An inventory of current beliefs on taxation, inequality and fairness

In my prior link compendium, the middle section of the post listed my prior beliefs about taxes and inequality. I’m going to separate and refine them here. As you can tell, I’ve already done a fair amount of reading on this, but we’ll see if they change shape as I write about the subject more during this month of fiscal cliffy goodness.

The overall summary is that income inequality is increasing somewhat, but I don’t believe it is a major social problem. Both inequality and effective taxes over time are hard to measure due to inconsistencies in how we work/live and how tax code changes have altered what shows up on returns.  I do believe the tax code is unfair in many ways and needs reform.  Finally, I believe if you are looking for social divisions, there are other social schisms we should pay attention to, such as the tax treatment of lenders and spenders.

  1. I’m not sure our inequality will lead to the social unrest some are predicting. I think they predict chaos as an ad hoc rationalization of burden-shifting in the tax code.  In terms of lifestyle and access to critical conveniences (like plumbing, food, etc.), inequality is waaaay down over the long haul.
  2. When we try to tax the very rich, we end up taxing the next tier down
  3. The tax system is highly progressive and has become more progressive over time. It already works hard to redistribute income. The right way to measure progressivity is share of taxes paid divided by share of income. My own analysis of this on the income tax is here.
  4. It makes more sense to focus on the fairness of the system today. Comparisons to the past, like the inequality stats, are fraught with measurement differences, especially pre & post the 1986 tax reform. Even Piketty and Saez’ empirical work, once thought to be beyond reproach, turns out to be riddled with convenient fake history inserted in spreadsheet cells instead of hard data.
  5. The system is most “unfair” at two points: 1) at the very low end where entitlements phase out and 2) and possibly at the very high end where the 95-99.5% get hit with full income taxation on their high salaries/bonuses and the 0.5% can structure around the tax code.  Whether we should or can do anything about that is another matter.  There is also clearly unfairness between those who are employed and those who control a business. The latter have much more latitude to find deductions, shelter retirement savings and structure income around the tax code.  The result is that the top half of the 1% is where ALL the action is:

    Even the bottom half of the top 1% (high earning professionals) haven’t seen major share growth.

  6. Unfortunately, the vast majority of the debate highlights this latter unfairness within the top 5-10% of the distribution, missing the boat entirely. Furthermore, such punditry is riddled with analytical traps, inconsistencies and outright pablum.
  7. I don’t think anyone should pay more than 25% of their income in taxes. Since I earn 95% of my income, I pay more like 45% (inclusive of state and RE, but not counting sales, tolls and other consumption taxes).  Forgive me if I don’t get all sentimental about paying more tax, or if I am cynical about it being used to actually reduce the deficit.  Surveys suggest that the vast majority of people think the highest fair tax rate is between 20-40% except, of course, that they themselves pay too much and clearly others are paying way less than this.
  8. When you own a tax-paying entity, the dividends are after taxes, thus it is double-taxation to tax most dividends.  A lower rate is appropriate here.
  9. However, taxing capital gains is not necessarily double-taxation.  This is mostly loophole and it would not be unfair to get rid of it.
  10. I think our tax system should be biased toward taxing consumption, not savings. Especially considering the savings drought ahead of us.
  11. I think more rich people would willingly pay more taxes if they thought it would create a permanent change for the better in the country’s fiscal situation, as opposed to providing more money to drunks.
  12. Our most pressing fiscal problem is entitlements that were not designed to handle our demographic future.  We can’t afford them. We can trim now or default later. The former is far preferable.
  13. A large portion of the change in measured income inequality comes from changes in household composition (double earners, for instance) and the increasing use of LLCs and S-Corps, which put business income onto personal tax returns.  This money showed up in corporate returns before.
  14. (more of a fact than a prior) Muni bond interest constitutes invisible tax income – it shows up as lower interest expense instead of higher revenues. Thus it is wrong to include muni income in the effective tax rate of wealthy people. That is after-tax income. However, the revenue is lost to the federal government and the savings accrue to state and local governments, so it functions as an intra-government transfer.

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