Taxes

Last week was tax week, and so I'd like to share some thoughts on the taxes we pay here in the Hadley-Ives household.

First of all, our income is very close to the median income. I work full-time, and my salary is close to the median full-time year-round earnings of all American men, and after you add in the little bit that Jeri earns, that brings our household close to the median household income. We have two children, so we get some deductions and tax breaks related to that. 

Here is what we paid in taxes in 2008 as a percent of our adjusted gross income:

FICA - Medicare: 1.85%

Property taxes to the state of Illinois and the city of Springfield: 6.44%

Federal income tax: 2.32%

Illinois state income tax: 2.20%

An estimation for sales taxes and various taxes on gas, electricity, etc.: 1.58%

Total that goes to the government: 14.41%

But, as Americans and as employees in a state education system, we have some private payments that would be part of the tax system in most other industrialized economies.  Here is what we paid for these in 2008:

Health insurance and all health care expenses: 6.26% 

Actually, since my employer helped pay much of the cost of my health insurance as part of my benefits, and that money could have gone from my employer directly to me in salary if there was a system of public universal medical insurance, the total cost of our household health care and insurance was probably over 10%.

SURS Self Managed retirement fund (instead of Social Security): 10.71%.

Actually, since my employer matched my contributions, and could have instead just paid me as salary what it contributed to my retirement plan, the total money that went into retirement savings was close to 20%. We're one of the very few American household where we don't pay Social Security taxes. And, unless I take some summer jobs or switch to some other job where I do, I'll never get any Social Security when I retire.  Also, since I am in a self-managed retirement plan, I get no set pension at retirement.  Instead, I get whatever is in my SURs retirement account, and that's it.  When it runs out, I have no source of public pensions with the way our national welfare system is set up now. All the risk and responsibility of saving for retirement has, in my case, been shifted to me. 

College Savings: 5.17%

In America we must pay for higher education, and it's quite expensive. So, we save over 5% of our income for sending our sons to college, and we have done so for nearly a decade, since our youngest son was a toddler. I'll have to increase this contribution to 8% or 9% of the household income pretty soon if I want to have enough saved to pay for my older son's college tuition.

We also contribute about 2.02% of our income to various charities, including medical research, social services, poverty alleviation, religious work, environmental protection, public television and radio, and the high schools and universities where we were educated.  I'd rather we contributed about 5%, but I take a rather large loss of pay by working in the public sector, so I consider my lower salary a form of giving to the public commonweal.

If you sum up all our taxes with all the spending we do on health care, retirement, college costs, and charitable giving, it turns out we are spending about 38.56% of our household income on social welfare and government.  But, since my pension and health care expenses are somewhat borne by my employer directly rather than passed on to me, probably our household income could be raised by 15% and we would spend every penny of that raise in covering the retirement and health care benefits we're getting from my employer. So, the Hadley-Ives household and our employer contributions to social welfare and government services combined probably equals about 53.56% of our gross income.

I was trying to figure out what would be a fair policy of taxation and spending that would give us a society where poverty was eliminated, college was nearly free for most students, and everyone had health care insurance as good as what we have. I also considered what it would cost to adjust Social Security benefits and Medicare and Medicaid benefits so they were sustainable (slight increases in taxation and slight decreases in the amount paid out in retirement pensions for some retired persons, I think).  This gave me an estimate of how our taxes and social welfare spending ought to be in the society and government system I would prefer to what we have now.

Here are some changes I'd make in taxation.

First, I'd forbid property taxes on a home of primary residence up to 125% of the median home value for a state or region. There could still be property taxes on cars, second homes, boats, or the value of a primary residence that exceeds 125% of median home values in an area, but most property taxes would be abolished.  I prefer to transfer taxes to income or consumption.

Second, I'd abolish most sales taxes. I'd keep taxes on gasoline, cigarettes, alcohol, nights spent in hotels or meals eaten in restaurants, and energy generated by burning fossil fuels, but for most items and services I'd abolish sales taxes. 

Third, I'd raise income taxes to make up for the lost revenue from the reduction in sales and property taxes. Income taxes should be progressive.  Poor people shouldn't pay income tax, working class people ought to pay trivial income taxes (about 1% or 2%), real middle class households (near the median household incomes) ought to pay between 14% and 18% of their income in taxes, upper-middle class households ought to be paying between 20% and 30%, and there ought to be a flat tax ceiling on tax rates set near 45%-50% on the wealthiest 4% of American households.

Here are some changes I'd make in policy.

First, I'd create a national health care system.  It would work this way:

1. There would be a national benefit plan similar to what I get now, or any other standard you want to choose, maybe the medical insurance enjoyed by members of the United States Congress. All health insurance plans would need to have a minimum coverage that matched this national benefit plan or were superior to it.  No plan would be allowed that provided less coverage.
   
