Comparing British and US Tax and Income Concentration

There's a very good short opinion piece in the NY Times written by DeAnn Julius about why she opposes the tax hike on the rich in Britain but believes the US is different.  Now, I'd like to add that with all of our loopholes marginal rate hikes are likely to be far less effective in the US than in Britain, loophole closing is what we really need to do (and why I'm currently annoyed with the Democrats for making Obama's good but imperfect plan rather worse).  Here's what happens if all tax expenditures are eliminated.

She points out that the top 1% of earners receive 11% of income and paid 21% of personal income taxes.

I'd like to add numbers for the US from the Tax Policy Center.  The top 1% receives 16.8% of income in the US and paid 25.6% of all taxes.

Of course, these figures aren't directly comparable because of differences in other taxes, such as US Social Security and Medicare taxes vs. UK National Insurance Contribution.  US payroll taxes account for 42% of US Federal revenue compared to 17% for UK's NIC (I don't really know which sources to use for UK data, it doesn't come up often).

For just US income taxes, we actually look worse for income taxes than the UK, the top 1% pays 34.3% of the individual income tax, compared to the UK's 21%.  However, they pay only 4.1% of the payroll tax which is 42% of Federal revenue compared to 44% for the income tax (I don't have figures for the UKs overall taxes or for the share the top 1% pay for NIC).

A few things to point out here.  First of all, I wish I had total tax shares for the UK.  Given the poor comparability of the data making a comparison is somewhat difficult, but given the large size of payroll taxes relative to government revenue in the US it seems the US wealthy are paying a somewhat smaller share of tax compared to their share of income in the US.

Perhaps the more important takeaway though is that while there is some concentration of income in the top 1% globally, the US is really an outlier, receiving a share of income that is 5% larger than in the UK, which is known as one of the most unequal in Europe.  As much as I dislike Occupy Wall Street for a variety of reasons their central grievance is very real, wealth concentration is occurring at unprecedented rates in the US and this is a US specific phenomenon and partially, or perhaps largely, due to policy.  Taxes are one tool to help combat this. 

Bumper Sticker Tax Reform

So, while I was writing my last post more details on the Reid proposal were announced.  As I suspected, it's far worse than Obama's original plan.  It's just a 5% surtax on incomes over $1 million.  I'm not opposed to a surtax but this is a bit steep.  I'd prefer 0.5% or 1% hikes on each order of magnitude over $1 million (so 1% on $1 million, 2% on $10, etc.).  The only advantage this plan has over Obama's is that it fits on a bumper sticker better.

The big problem with this though is that given the current number of tax expenditures in the US tax code simply imposing higher rates without closing loopholes just increases their distortionary effects.  Obama's plan did a decent job closing some of the worst incentives in our tax code, though missing the property and health deductions were problematic since this is two areas where the deduction is most likely to lead to cost inflation and resource shifting with no compensating gains.

Unless something really exciting comes up my next post is definitely on how current political dynamics screw over small business owners and possessors of high levels of human capital most of all.  This comes out particularly strongly by the Democratic party proposals.  In particular, I've got these comments in mind:

Democratic leaders said they believed that the new proposal would win support from Democratic senators like Mark Begich of Alaska and Mary L. Landrieu of Louisiana, who had expressed reservations about some of the tax changes in the president’s plan. It was not immediately clear whether the proposal would gain backing from moderate Democrats like Senators Joe Manchin III of West Virginia, Ben Nelson of Nebraska and Claire McCaskill of Missouri, who are running for re-election.

The window dressing about small business owners is BS.  If they were serious about tackling big business the carried interest deduction elimination would have been retained as would have some of the insurance company changes as well as the oil and gas tax deduction changes.  This is clearly a handout to America's biggest businesses, finance and natural resources.  Small business owners are getting screwed by this relative to Obama's plan.

Some Suggestions on Funding the Jobs Plan

Apparently Senator Reid doesn't like Obama's tax plan and wants the rich to pay for it.  Obama's plan seemed like a pretty good first cut to me, we'll have to see what Reid proposes.

I'll add my two cents:

In the United States, homeowners are afforded several generous tax preferences. Mortgage interest and local property taxes are deductible from taxable income, large exemptions are permitted for capital gains earned on the sale of a home, and imputed rental income is untaxed. According to the Office of Management and Budget, these tax expenditures are worth $167.3 billion in 2010 (Office of Management and Budget 2010), making tax expenditures for homeownership one of the largest in the tax code.

