Counterparties: Broken tax breaks

May 30, 2013

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The Congressional Budget Office is out with a report that boils down the byzantine US tax code into something relatively simple: the benefits of taxes aren’t distributed equally. In fact, more than half of the total dollar value of America’s 10 largest tax breaks, deductions and exclusions go to the top 20% of American earners. 17% of these tax expenditures — including the mortgage interest deduction and preferential tax rates for capital gains — go to the top 1%.

Meanwhile, the middle class and poor get relatively few such benefits from the tax code: 8% of the value of these tax expenditures goes to the middle quintile and 13% go to the lowest-earning quintile.

Gawker takes the populist angle on this: “Surprise: The Tax Code Mostly Benefits the Rich”. Derek Thompson has a headline tweak: “Right headline might be: Here’s What Happens When You Have a Progressive Tax System With Lots of Breaks in a Top-Heavy Economy”. And the CBO itself points out the poorest Americans get benefits equal to 12% of their after-tax income, while the top 20% of earners get benefits equal to roughly 9% of their income. (Regardless of which metric you use, the middle class gets screwed by the tax code.)

Kevin Drum thinks the CBO’s calculations distort the picture a bit. Lower tax rates for capital gains and dividends aren’t really tax expenditures, Drum writes. And the CBO ignores the value of the standard deduction to the lower and middle classes. As a result, Drum argues, the CBO makes the tax code seem more tilted toward the wealthy than it really is.

Whatever method you use, the tax code matters — which is one reason why reforming it has been so politically fraught. The 10 largest expenditures total $900 billion, or 5.7% of GDP, the CBO says. As Dylan Matthews notes, over a decade these expenditures cost nearly $12 trillion. That’s more than Medicare, defense, or Social Security.

The tax code has also had an unusually dramatic impact on the structure of American society. A new Piketty-Saez paper looks at why income inequality has grown in America at a far faster rate than most other rich nations. The answer: the 1% have more than doubled their share of American income in the past 30 years in large part because of tax policy. As America’s top tax rate has fallen, income inequality has soared, they find. – Ryan McCarthy

On today’s links:

America’s paper of record considering a pivot to America’s sponsored content provider of record – Edmund Lee

Second Acts
David Petraeus joins KKR for some reason – Jonathan Chait

Fannie Mae’s former CEO sleeps just fine, thank you very much – Max Abelson

Crisis Retro
The only group that’s skirted criticism over the financial crisis? Shareholders – Jesse Eisinger
Shareholders are selfish jerks – Matt Levine

Tax Arcana
How one Irish accountant helps Apple save tens of billions – Guardian

Bold idea: Give the poor money – Matt Yglesias

Wait, the “start-up nation” trend-mongering may have been just a trend? – WSJ

“Morgan Stanley Lowers Ambitions” – WSJ

Consumers’ attitudes toward the stock market have done a 180 in the last year – WSJ

Enough with the anecdotes, there isn’t another housing bubble – Ryan Chittum

How Goldman sailed around maritime law – WSJ

The nation’s largest oil store almost got hit by the Moore, Oklahoma tornado – Climate Wire

Follow us on Twitter and Facebook. And, of course, there are many more links at Counterparties.


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“(Regardless of which metric you use, the middle class gets screwed by the tax code.”

I think we’ve reached the point on tax policy debate where there are no undecideds left and reasonable polite people just waste each others time trying to explain how totally off base the other side is… but I just can’t help myself.

My wife and two children are somewhere between the 65th and 70th percentile (for a U.S. household, 92% globally.) We pay less than 10% of our income in Federal income taxes. Less in percentage terms than Warren, Mitt, Richy Rich, and Daddy Warbucks.)

As many frequent commenters, and other progressive thought leaders point out, we are also burdened with payroll taxes. These “middle class screwing” payroll taxes however offer us the statistical promise to collect a benefits stream worth substantially more than the taxes my wife and I will pay in over our working lives. (SS pretty close but not quite, but medicare offering almost a 2 to 1 return.)

