Saturday, March 08, 2008

It’s Time to Talk about Progressive Taxation

Last night I watched Matewan. It is a good movie. Chris Cooper gives a very effective performance as the Union organizer. But the movie is very disturbing. The mining company treated the coal miners as chattel. When the miners went on strike, the company brought Blacks in as scabs. (James Earl Jones is also very good as the leader among the Black miners, someone with real spine.) After the Black and Italian miners joined the other miners in the strike, the company brought in ruffians, dressed in suits and calling themselves the law, to terrorize the miners. There was a Judas among the strikers who worked with the company thugs. He made things even worse. All were on edge and much violence ensued. The miners learned they had to stick together and stand up for themselves collectively. But even with that, they suffered horribly and many of their brethren were killed.

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The Clinton-Obama struggle to be selected as the Presidential candidate for the Democratic Party has become emblematic of class warfare, with the working class (annual income under $50K, as represented by the electorate in Ohio) squarely in the Clinton camp and the middle and upper classes just as squarely for Obama. The party is unified against Bush, against the war in Iraq, and against the notion that government can’t solve problems. But it is divided along income and class lines. The division is not as stark as it was in Matewan, but if it persists it could be the source of the Dems snatching defeat out of the jaws of victory, something that seems to be on the minds of the many in the party.

While health insurance has been a big deal issue in the campaign, there has not been a broader discussion about social safety net and promoting worker mobility that is necessary for our economy to function efficiently. Perhaps the right answer for the unemployed in Ohio is for them to move to where the new jobs are likely to be. But who should bear the costs of that move? And who should bear the costs of those who stick it out in Ohio trying to find other work? Those are the questions that should be debated. But so far, they haven’t been.

The candidates have also been disingenuous on the issue of taxes, each calling for a middle class tax reduction, to be financed by increased taxes on the very wealthy. It sounds nice, but I don’t think it will cut it policy-wise, and it won’t unify the party. Instead, we need to abandon this Robin Hood type of thinking and move toward a vision of shared responsibility. I believe that is only possible if we voters ourselves communicate the desire to participate in that vision. In the rest of this post, I’ll draw out how it seems that should happen from my position as a taxpayer. If there are enough others who think along the same lines, those ideas will provide the source of the solution, a move toward unity in conception.

I finished doing my taxes last weekend. I used Turbotax Basic for that and based on the results from my return plus a bit of knowledge about how the marginal tax rates vary with income, I will give what I hope is an easy to understand analysis. Then I’ll draw some conclusions from that.

My family is in the bracket where the marginal tax rate is 28%. (University employees in Illinois belong to SURS, and income withheld for retirement is tax deferred, so does not count in calculating the marginal tax rate.) I would call myself middle class, but perhaps based on this information some might term that upper middle class. Regardless, the key observation is that my family’s average tax rate is less than 16%, which is much lower than the marginal rate. Between exemptions and, more importantly, itemized deductions we get to shield a good chunk of income from taxation. If we took the standard deduction instead, our average tax rate would be about 19%. My sense is that for fairness considerations, a family in my tax bracket should have an average rate of about 20% or perhaps a bit higher. A 4% increase in average tax rate on a taxable income of $150K is an additional $6K in taxes. That’s the magnitude of tax increase I’m talking about for families like mine.

The biggest part of our exemptions are related to housing, the mortgage interest deduction and the property tax deduction. My sense is that both of those should be capped much more tightly than they are now. (The proposals by the Bush panel are not nearly severe enough.) If you look at the underlying rationale for these deductions (this is the same rationale for why the sub-prime loan market should exist) they are ostensibly to promote the American Dream – families should live in their own homes; we should be a nation of homeowners, not of renters. It’s a nice aspiration. Yet I learned some time ago that in the name of income redistribution ideas aimed at benefiting those of modest income, in actuality we end up redistributing income in the other direction. This is a case in point.

Champaign-Urbana is probably not the best place to illustrate this problem, since housing prices are modest relative to those prices in larger urban areas. So for illustration follow this link to find some home listings in Naperville and then mouse over some of the home icons. At these prices a million dollar mortgage seems natural, even low, and with a 6% interest rate, about the current rate for a 30-year fixed rate mortgage, that is $60,000 of deductible income. That deduction is in excess of the total income of the typical Clinton voter. So people who can afford to live in Naperville get a huge tax break. Obviously, that’s a private benefit to those people. But what social benefit does it create? I’d argue there is no social benefit whatsoever. Indeed there is some harm created in that this bids up the demand for mortgages makes rates higher than they’d otherwise be and ditto for home values. Each of these effects makes it harder for lower income folks trying to purchase a home.

The mortgage on our house in Champaign is much smaller, a million dollar home here is still comparatively rare, yet our mortgage nonetheless produces a substantial shrinkage in our average tax rate and the point remains that the benefit is purely private, not social. We’d own a home anyway, with or without the deduction. (Without the deduction we might have opted for a smaller home or to have stayed where we used to live at a more rural address where property values were lower.)

The argument is that where tax breaks don’t produce some social benefit and where they are skewed toward middle and upper income individuals, they should be reduced if not eliminated outright. And in making the case for this point I’ve not yet even mentioned capital gains as income and how capital gains are (not) taxed. (This type of income is even more skewed in favor of high income earners than the mortgage deduction.)

Tax policy as a political issue has been the province of the Republicans, not the Democrats. That needs to change. But politically it can’t unless people in my bracket (and in the higher brackets too) willingly accept an increase in their average tax rates as a necessary burden to bear, to help those who are more needy.

Even if socially there has been great harm from the rising income inequality in society, people in the higher tax brackets have gotten a private gain from the tax policy changes that started with the Reagan Presidency and continue to this day. So in the jargon of the economist, the question is what is their willingness to pay to see inequality reduced? In my opinion, the candidates won’t go near this question until we in the electorate hash it out for ourselves for a while.

If the candidates are to take their lead from us on anything, this is the issue where that should happen. Otherwise, all they’ll do is pander to us. And what has been an entertaining and energizing race until now, will come to naught.

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