[Source: http://www.taxpolicycenter.org/UploadedPDF/1001364_reforms_metro_housing.pdf]

In this paper, we estimate the distributional effects of two of the three largest tax expenditures – those for deductibility of mortgage interest and state and local property taxes. Under current law, homeowners may deduct mortgage interest and property taxes on their homes even though the homes generate no taxable income. (The exemption of net equity returns on homes is also counted as a tax expenditure item by OMB, although not by JCT.) These deductions provide a substantial subsidy to owner-occupied housing to taxpayers who itemize deductions. A number of analysts have argued, however, that these tax provisions do little to increase homeownership, but instead provide an incentive for middle and upper-income taxpayers to own bigger homes (Mann 2000; Gale, Gruber, and Stephens-Davidowitz 2007; Poterba and Sinai 2008).

See pages 8 - 11 for distributional effects.

The 2010 Federal Budget lists six permanent tax expenditures for health insurance and health care expenses for individuals. These provisions (and their 2012 estimated revenue losses) are: exclusion of employer contributions for medical insurance premium and medical care ($184.9 billion)9, deduction of health insurance premiums for the self-employed ($7.5 billion), tax preferences for medical savings accounts and health savings accounts ($2.2 billion), deductibility of medical expenses ($14.8 billion), a refundable tax credit for health insurance purchased by certain displaced and retired individuals ($0.2 million)10, and exemption of distribution from retirement plans for premiums for health and long-term insurance for public safety officers ($0.4 billion).

See page 12 for distributional effects of eliminating most of these provisions.

Rather than eliminating them, I'd suggest capping the amounts that can be deducted, indexed to inflation.  This would fulfill Reid's goal of raising taxes on the rich while reducing the distortions in our tax code.  While this taxes the rich heavier, it primarily gives an advantage to wealthy individuals competing unequally with other wealthy individuals with certain consumption habits.  The current tax code tends towards disadvantaging professionals who get their high incomes through labor and small business owners.  It advantages those who get most of their income through capital.  Raising the capital gains rate and eliminating many corporate tax expenditures (while lowering marginal rates) would be another way to address this problem.

The argument for raising taxes on the rich isn't really all that good.  The argument for raising the taxes on some rich people who take the most advantage of distortionary tax incentives is, however, excellent.

Some Perspective on Federal Debt, Revenue, and Spending

I was playing around with the US Statistical Abstract and thought I'd publish this chart.  Note that there isn't any huge variations in spending or in revenue.  We get a bit of a divergence in the 1980s where both spending rises and revenue falls, this has the predictable impact on the debt.  GDP figures would have helped with this graph but I couldn't make them look good on it.  Main thing is that spending and revenue have diverged over the past 30 years which as led to a sustained debt problem.  However, this problem remains smaller than that from WWII and is likely less destructive of overall productive capacity than that war.  Raising taxes to cover the debts will likely cost some small amount of growth, but this has been done in the past with no major harm done to the economy, look at the 50s and 60s. 

This is the reason I'm not all that worried about the debt problem, but am very worried about the revenue problem.  We remain within historical ranges on these factors which gives me confidence we can overcome them.  However, over time international competitiveness has demanded increased spending on productive public goods such as health spending.  This requires more efficient, and somewhat more, taxation to pay for it.  I am worried the political consensus that allowed us to overcome our problems in the 50s and 60s is not there today.  The left-right divide then was different directions within a shared paradigm, today, the right has defected from the paradigm of Eisenhower and this makes it difficult to address these problems.

Just Plain Old Pound Foolishness

I just really couldn't believe this, well I could, but I wish I couldn't.

It's really amazing how we hear so much about cutting spending but when it comes to the programs that actually cost lots of money those calling for cutting deficits always oppose cutting spending.  The latest instance (the rest of the article covers about what I'd expect from a starting negotiating position, however this particular aspect should be something that any group  of rational individuals could agree on):

Federal health officials would have to curtail research comparing the effectiveness of different treatments for the same illness or injury. The Obama administration says such research can improve care. Many Republicans fear the results will be used to deny coverage of expensive treatments.

Comparative effectiveness research and associated rule-making is perhaps the single best way to save money in both the public and private sectors of health care.  If our goal is to save money and/or improve care, this research is essential.  Even if there is no concern with money having data on which treatments are more effective will help to alleviate pain and suffering.

This is just further evidence leading me to believe that there is no real intention to cut spending.  There is simply an ideological opposition to social programs.  The goal is similar to that of the Ryan plan, privatize everything despite nothing but flimsy evidence based on heroic assumptions that the policies will lead to overall savings.  Cutting spending has just become a polite term for opposition to social programs.  If they wanted to cut spending, why is there no support for more efficient alternatives or cost saving measure to existing programs?  It just doesn't make sense if the motivations are as claimed.

Pennywise, Pound Foolish

I just read one of the most disappointing stories I've read in awhile in the NY Times.  Unsurprisingly the State Department's budget is expected to be on the chopping block as we seek to trim spending.  This is a key example of something I've said frequently, the incentives involved in making immediate cuts to spending means that politicians will be prone to making cuts in ways that reduce immediate spending but raise long term costs.  It doesn't help that many of the politicians involved in deciding on these cuts have ideological beliefs regarding spending that make them blind to potential benefits.