2. There would be a national maximum price for the national benefit price.  It would equal the less of two figures: either 13% of a household's income or a rate of 5% of the previous year's median year-round full-time salary for each person covered on the policy. Wealthier families would pay the per-person rate and poorer and middle class families would pay the 13% of household income rate. No insurance plan could charge more than the national maximum price for health insurance.
3. The federal government would offer the national benefit plan at the national maximum price. Private insurers would be allowed to offer better plans for lower prices if they wanted.
4. Private insurers would be allowed to sell additional supplementary plans that covered more than the national benefit plan at whatever prices they wanted.
   
5. The national maximum price would be charged to everyone, but the government would help pay the premiums.  For persons or households with incomes lower than 50% of the poverty level the government would pay 100% of the national maximum price.  For every 1%-point of the poverty level over 50%-of-poverty a household earned there would be a 0.20%-point reduction in the amount of the health insurance plan covered by the government up to 100% of the poverty level, and then (at 90% of the premium subsidized for households at 100% of poverty) the subsidy would start decreasing by 1%-point of the subsidy for every 1%-point of the poverty level over poverty a household earned, so that the health care subsidy would decline to 0% of the payment when a household earned 190% of poverty (a 10% subsidy for a family earning 180% of poverty, a 50% subsidy for a household earning 140% of poverty, etc.). 
   
6. All insurers, whether government or private, would be forced to accept any legal American resident or citizen into their risk pool as beneficiaries. There could be no screening for conditions, no exclusions, and each insurer would need to charge exactly the same to all it's customers.
   

Second, I'd make states cover the full cost of tuition and fees at their public universities for the top half of students at each public high school within their state, and I'd have a national test for college scholarships, and the American citizens with the top 10% of scores on this national achievement test would earn full tuition and fee scholarships to any university in the world (with perhaps limitations on reasonable tuition and fee levels).  I'd also have a national policy to set reasonable tuition and fee levels in higher education. Only universities that charged below the tuition and fee thresholds would be eligible for federal financial aid for their students. Federal research grants would only go to faculty who taught at such schools.  The fee and tuition thresholds would be set at reasonable market levels, maybe at 150% of the median tuition and fees charged in some pool of most American 4-year universities. 

Third, I'd create two national pension programs similar to what the Canadians have.  Every American citizen and legal resident would get a pension equal to 110% of the poverty level for an individual, but this pension would be administered as if it were a negative income tax. For every dollar you earned up to 110% of poverty you would lose a dollar of this pension. This would thus give us a 0% poverty rate for Americans over the retirement age. Persons earning over 110% of poverty from their own private resources would get nothing from this first program, but persons earning nothing would get the full 110% of poverty pension income.  This would remove the economic incentive (but not the social incentive) for many elderly persons to work, and they would leave the labor force to make more opportunities available for young people.  Then, there would also be some sort of a retirement plan more like Social Security is now, and this plan would require everyone to make a flat 4% contribution out of their payroll, and would return to them a benefit level adjusted so that persons who paid more into it would receive more out of it. Everyone would also be encouraged to put money into income-tax deferred retirement savings accounts. A middle class family might put 4% of its income into the second retirement program with the flat contribution rate, and perhaps 3% into the negative income tax to eliminate poverty among the elderly, and then perhaps 4% into a tax-deferred retirement account, so that your typical median income household was saving or paying in taxes about 11% toward retirement security for themselves and everyone else in society.

With these reforms taxes would increase a bit, but employer and employee contributions toward health insurance would go down for most people.  Here is how I think our tax burden would change if these reforms were put in place:

FICA - Medicare: 0% (replaced by the national health care policy).

Property taxes: 0% (replaced by a higher state income tax).

Federal income taxes: 5.95% 

They should go up for a middle class family such as ours. Currently the very wealthiest Americans pay between 19% and 23% in the federal income taxes after all their deductions and tax loophole advantages (according to the IRS, and not counting their FICA-Medicare and Social Security payroll taxes). I think the wealthiest families ought to pay more, perhaps 30% or 35% in federal income taxes. After you adjust for the Earned Income Tax and other benefits so that poor Americans pay no income tax and then assume that the wealthy ought to be paying around a third of their income in federal income taxes (and perhaps another eighth in state income taxes), your left with a situation where the median middle class needs to pay somewhere between 5.5% and 8.5% of their income in federal income taxes.  Households earning $80,000 or $110,000 aren't median middle-class, and such upper middle-class households ought to be paying a rate somewhere between 10% and 30%. 

State income taxes: 8.59% 

Increase to match decreases in sales and property taxes. State taxes should be progressive, with the wealthiest families paying perhaps 11% to 12% of their incomes in state taxes.  In my state (Illinois) we now have a flat tax of 3% on incomes.  That's ridiculous.

Sales taxes: 0.92% 

We would still pay taxes on gasoline, and our energy consumption that wasn't using renewable energy sources.

Health insurance and medical costs: 13.28% 

We would pay 13% for the national plan and still have co-pays worth about a quarter of one percent of our income. We could go with a public plan and have the 13% taken out of our taxes or use a private health insurance plan and have 13% or less paid to them.

Retirement pensions and old age security: 11.10%

This includes the two universal retirement programs that replace Social Security plus our tax-deferred retirement savings account.

