The Learning Curve

New tricks for an old dog.

Federal income tax policy – doing the math

By Federal income tax, I mean every Federal tax withheld from a person’s paycheck. This includes what is commonly called income tax plus the Medicare tax and Social Security tax on earned income.  I use the phrase “doing the math” to mean using MoneyChimp’s quick tax calculator, and adding in the Medicare and Social Security taxes.

My idea is to get a representative  snapshot view of present Federal tax law to better understand the current budget debate in Washington.  My method is to compare the Federal taxes paid by low, middle and high wage earners, plus taxes paid by the wealthy.  This is the working definitions for these four categories:

  1. Low wage earner – $25,000 annual taxable earned income;
  2. Middle wage earner – $70,000 annual taxable earned income;
  3. High wage earner – $500,000 annual taxable earned income, and;
  4. Wealthy – $500,000 annual taxable unearned income from passive investments.

For simplicity, I assume that individuals in the respective categories file Federal income tax returns as single individuals with one exemption, that the earned incomes are all from self-employment, the unearned income is from qualified dividends or long-term capital gains, and that in each case only the standard deduction is claimed. Long term capital gains are earnings from investments held for more than a year, and (simplified) qualified dividends are from investments held for more than sixty days.

Here are the results expressed as a percentage of taxable income paid to the Federal government:

  1. Low wage earner – 23%;
  2. Middle wage earner – 31.5%;
  3. High wage earner – 35.4%, and;
  4. Wealthy – 13.7%.

If the focus of the debate is the relative tax burden shouldered by different economic groups, the numbers fairly speak for themselves, with a half-million dollar wage earner paying only about twelve percent more Federal taxes than a middle class wage earner, and a denizen of the trust fund world paying only sixty-eight percent of the Federal taxes required of a low wage earner.

If one takes a wider view of these facts from a policy perspective, several considerations emerge:

Long term investments for preferential capital gains and dividend treatment is not defined to mean “long-term” by any normal use of the words. Income from investments qualify for lower tax rates relatively soon. This plays to the quick-buck and quick-fix mentality that has yielded many of the social and individual problems we face. One year is not long-term investing, or thinking. Cf: The oak beams of New College.

By rewarding passive investments over active individual effort, Federal tax policy enshrines an ideal best expressed by John Gardner in his novel Grendel, as stated by the monster which I paraphrase, “The goal in life is to amass a pile of gold and then sit on it.”

Wealth creation and wealth accumulation are different processes.  Federal tax policy strongly favors wealth accumulation by individuals, but it does so with a very short-term investment horizon.  This puts pressure on financial markets to produce short-term profits, frequently at the expense of long-term development.

The economy is driven by consumption.  The lower an individual’s income level, the higher is the percentage of income that goes to current expenditures, of necessity. In nearly all jurisdictions, consumer spending is also taxed by way of sales taxes, use taxes and value added taxes.

The picture briefly sketched here shows existing Federal tax policy places the greatest burden on those least able to carry it. Over the last thirty years all reasonable meaning behind the idea of progressive taxation has been abandoned. The suggestion that those who are economically best able to pay the costs of social and governmental functions should pay more is dead, and the current political debate in Washington merely confirms the age-old wisdom that it is impossible to satiate a pig.  Attempting to do so is not a sustainable option.




Written by Tom Fox

04/12/2011 at 11:47 am

Posted in Politics

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