better boss, more interesting or safer work, we can try to get any job at all, anywhere. 

Furthermore, capitalism requires property rights and other laws while in slave-owning and feudal societies, laws are the whim of the slave-owner or land-holder. 

We did not dispute the ideas in the preamble to the Constitution; that central government must enable us to live in peace under the protection of the law.  Hamilton in the Federalist Papers was emphatic about “a more perfect union” and “common defense”.  States must not have armies, he wrote, because they would go to war with each other if they did.  The nation as a whole must defend itself. 

Where we disagreed was on Section 8, about the meaning of “the general welfare” and the Federal government responsibilities it implies. 

My thoughts were clarified by the discussion.  I believe the central government of any nation is responsible for establishing the infrastructure, broadly defined, that is necessary for the general welfare.

Infrastructure means basic facilities, services, and installations necessary for a society to function, e.g., transportation and communications systems, water and power lines.  Infrastructure also includes public institutions such as schools, post offices, and prisons. And it includes protection of “the commons”, things we all need that nobody owns such as the air.

Different combinations of public and private involvement can create and maintain infrastructure, but the central government is always responsible for ensuring that current and future generations will have an infrastructure that enables the nation to remain competitive and viable.

I have long thought, for example, that our central government should lead us from dependency on Middle East (or other) oil by establishing a suitable electricity grid.  What struck me in this discussion is that I think a well educated and healthy work force is also part of our infrastructure. 

And I want nobody to be prevented from fulfilling their potential by the circumstances into which they are born.

That led me to two conclusions about education.  First, it must be funded from the center because if it is not, welfare cannot be general.  Some will be privileged by accident of birth while others who may have high intellect and/or other gifts will not get an education that enables them to fulfill their potential.  Second, the curriculum must be set at the center because if it is not, our workforce will not have a dependable base of skills.

I do not mean specific work-related skills, almost all of which now have a short shelf-life because technology is advancing so fast.  I mean the ability to seek out and recognize facts, to reason from facts to conclusions, and to communicate effectively with people whose ideas are different. 

We are not born knowing how to do any of those things or how to act as members of society, just as we are not born knowing how to read or do arithmetic, and that’s important because we can’t have an effective democracy if voters can’t recognize facts or reason from them. 

In fact, we do not have an effective democracy, and I want that to change!

My views, taken as a whole, seem to fit no label.   I believe, among other things, that:

  • Markets should operate as the engine of creative destruction (i.e., I’m a capitalist)
  • Which means, for example, that too-big-to-fail financial institutions must be broken into smaller entities that can go bankrupt
  • And (almost?) all tax incentives should be eliminated
  • Individuals should be held accountable for their actions
  • Which means we must strengthen regulation and enforcement of individuals’ behavior in markets (i.e. prosecute criminal behavior)
  • Everyone should have a reasonably good opportunity to fulfill their potential (i.e., I’m a progressive)
  • Which means we need a progressive income tax code and high inheritance taxes
  • And Federally funded education with a uniform national curriculum
  • A reasonable amount of health care and etc should be available to all (i.e., I’m a socialist)
  • Which means we need a universal single-payer health system
  • Infrastructure investment by the central government is necessary and can be funded by borrowing (i.e., I’m not a fiscal hawk)
  • But spending programs should be funded with current revenue, i.e., taxes (so maybe I am a fiscal hawk)
  • Our misguided spending on wars should be invested productively, e.g., on an electricity grid that helps us overcome our dependency on oil and coal (i.e., I’m a peacenik) 

My education left me unable to accept an entire package of ideas from anyone else, but it’s hard to avoid cognitive dissonance when you assemble your own set.  It’s almost impossible to spot every inconsistency.  This is why I’m so grateful to my diverse friends for helping me see more clearly.

An Unskillful Conversation

Here in Maine the daffodils are up.  There must be more flowers further south where I sat in the spring sun in 1971 designing how a global network of computers would communicate.  The design was good, it worked well for many years, but it was a long job fixing bugs in the engineering.

Communication media are noisy.  We’re used to it with cell phones and in restaurants and such.  We know we won’t always hear what each other says or get their meaning.  Message-sent is not necessarily equal to message-received.  Computer communications work despite that because of error detection and correction protocols.   Human communication uses quizzical expressions, tones of voice, “I’m not sure I understand” and so on.

Difficult as it is to perfect computer communication, human communication is far harder because what we say and hear is distorted by our emotions.

Here’s a conversation I recently had that was prompted by Piketty’s book, Capital, which shows that capital grows faster than the economy in which it is invested.  The book is the subject of much debate at this time because the wealth of those who are already very wealthy is increasing rapidly while the income of everyone else is shrinking.

