Claire reminded me that Ricochet exists to advance the discussion. And since Ponzi schemes are a topic du jour (see Rob and Genferei ), this seems timely. [warning: long post]
For several weeks now, I have been peering into the vastness of the conservative echo chamber, and have identified a certain non-trivial inconsistency. There are two arguments that I have used repeatedly when discussing politics and tax policy with my wonkish friends.
Argument #1 The Social Security System has been a big Ponzi scheme since the beginning. There are no premium payments into a retirement system. Payroll taxes are just that, taxes, and Social Security disburses old age welfare checks (albeit partially indexed to the amount of payroll taxes collected over a recipient’s lifetime). Social Security surpluses are just the difference between a line item tax and its offsetting line item expenditure. And don’t get me started about the Lockbox. Illiniguy sums it up: “Bernie Madoff is a piker compared to the bunch that foisted this mess upon us”.
Argument # 2 The poor and lower middle class people don’t pay income taxes. The King Prawn cites Victor David Hanson. The overwhelming majority of income taxes are paid by the high wage earners. The Earned Income Tax Credit is an Orwellian masterpiece.
I have had no reason to doubt the logical impeccability of either Argument 1 or 2, until recently. It actually started with an “I told you so” moment.
In the throes of the debt ceiling crisis, Mr. President threatened to withhold Social Security payments to the nation’s elderly. With limited funds available to avoid a looming default, who should Uncle Sam pay next month? Grandma’s check? A soldier’s paycheck? The fuel and ammo invoice for Afghanistan? NIH grants? The Fannie Mae bailout payments? There won’t be enough to go around, and those Social Security checks are not subject to any special prioritization.
SEE, SEE, SEE!! Obama finally gave up the fiction of the trust fund, and admitted that the social security system is just a governmental accounting gimmick (hereinafter “The Big Lie”),. We win Argument #1, slam dunk.
But wait …
If we strip away the Big Lie, then what do we call the 15.3 % (temporarily reduced to 13.3 %) in Fica/medicare/FUTA taxes collected on payroll, partly withheld, partly added to the gross pay by employer. Well payroll “taxes” of course. But everybody pays such taxes, even working class people. It is the closest thing to a flat tax we have.
How much of the total federal revenue comes in from payroll taxes? Turns out: 40%. The first 106,500 in wages per person generates a large percentage (but not a majority) of the tax revenues. Add to that 18% of Federal Revenue attributable to “other”, which includes many regressive taxes like gasoline taxes. 1040 income taxes cover a large percentage also, but certainly not a majority of the overall tax burden.
If we win argument # 1, then we imperil Argument #2. We have demonstrated that (a) payroll taxes are taxes, and (b) everybody pays such taxes, and (c) such taxes are a substantial portion of Federal Revenues.
Contra, if we want to hold onto Argument #2, we have to hold onto the fiction that payroll taxes are not taxes, but “premiums” paid into the oxymoronic “Trust Fund”. Thus Social Security premium payments are kept off the Fed balance sheet, and onto the rich falls the heavy tax burden.
Now my head hurts. Let’s persevere here and dig a little deeper into several concerns.
Concern #1. A comment to VDH’s article asks how much tax do you expect the moderate income, working class citizens to pay? Even the most ardent flat taxer would not say more than 15%. Is this not what they do in fact pay through payroll taxes? Please don’t bust my chops over the portion contributed by the employer. We are looking at the combined payroll tax from both sides as calculated as a percentage of payroll, and which is deductible by the employer a business expense.
Concern #2. I have for a long time scratched my head over the data that the top 20% of filers pay the top 50% of income taxes, and the corresponding assertion that only the wealthy pay all the taxes.
You only need an AGI of 75,000.00 to be placed in the top 20%. We are counting returns filed, and I am left unsatisfied. Example A: A student working part-time, earning 6,000 per year (with one exemption) counts as one filer, while her parents, earning a combined income of 100,000 with 2 more kids at home (4 total exemptions) count as one filer. Example B: Grandma works as the Wal-Mart greeter part-time – one filer, whereas my doctor and his wife and 5 kids, count as one filer.
So we conclude that the top 20% of “filers” pay most of the 1040 taxes. Well, duh. Is that really good statistical work? Kosmo attacks these issues in great detail at thesoapboxers.com (Hat tip to Bereket)
And yes, I realize that higher wage earners pay both payroll and 1040 taxes, and carry a higher aggregate burden. Please keep reading.
Concern #3. The preferential capital gains rates create a perverse disincentive to earning high wages. We wish to incentivize our investing classes to put capital to work . Therefore we give a preferential tax rate to income derived from investments held for at least one year. But at the same time, in the interest of fairness, we have create a progressive rate structure on wage income, based in part on the marginal utility to the taxpayer of each successive dollar earned.
But this is like asking a volunteer to step forward, but in effect finding your volunteer by having everyone else take one step back. Warren Buffet takes one step back, because he is a member of the capital gains class. He pays 15% capital gains tax. The famously working poor step back, in the interest of fairness. They pay no income tax, receive the EITC, but do pay 15% in payroll taxes. And the good citizens working hard, earning good wages and bonuses are left standing out front. They pay 15 % payroll (or self-employment) tax, plus 20% to 30% in 1040 taxes.
So there you have it. My head still hurts, but my mind is somewhat unburdened.
Reconciliation: No critique is well accounted for unless a solution is offered therewith. What pathway lies ahead to the land of fairness and logical consistency?
Flat tax fans, jump up and cheer. Try this: Eliminate 1040 taxes altogether, and take the cap off of the payroll tax. Just one tax, the payroll tax, on all income regardless of the source.
This idea smells too regressive? Then use two tiers: (1) the existing payroll tax rates up to the current $106,500.00 of earned income (15.3%, as temporarily reduced to 13.3% combined), and (2) 20% on everything over 106,500.
How to file your return:
(a) For any given year that you only earned your income through W-2 wages, then you would not file a return (most people). All taxes paid as payroll tax. No more itemization, no more tax code spending in the form of deductions favoring this interest group or that, no more EITC. This is even better than Steve Forbes’ famous postcard tax return.
(b) If you are self employed, you would still need to file a schedule C to calculate your payroll (a/k/a Self-employment) tax.
(c) if you earn income through profits and distributions, which don’t have withholdings (i.e. 1099s and K-1s) then you simply add up the gross amounts of the 1099s (minus your basis) and any K-1 payable to you, and pay the payroll (self-employment) tax rate on those profits. No capital gains rates, no perverse investment credits. Saint Warren of Omaha can finally pay at a higher rate than his secretary.
You may now commence slings and arrows.
P.S. Calling an intrepid Ricocheteer to help run my numbers. Am I revenue neutral?