Friday, June 01, 2012

Income Tax Solution: Apply Social Security Taxes to the Super-Wealthy

The merely wealthy already pay 70% of Federal income taxes; the evaders are the super-wealthy in the top 2/10th of 1%. 

Arriving at a "simple" solution is a complex process. Yet there is no other pathway to a comprehensive solution. If we attempt to address complex problems with equally complex solutions, we get friction and crony capitalism as cartels navigate the complexity to their own advantage and small enterprises and the citizenry are reduced to serfs toiling outside the complexity-moat. ( Complexity and Collapse July 26, 2011)

In terms of our response to financial crisis, compare our financial-sector fix of 1933, the Glass-Steagall Act (37 pages of legislation) and the current Dodd-Frank Wall Street Reform and Consumer Protection Act (2,319 pages of legislation). Does anyone seriously think these 2,300 pages of legislation and the thousands of pages of regulations the bill spawns will 'fix" what's actually wrong with America's financial sector?

Stripped to its bones, Dodd-Frank is a massive power grab by the Federal Reserve (via the Orwellian "consumer protection" part) and a vast complexity-moat that protects the very industry it supposedly tames. "Simple" doesn't infer simple-minded, but the opposite: the ability to cut through distracting jargon and ideological rigidities to the heart of the problem, and devise a response that any reasonably informed citizen/taxpayer can grasp at a glance.

If the "reform" further complicates and obfuscates the problem, it is not a solution but another layer of problem burdening the nation.

We all know the current tax code is a complexity moat benefiting the super-wealthy financiers and the tax and accounting industries that live off the 5,296 pages of mind-boggling complexity. The total package of tax regulations and explanations weighs in around 70,000 pages, and attempting to comply with all this feeds one of the nation's largest industries, the equivalent of 3.8 million full-time workers toiling year-round on tax-related tasks.

We also know that those benefiting from this complexity moat have the money and will to kill any real reform: Why Congress Won't Simplify The Tax Code.

A complex solution to the tax code complexity is not an answer, it is merely an extension of the root problem. There is another vast industry which benefits from rejecting straightforward solutions and arguing over how many angels can dance on the head of the tax-code pin: The Argument Industry: Hyping Controversy and Avoiding Solutions Is Profitable
(May 25, 2012).

Any straightforward solution is instantly shredded by the whirling blades of various ideological obsessions and then buried with enough riders and adjustments that it becomes just another version of the impossibly complex code it was supposed to replace.

That is the backdrop to my proposed solution to the tax code's other problem. Most people think the problem with the current tax code is that wealthy people don't pay "their fair share." This is not quite accurate: if we say the top 10% of earners are "wealthy," it turns out they shoulder most of the income tax burden. (Where Do You Rank as a Taxpayer?)

The top 1% of taxpayers reported almost 17% of all taxable income and paid 37% of all income taxes. The top 5% reported 32% of all income and paid 59% of the taxes, and the top 10% earned 43% of the income and paid 70% of the taxes. The top 25% (those earning more than $66,193) paid 87% of the taxes.

The bottom 50% of taxpayers, roughly 70 million people, earned 13% of the income and paid 2% of the income taxes collected. Almost 50% of the workforce pays no income tax and ponies up only the employees' 7.6% half of Social Security and Medicare taxes.

Clearly, the tax system is progressive: those with higher incomes pay a disproportionate share of the income taxes. Social Security/Medicare taxes are of course paid by low-income workers who pay no income tax, but this amounts to 7.6% of income--not zero, but not too punishing compared to Federal tax rates which climb to a steep 25% at the relatively low level of taxable income above $35,350.

Those who earn more than $106,000 annually in earned income get a break, as Social Security contributions are capped at $106,000 ($110,100 in 2013). Many people see this as an unfair break, but we need to balance this against the very progressive income tax high earners are already paying as they make more income.

In 2013, the tax rate paid by the middle class, those with taxable incomes between $35,350 and $85,650, jumps to 28%. Above $85,000 the rate moves up to 33%, and the rate for the top 4% (roughly speaking, those with taxable income over $178,000), climbs to 36%. The top rate, for incomes above $178,650, moves to 39.6% (heck, why not just say it's 40%? It's not like something's on sale here....)