The implication of Piketty’s research is that owners of capital inevitably get an ever increasing portion of a capitalist economy’s wealth.  In theory, all wealth would end up owned by one individual but in the real world wealth is always redistributed, sometimes as a result of violent revolution, more often in a managed way via a progressive tax system.

A friend asked on Facebook about restoring balance with a wealth tax.  Someone I don’t know responded: “Wealth has always been concentrated in the relatively few wealthy.  But you just can’t take it and redistribute it like pirates taking a ship and dividing the booty.  Some pirates kill the others to get more than their fair share and it starts all over again.”   He went on at length about wasteful Big Government and appeared to be opposed not just to income redistribution, but to taxes in general.

I replied:  “We need some things governments alone can provide.  Governments need revenue.  That means taxes, so one set of questions is about the best tax system.  One element of a better one than we have now is an inheritance tax because those who inherit a lot of money did nothing to earn it — better to tax inheritances and use that to offset some personal income tax.”

His response was:  “One thing many don’t think about when it comes to inheritance tax is all that money was taxed when it was originally made during the deceased individual’s lifetime.  You are taxing it all again.”   He added:  “There’s something else about taxing the rich more than we do presently; they can remove themselves from taxes by moving their wealth or their corporations out of the country.”

I asked:  Why does it matter if inherited money has already been taxed?  Those who inherit the money did nothing to earn it — that’s the big point.” 

And in response to “something else” I wrote:  It’s important to think separately about taxing corporations and individuals.  Corporations are increasingly global entities that can easily relocate aspects of themselves.  They can choose which legal systems the side-effects of their operations will be regulated by, and by which their IP and etc will be protected.  Human people, however, can only be citizens of one nation.  It’s a big step for a wealthy American to give up US citizenship, the only legal way of avoiding US taxes.”

The tone of my reply took the conversation off track.  The response was:  “The real big point is this: Who are YOU to say how anyone else’s money is yours to give away?  There’s no one so generous as someone who is earnestly and self righteously advocating the gifting of someone ELSES money.”

We could have hit “reset” in a face-to-face conversation and gone on to discover what exactly we disagree about but I couldn’t see how to do it on Facebook or any such medium.  I ended up answering the question as phrased, knowing it really wasn’t an answer:  “I’m a citizen of a democracy, which means it is my responsibility to think through and say what policies I believe are best for our society.”

The apology that came for “misusing a figure of speech” gave me the sense that a face-to-face conversation might have led us both to more insight, but I let the conversation fizzle out.

I’ve written and re-written, over and over again, my lessons from this conversation.  First, I convinced myself the problem was the restricted kind of communication inherent in online media.  Eventually, I acknowledged that I was more interested in telling the other fellow what to think than having him show me flaws in what I think.

At last, I recognized the root of the problem.  I let myself feel angry when in his first comment he dismissed Piketty’s research by calling him a fashionable intellectual.  “He’s one of those whose beliefs are impervious to facts,” I said to myself.  That set the tone of my reply. I imagined it to be factual and helpful but that was not the only message I sent.

We can see our logic errors, flaws in our perceptions and what we don’t know by articulating what we think and listening carefully to our words.  That’s what I’ve been working on as I kept rewriting this post.

But it’s quicker if others tell us our errors.  They must listen carefully to be right, of course.  What I just relearned is they only do that if we communicate skilfully, which means not just being clear but also putting ourselves in their shoes.  That’s especially necessary if we imagine their shoes won’t fit.

Our Sacrosanct Jobs Program

A news article this week brought to mind something British politician Tony Benn said, “I remember setting sail to South Africa for training [as a WW2 RAF pilot] and being part of a war aims meeting.  It was the most brilliant political meeting I ever attended.  One man spoke of the mass unemployment of the 1930s and said that if we could attain full employment by killing Germans, we could have full employment by building houses, schools and hospitals.”

The article is about a $643M contract with Bath Iron Works (BIW) for which Maine Senators Collins, a Republican, and King, an independent, got funding.  They say it will “allow the Navy to send another DDG-51 to sea when the Navy’s fleet needs to preserve important combat capabilities in support of our national defense.”  Democratic Representative Pingree said, “this is excellent news for the families who earn their living at BIW.”  A shop steward who represents BIW workers said, “the contract brings more stability to the company, which employs about 5,400 people.”

So, my representatives in Washington, the BIW workers and their families, local business owners, everyone around here is happy we’re going to build more of these ships that were “originally designed to defend against Soviet aircraft, cruise missiles and nuclear attack submarines.”

What struck me is, although we don’t think of Defense that way, it has grown into an enormous jobs program.  What’s more it’s a program whose rationale and scope we do not question.