Middle Class Childless renters who forgo health insurance and don’t save for retirement get screwed.

Middle Class Home-owning parents building a nest egg while providing their family with health coverage get off nearly scotch free.

Which of those two groups do you think rely on government to cover the tail risks and black swans of life?

The very simple truth Paul Krugman (and the rest of the 60% majority) doesn’t seem to see is the current level of benefits were only affordable with a large pool of workers supporting a small pool of non-workers. Look across the pond for gods sake Europe is 10 years ahead of us on the demographic curve they tax their population at far higher levels than we do and all that sacrifice in the name of fairness gets them is rioting in the streets!

Posted by y2kurtus | Report as abusive

@y2kurtus, when you add the employee and employer contributions to Social Security, what is the implied rate of return?

Because the calculation of accruals is tiered, those below the median make out quite well. Those above the median are promised barely more than they put in. The nominal value might be greater, due to inflation, but that doesn’t make it “substantially more than the taxes paid”. My personal investment accounts have almost tripled over the last decade. In real terms they have more than doubled. The money “invested” in Social Security doesn’t grow at all.

And that’s assuming that the benefits are actually paid as promised. As long as there is no long-term strategy in place to pay for Social Security and Medicare, I have to presume that the benefits will be reduced for some recipients. As long as we work to save and provide for our own retirement, I have to presume that the benefits will be reduced for us personally.

A tax is a tax. We might get something back from Social Security and Medicare eventually, but it won’t be more than we put it. What you describe is a Ponzi scheme, mathematically impossible.

Posted by TFF | Report as abusive

Off the cuff, a Ponzi scheme is a system in which “investors” are promised/paid returns that exceed the actual gains on “investments”, by repaying old investors with contributions from new investors. A Ponzi scheme works as long as the number of investors increases sufficiently rapidly to balance the cash flows, after which it collapses with massive losses since nobody wants to invest in a scheme that is already bankrupt. Ponzi schemes generally collapse long before they run out of assets. They collapse when people realize that the underlying assets are insufficient to pay the promised benefits.

So how does this compare to Social Security? Current retirees are paid with contributions from current workers. The benefits paid are nothing exceptional, but they are still greater than what the underlying investments (Treasury bonds) have any hope of supporting. The system can only continue as long as the working population continues to increase rapidly.

Over the last 40 years, the working-age population has increased 70%, almost 1.5% per year. Employment has increased even faster. Over the next 50 years, the working-age population is projected to increase just 20%, less than half a percent per year. And if recent trends are any indication, actual employment will lag even that. Meanwhile, the population over the age of 65 will double. Social Security has hit its demographic inflection point — going forward, benefits paid will exceed taxes raised.

I know that there are fiscal “solutions” for this. Receipts will continue to be at least 75% of outlays. In theory, you can solve this by raising receipts by a third (as long as you don’t also promise to pay more money). Lifting the cap on Social Security contributions, taxing investment gains, means-testing benefits, and so forth… There are many possible answers.

Yet it already requires smoke and mirrors to claim that the promised benefits exceed the taxes paid while working — if you run the calculations for an above-median family, including both employee and employer contributions, and factor in a reasonable IRR, then the promised benefits are worth less than the lifetime contributions. Cutting benefits, or increasing contributions, will only make that gap more obvious.

Go ahead and treat Social Security as a necessary (and affordable) safety net, to ensure that our elderly don’t end up on the streets after they are no longer able to work. I grok that! But it is insulting my intelligence to pretend that my future benefits will be more than my contributions — and mathematically impossible for that equation to work across an entire society.

Posted by TFF17 | Report as abusive

@TFF17: “But it is insulting my intelligence to pretend that my future benefits will be more than my contributions — and mathematically impossible for that equation to work across an entire society.”

Not if you assume national productivity increases.