It seems to me that the cutoff point for Social Security contributions should align with jumps to higher tax rates. Is that too much to ask? The only possible justification for limiting Social Security contributions is that high-income taxpayers are paying much higher rates of income tax. Shouldn't the cutoff align with the jump to higher rates?

The only slice of taxpayers who are getting away with murder are those with minimal earned income and vast earnings in capital gains and other unearned income taxed at lower rates. You know, the Mitt Romneys of America who have bought control of the tax code via political contributions so they can declare their gargantuan financial-skimming incomes as long-term capital gains taxed at 15% rather than as earned income taxed at 35% or 39.6% (assuming the Bush-era tax cuts go away as planned at the end of 2012).

The number of people earning millions of dollars in unearned income is more like the top 2/10th of 1%, not the top 1%, many of whom report earned income and pay about 1/3 of all income taxes paid, as noted above.

The straightforward solution to get the top 2/10th of 1% to pay their fair share is to apply the Social Security and Medicare taxes to all unearned income above $250,000.The basic rap against progressive income taxes is that they punish the most productive, and this is certainly an issue when taxes push above a threshold where it makes sense to work less and earn less.

The goal here is to separate the merely wealthy, who already pay most of the taxes, and the super-wealthy, who earn millions in unearned income that is taxed at less than half the rate paid by high-income earners and us self-employed people.

So let's guess that $250,000 per taxpayer will separate the typical small business owner or investor from the super-wealthy.

In other words, if J.Q. Taxpayer manages to earn $250,000 a year in long-term capital gains, these long-term capital gains would be taxed at the current rate (which moves up to 18.8% in 2013, as 3.8% healthcare taxes are added. Some sources say the long-term rate will revert to 21.2% and the 3.8% healthcare tax would bring this to 25%). Couples could thus earn $500K annually in unearned income and pay the lower rates.

How many households earn more than $500,000 in unearned income annually? Recall that this is not counting earned income: this is income from rental properties, capital gains, etc. (Income from rental properties is already taxed at the same rates as earned income, so the real tax break is for long-term capital gains.)

Recall that the total Social Security tax paid by self-employed people like myself is 12.4%. Add 2.9% Medicare taxes brings the total to 15.3%. Self-employed income above $35,350 is taxed at 15.3% + 25% = 40.3%. (How do you like them cookies, Mitt?) If all unearned income above $250,000 annually paid this 15.3% plus the rate for long-term capital gains, then the Mitt Romneys of the nation would at least be paying around 35%--less than self-employed tax-serfs like myself, but considerably more than the 17% average tax the super-wealthy currently pay.

I know this proposal steps on every ideologically sensitive toe in the land, but if the tax code cannot realistically be changed on a wholesale basis, then why not move to a straightforward plan that gets the super-wealthy top 2/10th of 1% to pay something approximating the 40% rates paid by self-employed stiffs?

The other alternative being floated, the "Buffet rule," would jack long-term capital gains rates to 30% above a high-income threshold. This is another approach to bring the super-wealthy's tax rate more in line with what self-employed and upper-middle class workers pay. I support any plan which is designed to re-align taxes paid by the top 2/10th of 1% with the real rates paid "by the rest of us."

Should taxes be lower? Yes. The best way to lower the total tax burden, including the costs of tax compliance, is to radically simplify the tax code and eliminate entire swaths of sheltered income reserved for those with enough money to pay Panzer divisions of tax attorneys to convoy wealth to the Bahamas or other tax havens.

Is that possible? In a political arena where the gladiators are all for sale to the highest bidder and voters keep returning the same gladiators to the arena: no.

My latest conversation with Gordon T. Long, on Crony Capitalism: (YouTube)

Resistance, Revolution, Liberation: A Model for Positive Change (print $25)
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We are like passengers on the Titanic ten minutes after its fatal encounter with the iceberg: though our financial system seems unsinkable, its reliance on debt and financialization has already doomed it.We cannot know when the Central State and financial system will destabilize, we only know they will destabilize. We cannot know which of the State’s fast-rising debts and obligations will be renounced; we only know they will be renounced in one fashion or another.
The process of the unsustainable collapsing and a new, more sustainable model emerging is called revolution, and it combines cultural, technological, financial and political elements in a dynamic flux.
History is not fixed; it is in our hands. We cannot await a remote future transition to transform our lives. Revolution begins with our internal understanding and reaches fruition in our coherently directed daily actions in the lived-in world.

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