President Reagan’s budget director David Stockman has points to make, however.  In The Ukraine, The War Party and the Pentagon’s Swamp of Waste he writes, “the $625 billion allocated to DOD this year amounts to a colossal destruction of economic resources for no benefit whatsoever to the safety and security of the American people.”

Stockman is angry, perhaps because “About three decades ago I called the Pentagon a “swamp of waste” during an off-the-record interview that ended-up on the evening news. Presently I ended-up in President Reagan’s woodshed–explaining that, well, yes, I did say that because it was in fact true.”   His article is excellent background reading.

I don’t feel emotional about this but I am equally determined to do what I can so we do question how we want to spend that $625B of tax revenue.  The current program does have some benefit — it provides a lot of jobs — but as Tony Benn realized, some of them could be different jobs.  Some could be jobs without the risk of being killed or maimed.

Defense spending has huge support.  There was a bi-partisan agreement to cut (sequester) federal spending this year.  Stockman notes that “Had every dime of the $55 billion sequester been implemented, this year’s DOD budget would have been roughly $600 billion … in 1989, the DOD budget was about $475 billion in today’s inflation-adjusted dollars.”   Even though DOD spending would have been up 25% from 25 years earlier, when the time came to make the cuts, Congressman Paul Ryan and others said making them would be tantamount to surrender.  So the cuts were not made.

What provoked Stockman’s article is, “Contrary to the bombast, jingoism, and shrill moralizing flowing from Washington and the mainstream media, America has no interest in the current spat between Putin and the mobs of Kiev.”

Echoing President Eisenhower’s famous warning when he left office sixty years ago, he says,  “The source of the current calamity-howling about Russia is the Warfare State–that is, the existence of vast machinery of military, diplomatic and economic maneuver that is ever on the prowl for missions and mandates and that can mobilize a massive propaganda campaign on the slightest excitement.”

Stockman is outraged that we believe the propaganda and by our hypocrisy: “We have invaded every country to our South–from the Dominican Republic to Guatemala and Panama and assassinated or overthrown dozens of  their leaders–all within the 60 year span since Nikita Khrushchev gifted Crimea to his minions in Kiev. So precisely which nearby borders are so sacrosanct and exactly who has done the more egregious violating?”

I’ve written before about our defense spending and military strategy over which “we the people” have no control.  President Reagan greatly accelerated spending on what was in fact a spurious rationale, it dropped and stabilized in the next decade, then it was driven to extraordinary new heights by President Bush based on a new spurious rationale.  The numbers below show our total defense spending, not just what is presented in the US budget defense line item but also the spending on “overseas contingency operations” i.e., the wars President Bush started in Iraq and Afghanistan.

Trends in US Military Spending

We might be encouraged by Congress’ refusal to approve President Obama’s recent desire to take military action in Syria except that (A) Congress is currently of a mind to refuse everything he proposes and (B) everyone in Congress always wants more military spending in their district.

Important as it is to make rational changes to our defense spending and decide what kind and size jobs program we want to fund, however, we first need a government that functions, one that could debate such questions, arrive at decisions and take action.

I’m still absorbing research about how we could get such a government and, following a break where I’m hoping for sun and heat, I will report back next month.

Will Politicians Doom Our Economy?

This Guest Post is a copy of comments by “Dryly 41” about Why the Economy Isn’t Doomed, an article whose theme is, “challenges have been with us before and have preceded eras of broadly shared prosperity?”

The article starts with the positives, “slowing health-care costs, rising college graduation rates, a shrinking federal budget deficit [and] we’ve finally become aware of just how lousy the past several decades were for the average U.S. worker.”   The greatest negative, it says, is intelligent technology from checkout machines to driverless cars that “may bring about profound declines in employment.”   But that technology might instead be the greatest positive if more of our workers have “the education to take advantage of these changes.”  The conclusion:  Economic growth could turn out to be high, its benefits could be felt throughout our society, and “government could promote such growth by spending on infrastructure, education, and research and development.”

There is at this time no prospect that our government will take the indicated action.  Dryly 41 has thoughtful things to say about that.


We had banking panic/depressions in 1819, 1837, 1857, 1873, 1884, 1893 and 1907 before The Great Depression. The prevailing approach to finance was “laissez faire”.

The New Deal under FDR put an end to “laissez faire” and adopted a “strict supervision” approach to finance. They kept the 1927 McFadden Act restrictions on interstate branch banking that President Calvin Coolidge signed into law. The purpose of that legislation was two-fold. They wanted to protect small banks form large bank competition. But equally important they wanted to curb the economic and political power of large financial institutions.