Foreign aid is one of the most cost effective means America has in projecting its power.  It's effectiveness is difficult to assess properly, it is hard to put a concrete value on relationship building and public perception.  It can also be done sufficiently poorly as to be counter-productive, such as when US foreign aid flows through a hated regime that we become associated with through our giving.

That said, the pay-off from having foreign support is tremendous.  Contrast the cost of the war in Libya ($896 million) to the cost of the wars in Iraq and Afghanistan (~$800 billion and $460 billion respectively).  While it's hard to untangle precisely why the Libyan public had a favorable view of the US while the Iraqis and Afghans didn't have similarly positive views* it is illustrative of the kind of difference public opinion can make on achieving strategic objectives.

A country that is seeking to get its economic house in order and to reduce spending should be reallocating resources away from the military and towards economic and diplomatic means.  A shift away from foreign aid is the worst kind of thing we can do if our goal is to balance our budget.  This is just another piece of evidence that makes me believe that the deficit cutters have little concern with actually balancing the budget and far more concern about making this country fit their ideological vision.  This behavior is the exact opposite of what a country seeking a foreign policy within its means should be doing.

*It's not like we were giving a lot of aid to Libya, but we had been pressuring them diplomatically to open up for awhile.  We have also been very active in the Mideast, particularly in neighboring Egypt.  It's easy to see why Afghans weren't crazy about us since we did so little in the region, contrasting Iraq and Libya is harder.  I find it plausible that our focus on Egypt may have had something to do with it.

What really worries me is statements like this:

She recalled a State Department envoy’s informing her of $250 million in relief to Pakistan after last year’s devastating floods. “I said I think that’s bad policy and bad politics,” she said in an interview at her office on Capitol Hill. “What are you going to say to people in the United States who are having flooding?”

I get the domestic politics, but Pakistan remains one of the most likely countries where some type of intervention may be necessary in the future.  Giving aid to improve our image there is an essential component to reducing the risk of an Afghanistan or Iraq size debacle.  $250 million is small change compared to the costs of a potential intervention (I blogged about the importance of aid there at the time).  The only reason we have a perception problem is because of politicians unwilling to take necessary action domestically.   These kinds of shortsighted actions are how states decline and fall.  That isn't meant as hyperbole, I'm being completely serious.  If the deficit cutting mania continues to erode key US competencies, such as foreign policy, by cutting long range projects for short term cuts to show the electorate we may be painting ourselves into a corner we can't get out of.  If we ignore the potential benefits to government spending to avoid tax hikes we'll lose the capacities our state needs to maintain stability and prosperity.  I'm getting increasingly worried.

A Metaphor to Explain Why Tax Breaks are the Same as Spending

I've read a few articles recently mentioning the rather frequent feigned confusion about how tax breaks are different then spending.  I'll give a brief metaphor to explain why the two are identical.

Consider a club that you want to join.  The club requires payment of a fairly high entrance fee.  The club owner now decides he wants to encourage people to wear Metallica T-shirts.  The club owner knows incentive effects are powerful so decides to offer a cash bonus.  He suspects people will be upset if he simply hands $5 to everyone that walks in the door wearing a Metallica T-shirt.

Instead, he posts a sign up saying "I'm now allowing you to be a member of the club and keep more of your hard earned money for yourself, wear a Metallica T-shirt and I'll give you $5 off the entrance fee."  Then when someone wearing a Metallica T-shirt shows up they pay $5 less.  This is identical to the above scenario, but given the rhetoric surrounding this idea on tax issues you'd think there's some kind of real difference in outcomes, when such a difference is logically and mathematically impossible (ignoring timing of a discount vs. a receipt of a payment).

The club owner believes that people will be more accepting of his handing out money to people that love Metallica as much as he does if he advertises it as a discount rather than simply handing out money when people walk in the door.  On any rational level however, these two scenarios have exactly the same impact on both the club owner's budget and that of individual club members, people who love Metallica and wear their T-shirts become slightly wealthier than those that don't.  This is grossly unfair from the standpoint of anyone who thinks that club membership and fees should be completely unrelated to a member's opinion on Metallica.

The question is, how many people are suckers who will buy the difference between the discount and the handout when both have identical effects on people's income?

I'm pretty sure that everyone that reads this blog understands that spending and targeted tax breaks are identical (some tax breaks can be arguable from an efficiency perspective but they are just as defensible from a spending perspective provided that differences in administrative and oversight costs are ignored since these two factors are not identical between these two policy options), but this is a political tactic I see so often despite its transparency that I feel the need to express my exasperation over it.  Who really falls for this framing?