[To simplify the power of compounded productivity increases: imagine a breakthrough technology that occurred tomorrow - robust, controllable AI in a cheap, powerful robot. Wouldn't that nullify your assertion?]

Posted by SteveHamlin | Report as abusive

@SteveHamlin, productivity increases simply kick the can down the road. You need large increases EVERY generation to resolve a Ponzi scheme that way.

Moreover, Social Security is paid on wages, not GDP. A breakthrough technology such as you suggest would benefit the corporations more than the wage workers — and thus would do less to repair the Social Security equation than you imagine.

Restoring the capital/labor balance in this country would go a long way towards fixing Social Security for another generation, but I’m presuming that is off the table. The concept that wealth is best concentrated in few hands is too firmly entrenched in the political culture today.

Posted by TFF | Report as abusive

@SteveHamlin: God forbid anything like “robust, controllable AI in a cheap, powerful robot”.

The resulting 90% unemployment rate wouldn’t help anybody, except the Chinese robot manufacturers.

Posted by upstater | Report as abusive

What the country needs is a flat tax: everybody pays 10% except for the indigent. Unfortunately we can’t get a majority of our US Congress to approve it because they are controlled by the campaign money provided to them by our rich and powerful corporations and individuals. There is only ONE way to make a flat tax happen and that is when enough people sign the petition

Posted by Flounderbay | Report as abusive

TFF you are right that the “return on social security” is minimal in real terms. It is absolutely a ponzi scheme, with the possible exception that the scheme is completely transparent with a full current accounting and well modeled projections published for all to see.

The reason that currently working generations will consume more than they contribute to retirement programs is a multi part answer. You already hit the first part with population increases… something we can continue to count on for decades to come… albeit at a slower rate. Productivity increases also help some. But what exactly do you think will happen in 2033 when the trust fund is exhausted. Do you think 50 million seniors are actually going to get 78% of what they were promised?

No… the bill for social security will be paid in full with income taxes, corporate taxes, mineral royalties, wireless spectrum auctions… hell we might even have a carbon tax by then.

My original point stands firmly rooted in truth, unyielding to the populist myth of an overtaxed middle.

The middle class pay some taxes as a group… roughly 10% of their income; a far lower rate than the rich. They also pay in less then they take out in elder benefits but it’s a closer case than the working poor who pay no federal income taxes as a group and get an even better deal on entitlements.

The only middle class people who get screwed by income taxes are the people who are most likely to need government help to get through life. People who don’t save for retirement will buy groceries with food stamps. People who don’t have health insurance shift cost to those who do. People who don’t own their homes can’t trade down and scrape by on the equity for a few years… some of those people end up paying their rent with a section 8 voucher.

The tax code generally rewards socially desirable behaviors. I’m not saying the mortgage interest on that 2nd home should be deductible or that the government should give you another credit for your 4th or 5th child, but generally the tax expenditures promote the American dream.

Posted by y2kurtus | Report as abusive

“But what exactly do you think will happen in 2033 when the trust fund is exhausted. Do you think 50 million seniors are actually going to get 78% of what they were promised?”

I expect that 40 million will receive their promised benefits, and the 10 million who can most afford it will receive sharply reduced benefits. The difference will be made up through the additional taxes that you mention. I certainly hope and expect to be among the top 20% that loses benefits, as the alternative is worse.

The middle is not particularly overtaxed. The greatest tax burden falls on two-earner families making between $100k and $200k. They phase out of the middle class tax breaks. They pay Social Security on the majority of their earnings. They fall squarely in the 25% tax bracket. Sure, they stand to benefit from the mortgage interest deduction and the retirement account deductions, but they still pay a marginal rate on their income pushing 50% (when you include state taxes) and an overall tax burden that is greater than those on either side of this range.

And this is the group that I expect to lose Social Security benefits. After all, they can afford it.

Posted by TFF | Report as abusive

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