The Glass-Steagall Act introduced deposit insurance to curb bank runs that plagued otherwise healthy banks. But they recognized the “moral hazard” that bankers would have with the use of what Louis Brandeis called “other people’s money” with the government guarantee. To deal with the “moral hazard” problem they separated commercial and investment banks, and restricted speculative activities that banks could engage in. To meet the fraud in the stock market they enacted the Securities Act and enforcement legislation.

It worked. At least until Ronald Reagan started the march away from “strict supervision” back to “laissez faire” by deregulating the Savings and Loan banks. Notwithstanding the disaster of 1,000 of some 3.200 S & L banks failing, the march back to “laissez faire” continued on a bi-partisan basis. Clinton, Rubin and Summers, Greenspan with Gramm, Leach and Bliley repealed the “strict supervision” measures designed to deal with “moral hazard” in 1999. Legislation was enacted to repeal the McFadden Act and the Bank Holding Company Act of 1956 restriction on interstate branch banking in 1994, which paved the way for Too Big Too Fail banks.

The 78 years and 11 months between October 1929 and September 2008 was the longest period of financial stability in our history.

So which do you prefer: “strict supervision” or “laissez faire”?

One might be more optimistic if it were recognized that our economic problems were caused by self-inflicted policies and we corrected them.

First: In 1946, the Gross Federal Debt amounted to 121.7% of GDP. The Truman administration reduced it to 71.4%; Eisenhower to 55.2%; Kennedy/Johnson to 38.6%; Nixon/Ford to 35.8%; and Carter to 32.5%.

Then came Ronald Reagan with “supply side” tax cuts.  His Budget Director said they were a “Trojan Horse” to reduce the top rates for the wealthy. Inequality began. The class war was declared. Eight years of deficits raised the Debt to 53.1%. Four more years of deficits under Bush I increased it to 66.1%.

Clinton raised taxes, had 4% unemployment, balanced budgets, and reduced the Gross Federal Debt from 66.1% of GDP to 56.4%.

Then Bush II had two rounds of “supply side” tax cuts in 2001 and 2003. V-P Cheney explained to Treasury Secretary Paul O’Neill: “Reagan proved deficits don’t matter.” When O’Neill continued to object over the second round Cheney fired him. Eight years of deficits raised the Gross Federal Debt from 56.4% of GDP to 85.1%, and left a crippled economy.

No mention in the article of “supply side” even though since Washington in 1789 no political party has inflicted this harm on the nation. It was not for some great national purpose like the Revolutionary War, the Civil War, WW I, or, WW II. All those trillions were borrowed to fund tax cuts for the wealthy who were most able to pay their fair share of taxes.

The most mysterious thing is how members of the media call Ronald Reagan and George W. Bush “conservative”. This was the most radical departure from traditional Republican tax and fiscal party in history. There is no way Calvin Coolidge, Herbert Hoover, Andrew W. Mellon and Reagan and Bush II are “conservative”.

We should consign “supply side” to the dust bin of history. It was quite harmful to the nation.

I wish I could be as optimistic as the author. Our political system is broken and it matters.

Toward A Better Tax Structure

When I began this series of posts, I had no definite opinions.  Now I do.  Some conclusions surprised me, some changes would be very contentious, one looks promising but requires more research, and one may be good in theory but not in real life.

Our current system is explored in the first few posts and summarized in The Purpose and Performance of Our Tax System.  Our current system:

  • Fails by a wide margin to fully fund government spending
  • Creates a wealth distribution that 90% considers highly unfair
  • Costs far too much to operate (30% overhead on income tax)
  • Allows illegal evasion on almost 20% of taxable income
  • Is so complex nobody fully understands it
  • Creates seriously false beliefs about tax and spending

False beliefs?  Three in four Americans believe almost half of all government spending is wasted but oppose any cuts to programs that account for 60% of spending.  Unfair results?  Nine in ten Americans believe the wealthiest fifth has three fifths of the total wealth and wants them to have a third but in fact they have over four fifths and it’s growing fast at the expense of every other group.

Taxes, Wealth and Fairness notes that a fair distribution of  wealth means a relatively equal opportunity to become wealthy.  Who We Tax shows that while wealth is now extremely and increasingly unequal, the percentage of tax paid relative to income is similar for all income groups.  What We Do Not Tax shows that tax deductions equaling almost a third of Federal spending disproportionately benefit those with the highest incomes.  Business Tax shows how corporate income taxes have fallen as a share of GDP and corporate profits are transferred overseas where they are not subject to US taxes.

The last background post, Qualities of an Excellent Tax System, summarizes what public opinion surveys say we want, a system that:

  • Fully funds all authorized government activities,
  • Leads toward the distribution of wealth we democratically choose,
  • Has a low collection cost and minimizes illegal evasion,
  • Does not disadvantage US business in the global economy, and
  • Makes it easy to understand the impact of proposed tax and spending changes

What changes must be made to get what we want?  What We Tax, summarizes the existing structure.  The Federal government collects half of all tax revenue, chiefly from individual income tax (8.8% of GDP) and corporate income tax (2.2% of GDP).  The States collect 29%, chiefly from sales tax (2.1% of GDP) and individual income tax (1.9% of GDP).  Local taxes make up 19% of the total, mainly property tax (2.4% of GDP).  Later posts explore the pros and cons of that structure and of different taxes.

Estate Tax and Fairness highlights an extraordinary failure of logic – inheritance tax is felt to be the most unfair tax of all by a society that wants equal opportunities for all to become wealthy.  It also notes that estate taxes provide the least disincentive for economic activity.

The top estate tax rate was 77% at the end of WW2 (“equality of sacrifice”).  The UK ended domination by its hereditary aristocracy the same way (“equality of opportunity”).  Our huge public debt from wars in Iraq and Afghanistan, tax cuts on high incomes, and the Great Recession calls for equality of sacrifice now.  Our great inequality of wealth calls for equality of opportunity now.

Personal Income Tax and Fairness shows the higher top rates necessary to get the wealth distribution 92% of Americans want will not harm economic growth.  Research indicates we should raise the top rate closer to a revenue-maximizing 66.1% from today’s 39.6%.   Income is increasingly from capital gains taxed at lower rates than “ordinary” income.  93% of that $161B tax break goes to the top 20% of earners and two-thirds to the top 1%.  Half of all capital gains are not taxed because one who inherits property pays gains tax only on the difference between what it was worth when inherited and when sold.

The six Walmart heirs dramatically illustrate the result of the combination of low marginal tax rates on both inheritances and incomes.  They have more wealth, $90B, than the bottom 42% of Americans and it’s up from $73B in 2007, the same as the bottom 30%.   Meanwhile, the average American’s wealth declined from $126K to $77K and 13 million Americans have negative net worth.

Consumption Taxes and Fairness explores issues with this tax and with the central/local tax structure.  The wealthiest residents in most States pay the lowest rates because of consumption taxes.  The poorest 20% pay 6 times as high a percentage of income as the richest in the ten most regressive states.  The average state’s consumption tax structure is equivalent to an income tax with a 7.1% rate for the poor, 4.7% for the middle class, and 0.9% for the wealthiest taxpayers.

The attraction of consumption taxes is they are hard to evade and cheap to collect.  The problem is they disproportionately impact those with a low income.  That can be mitigated, however, by higher tax rates on high incomes, a subsidy for those who work for low pay, exempting food and other necessities, and providing essential services such as healthcare at no or low cost.  Consumption taxes must be part of our system since personal consumption historically represents 70% of our GDP.

Property Tax and Fairness explores another aspect of the local/central issue.  Property tax is the chief source of revenue to support local education, police and fire protection, and infrastructure.  A protest against high Local property taxes in California resulted in higher State income taxes and a shift in power from Localities to the State.

This post also looks at how tax structures impact economic growth.   An analysis of 21 OECD countries over the last 35 years concludes:  “Property taxes … seem to be the most growth-friendly, followed by consumption taxes and then by personal income taxes.  Corporate income taxes appear to have the most negative effect on GDP per capita.  …  These findings suggest that a revenue-neutral growth-oriented tax reform would be to shift part of the revenue base towards recurrent property and consumption taxes and away from income taxes, especially corporate taxes.”

To get the desired wealth distribution, it may be better to collect property taxes at the Federal level and redistribute them on a per capita basis to the Local level.

Corporate Income Tax and Fairness notes they are costly to collect, easy to evade, and fraught with competitive issues.  Two thirds of US businesses reporting profits of $1 million or more are not incorporated, which means tax on their income is paid by their owners.  Treasury Department economists reckon four fifths of the profits of corporations is also paid by owners.  When we say corporations should pay more, what we probably mean is we want business owners to pay more.

A related issue is corporations pay very different rates of tax because they have flexibility in where they locate production and where they realize profits.   They can borrow in one country and take the interest deduction there, locate production facilities and employ workers in another country, and realize profits in a third country.  $1.7T of profits is estimated to be offshore where US taxes are not incurred.

Because 80% of corporate income tax is ultimately paid by business owners, is costly to collect and easy to evade, it looks better to eliminate it while raising the tax rate on high personal incomes.  Tax on all business profits would then be paid by business owners.

To end the harm to our economy caused by the offshore tax break, it looks better to combine business profits shown in all jurisdictions, deduct income taxes paid in other jurisdictions and tax the balance at US rates (ala State and Local tax deduction for Federal income tax).

Social Security Tax and Fairness notes that Social Security spending is matched by dedicated payroll deductions that are fundamentally different from other taxes because they are payments for our individual pensions and insurance.  We need payments to be mandatory because we don’t save enough voluntarily or have enough disability insurance.

Keeping Social Security financially sound is a separate issue from balancing overall government revenue and spending.  Social security can be kept sound by increasing the payroll tax ceiling to the same percentage level it was not long ago and modestly raising the tax rate as we’ve done before.

We are easily misled about the health of Social Security because its revenues and spending are rarely presented together.  That is a problem with all government activities that leads to our mistaken beliefs about overall tax and spending and makes it easy to mislead us about necessary changes.

Conclusion:  When I began these posts, I had no definite opinions.  Some changes that I now see to be positive are not unexpected but I was surprised to find no basis for lower tax rates on capital gains.  That and other changes could be made but eliminating all tax deductions, which would make the system fairer and cut collection costs would be very difficult (as the Japanese say).  I will in future posts return to tax preferences and explore whether we really should want government, for example, to be encouraging home ownership.

Another change, eliminating corporate income tax, looks positive but to come to a definite conclusion I must research international tax treaties and think through how the accounting would work.  Centrally collected property tax and VAT for redistribution to State and Local governments also looks positive but to come to a conclusion about that I must explore issues of governance.  What about the associated increase in Federal government power?

So, here are conclusions I’m confident about (definite) and those needing more research (probable).

Definite – to more fully fund government activities, make the opportunity to become wealthy more equal, lower tax collection cost, minimize illegal evasion, make it easier to understand the impact of proposed tax and spending changes, and not harm our economy we need:

  • Higher tax rates on inheritances
  • Higher tax rates on high personal incomes
  • The same tax rates for all kinds of income
  • Higher payroll tax ceiling and payroll tax rate
  • Revenue and spending reported together for every major government program

Probable – to more fully fund government activities, minimize tax avoidance, and not disadvantage US businesses in the global economy we should:

  • Eliminate corporate income tax and account for all business profits the same way globally
  • Eliminate all tax exemptions
  • Collect property tax at the Federal level (instead of some or all by Localities) and redistribute it per-capita to Localities
  • Collect VAT at the Federal level (instead of some or all State Sales Tax) and redistribute it per capita to the States

Because only some changes are definite, I can not yet propose exact rates, what percentage of revenue should be raised by each tax, or what percentage should be collected at each level of government.  I will explore international tax treaties and governance to decide about the “probables” then propose an overall structure but first, a more urgent question.

Presumably, it’s the same 92% of Americans who want less inequality as the 93% who lost an additional 4% of their savings in the past three years while the wealthiest 7% grew 28% even more wealthy.  No surprise they want less inequality but would that in fact be better for society?  I used to want cigarettes; it’s better I no longer do.  I still want red wine; that is in moderation OK and it may even be positive.  Is the more moderate inequality our majority wants more like cigarettes or red wine?

Personal Income Tax and Fairness

To get the more equal distribution of incomes 92% of Americans want, we must have higher taxes on high incomes.  But wouldn’t that kill economic growth?  Extensive recent economic research says not.

We have repeatedly cut the top rates on income since WW2, from 92% to 91% under President Eisenhower, then in steeper steps down to 35% for most of the past decade.  We said this would reward entrepreneurship, benefit everyone by creating more jobs, and boost economic growth.  We said growing the economy would result in enough additional tax revenue to pay for the cuts.  However, as this article notes: “The logic of the idea is hard to refute. It just doesn’t seem ever to have happened.”

As early as 1989 the data showed the recovery that began in 1983 and was believed to result from reductions in the personal income tax rate was caused mainly by expansionary monetary policy and to a lesser extent by growth in business investment after changes to corporate taxes in 1981.  Economic growth was much higher in the 1950s when personal income tax rates were much higher.

The paper I cited in Property Tax and Fairness that modeled the impact on economic growth of property, consumption and income taxes was based on annual data for 1971-2004, a relatively short period.  This much more comprehensive Review of Recent Academic Research indicates that cutting top individual income tax rates since WW2, more than twice as long a data series, had an insignificant impact on economic growth.   The data suggest we should in fact raise the top income tax rate closer to a revenue-maximizing 66.1% from today’s 39.6% rate.  

What does revenue-maximizing mean?  No revenue will be collected if the tax rate is 0% or 100%.  There is some percentage below which tax-payers keep enough of what they earn so they keep working to earn more, and above which they lose incentive.  The idea that cutting taxes would motivate growth was based on the assumption that the top rate was higher than the revenue-maximizing rate.  We now know it was, and still is, substantially lower.

The result cutting the top individual income tax rate did have was to greatly increase federal budget deficits and income inequality.  Income inequality grew because a low top rate motivates what economists call rent-seeking.  When high income folks can keep more of what they’re paid, they have a greater incentive to get higher wages.  A CEO has great influence to achieve that.  Lower level workers do not.  Because CEOs have the stronger bargaining position, they get a greater share of overall income.  That increases income inequality without increasing economic activity.

The recent sharp growth in income inequality is because a growing share of income is generated from capital, and capital gains are taxed at lower rates than “ordinary” income.  Long-term capital gains are currently taxed at a top marginal rate of 23.8% vs 39.6% for ordinary income.  The CBO says this cuts annual revenue by $161B, and is the most regressive of all tax breaks.  Fully 93% of the benefit goes to the top 20% of earners and two-thirds goes to the top 1%.

We have long, but not always, offered incentives for investing capital.  From 1934 to 1941, for example, 20%, 40%, 60%, and 70% of gains could be excluded on assets held for 1, 2, 5, and 10 years.  The recent history is detailed here, starting from 1988, the last time the tax code was significantly reformed.  The lower rate for long-term gains was briefly eliminated at that time, then set at 28% from 1991-1997, cut to 20% from 1997-2007 and cut again to 15% from 2007-2012.  Long term rates currently range from 15% to a top rate of 23.8%.

We encourage investment with lower tax rates because investment carries risk.  If I work at a job, I will get paid.  If I invest, I hope to get paid but I may not even get my investment back.  It does not make sense, however, that gains should be taxed at a lower rates to compensate for that risk because the size of potential gains already reflects their relative risk.  That’s why on average and over time the gains are higher with riskier small company stocks than stocks of well established large ones.

There is a “step-up in basis” rule that means someone who inherits property pays gains tax only on the difference between what it was worth when inherited and when sold.  The capital gain from when it was purchased to when it was inherited is not taxed.   There is no basis in fairness for exempting that capital gain which, according to the Congressional Research Service, is about half of all capital gains in the US.  There are other special cases, too, including lower rates on gains from collectibles, an exemption that benefits only the very wealthy.

Another special case is “carried interest” paid to investment managers.  Carried interest is their share of the investment profits.  It is taxed at capital gains rates even though the investment managers have nothing at risk because they contributed none of the investment.

As Ben Bernanke said in a recent speech“We have been taught that meritocratic institutions and societies are fair. … A meritocracy is a system in which the people who are the luckiest in their health and genetic endowment … [and] in so many other ways … reap the largest rewards.  The only way for a meritocracy to … be considered fair, is if those who are the luckiest in all of those respects also have the greatest responsibility to work hard, to contribute to the betterment of the world, and to share their luck with others.”  Reduced rates on capital gains mean those who are luckiest, and who in many cases do work hard, unfairly share less of the results of their good luck than those who are less lucky.

Perhaps, however, our unfair personal income tax system is redeemed by being effective?  I will explore the details in a separate post, but in brief, no.  Societies break down when wealth is distributed highly unequally.

So, our current income tax is both destructive and delivers results nine out of ten of Americans do not want.  Specific problems include:

  • Low top rates increase inequality
  • Lower rates on capital gains than “ordinary income” increase inequality
  • Exemptions for spending by wealthier citizens increase inequality
  • The “step-up in basis” rule increases inequality

In the next post in this series I will come to some conclusions about a better tax system.  I will not, for example, try to work out what should be our highest income tax rate nor what percentage of total revenue should come from income, consumption, property and estate taxes.  What I will do is figure out a tax structure that better fits what the majority want, subject to any gross mistakes in those wants.

Consumption Taxes and Fairness

Consumption taxes are among the least harmful for growth but they fall heavily on those with low incomes.  Analysis of their fairness must consider their role within an overall tax structure.

Consumption taxes come in several forms.  Sales tax is collected by retailers at the point of purchase.  Use tax is collected on items purchased outside a taxing authority’s jurisdiction, e.g., a vendor in another state.  Excise tax is paid by the producer or wholesaler, e.g., of gasoline or alcohol.  Value added tax (VAT) is collected step by step from every buyer in the value chain (see below).

Sales tax:  We have no federal sales tax but 45 states levy it at rates ranging  from 1% to 10% and many local governments collect an additional amount.  What goods and services are taxable varies.  Nearly all jurisdictions exempt some categories or tax them at reduced rates.  Most exempt food sold in grocery stores, prescription medications, and many agricultural supplies.  Raw materials and goods purchased for resale are always exempt.

Use tax:  US retailers with no physical presence in a state can ship goods to customers there without collecting that state’s sales tax.  Tax payers should in that case pay the tax directly but they often don’t.  Because online retail has greatly increased the lost revenue, the Senate recently voted for a Marketplace Fairness Act so states could compel online businesses to collect all applicable taxes.

Excise tax:  The US federal government and many states levy excise taxes on a few items, typically ones for which demand is not greatly impacted by income.  One does not buy a lot more gasoline, for example, if one’s income grows.   That means excise taxes are usually the most regressive.  State excise taxes on gasoline, cigarettes and beer take about 1.6% of the income of the poorest families, 0.8% of the income of middle-income families, and 0.07% of the income of the very best-off, which means they are 22 times harder on the poor than the rich.

Value Added Tax:  VAT is collected every time an item or its components is sold, e.g., by manufacturer to wholesaler, wholesaler to retailer and retailer to end customer.  Each seller pays VAT on the difference between his cost for the product or its components and his revenue from the sale.  When he collects VAT from his customers he keeps the VAT he paid on the inputs and remits the difference to the tax authority.  That means VAT is like sales tax in that ultimately only the end consumer pays but different in that some of it is collected by every business in the supply chain.

VAT was first introduced in France in 1954.   Governments like it because most of the collection cost falls on business and sellers have a direct stake in collecting the tax.  Value added taxes have now been adopted by more than 140 countries and provide an estimated 20% of worldwide tax revenue.  The US is one of the few to retain conventional sales taxes.

Consumption tax fairness:   The OECD research I referenced in Property Tax and Fairness analyzes the impact of different taxes on economic growth.  As noted there, property and consumption taxes are among the least harmful for overall economies.   They are also, however, the least fair since they fall most heavily on those with a low income although that can be mitigated by exempting “necessary” items, such as food, clothing and medicines and/or by providing Earned Income Tax Credits (EITC).

This Distributional Analysis of the Tax Systems of all 50 States assesses the fairness of every state’s tax system in terms of income groups.  “The main finding of this report” it begins, “is that virtually every state’s tax system is fundamentally unfair.”  That’s because when all state and local taxes are added up, most states tax wealthier families at a lower rate than low- and middle-income families.  Only two tax their wealthiest as much as their poorest and only one taxes its wealthiest at a higher effective rate than its middle-income families.  The primary source of unfairness is consumption taxes.

State Taxes by Quintile

The average combined rate on the best-off 1% of families is 6.4% before federal deductions for state and local taxes.  After accounting for that “federal offset”, their effective tax rate is 5.2%.  The average rate on families in the middle 20%  is 9.7% before the federal offset and 9.4% after.  The average for the poorest 20% is 10.9%, more than double the effective rate on the very wealthy.

The average state’s consumption tax structure is equivalent to an income tax with a 7.1% rate for the poor, a 4.7% for the middle class, and a 0.9% for the wealthiest taxpayers.

Property taxes:  Also tend to be regressive, but much less so than sales tax.  A home represents the lion’s share of the total wealth of average families but only a small share at high income levels.  Because property tax usually applies mainly to homes not all assets, it applies to most of the wealth of middle-income families and a smaller share for high-income families.  Because the tax on rental property is passed through to renters as higher rent, it represents a much larger share of income for poor families.

Different states have very different tax structures with very different degrees of fairness.

State and Local revenue composition

Most regressive tax states:  The ten most regressive states collect six times as high a percentage  from their poorest 20% as their richest.  They either collect no income tax or collect it at the same rate for all income.  Washington, the highest-tax state for poor people, taxes its poor families 17.3% of their total income.  In neighboring Idaho and Oregon, the poor pay 8.6% and 8.7% of their incomes.  Florida, also a no-income-tax state, taxes its poor families at the second highest rate, 13.5%.  Illinois, which relies heavily on consumption taxes, ranks third in its taxes on the poor, at 13.0%.

Washington Taxes

Least regressive tax states:  Vermont has a highly progressive income tax, low sales and excise taxes and an Earned Income Tax Credit (EITC).  Delaware’s income tax is not very progressive but that is its main source of revenue and its very low consumption taxes result in a system that is only slightly regressive.  New York and the District of Columbia achieve a close-to-flat tax system through EITC and income taxes with high top rates.

Vermont Taxes

Conclusion:  Consumption taxes are effective but if the tax structure is to be fair, their disproportionate impact on lower income families must be mitigated.  Ways that can be done include:

  • Progressive income taxes that provide a balance by disproportionately impacting higher income families
  • Earned Income Tax Credits (almost a quarter of states use them)
  • Exempting necessities, food in particular, that account for a higher part of low income family spending
  • Providing essential services such as healthcare at no or low cost because that most benefits those with low incomes

In a future series of posts I will explore services governments can provide and how public spending on them impacts fairness.  Next up in this series, everyone’s favorite, personal income tax and fairness.