College costs: 0% 

Covered by national and state taxes. When our sons are at college we would pay significantly to help with room and board, but those costs would not be so high that we would need to save 5%-10% of our income for each year that our children are under 18.

Charitable giving: same as in the existing system, or about 2.02%.

The total amount paid by our family in social welfare an taxes in the new system would be 41.86%.  This is more than the 38.56% our family is now paying directly, but probably less than the 44% I estimate is paid by our family and my employer when I exclude the matching pension contribution from my employer.  I think my figures are all reasonable, and the figures for typical 4-person households near the median income distribution would be about the same.  That is, if you want a well-functioning government that eliminates poverty among persons over 64 years of age, provides free college educations to most of the country's students who are able to do college work, and provides a national health care system, then middle-class families need to figure they'll be paying somewhere between 36% and 46% of their income on public spending (taxation) or personal savings and health insurance. You can't get what you want and have the middle class paying under 36% (unless you totally soak the rich with something like 65% taxes on them), and you don't need to have the middle class pay and save more than 46%.  

Also, I think this exercise points out that state taxes (and state and local policies) are very important for middle-class taxpayers.  We actually are paying more to our state and local governments than we pay to the federal government, yet most news media coverage devotes far more attention to national policy and very little attention to local and state policy.  This is funny, because at the level of state and local policies it's pretty easy to meet your elected representatives and influence how they make policy, while it's pretty darn difficult to have much of a say in national policies.

Submit your ideas to the Obama Administration

You can go to the new Change.gov website and submit suggestions. Presumably, volunteers and campaign staff catalog and index the suggestions, and pass on some sort of summary with representative sample posts to Obama himself.

I've submitted a few of my own suggestions. I might as well share them here.

Suggestion Submission #1. Foreign Aid and Cultural Exchange.

You know Kenya. I've lived there one semester myself, and lived in Kibera, where I understand you have stayed--I had some Luo friends, too. You, better than any president we've ever had, understand the material poverty of the money-poor nations.

The key thing to do is to meet our promise from the Monterrey Consensus to devote about 0.7% of our GNP to international aid to the poorest nations. That aid should be mainly devoted to developing infrastructure, education, and health care provision in the materially poor world. It should be targeted to nations that have the greatest political transparency and show signs of moving toward democracy and independent institutions of civic society.

Foreign aid of this nature should rightfully be considered a matter of national defense, and so we ought to take the increase in international aid from our bloated and wasteful defense budget.
If as part of this policy we establish more American-supported public universities in poorer regions of the world I would volunteer to serve.

As a supplement to this dramatic increase in development aid we should make a massive effort to increase direct public exchange between America and poorer nations. We should be sending 100,000 American high school students and college students abroad each year, and bringing in a similar number of foreign students for cultural and educational exchanges. Thousands more Americans fluent in Mandarin, Arabic, Spanish, Pashtun, and Swahili, (with friends in the lands where those languages are the native or second language) will be worth more to us in helping America maintain peace and security than tens of thousands of more monolingual soldiers.

Make the foreign exchanges part of the foreign aid increase policy. Send American kids from the poor and violent environments to do a year of education and service in an entirely different environment (orphanages in Zambia, for example), and you can imagine the kind of changes we would witness.


Suggestion Submission #2. Higher Education Affordability.

Make higher education affordable. Establish some sort of target costs of providing higher education and some federal guidelines of fair cost-sharing between the public (we all benefit from having better quality higher education that is affordable in our society) and the college students (who reap more direct benefits than the taxpayers who never go to college or finish their college degrees). For example, it seems to me that costs of college education ought to be split with students paying about a third of the cost of their education and the public paying nearly 2/3rds (with alumni donations and private grants used to fund non-educational expenses). Further, costs of education ought to be indexed to median-full-time-year-round wages of the previous year and tuition at public institutions ought to be set on a sliding-scale.
Public universities and the states that control them work out the details of spending and tuition rates, but the federal government can dictate certain broad principles of how public education ought to be funded and priced. The National Institutes of Health, the Department of Energy, the Department of Education, and other federal government organs ought to have policies of only giving grants to researchers at universities that follow federal suggested guidelines for pricing education. Only states that follow guidelines in keeping college costs under control ought to receive federal financial aid for higher education.

Costs of college have nearly doubled in real inflation-adjusted terms since I attended college in the 1980s, but median and mean faculty salaries have declined by approximately 11% over the same 20-30 year period. The problem has reached a point where I could earn more money by leaving my job at the University of Illinois and taking a job in the local public school system as a high school teacher! I'm working 50-60 hours each week trying to help my undergraduate and graduate students get a good education, but even though I've been saving 5% of my income for my two sons for their college fund since they were born, I will be unable to afford to pay for more than two years of their college education, even if they attend the university where I myself teach! My salary and our household income match almost exactly the state median year-round-full-time wage and median household income, so I know that most people in Illinois are in a situation like mine in terms of being unable to afford to send their children to college.

State governments are unwilling to make affordable higher education a priority. Please use the federal government to force the state governments into taking action on this issue.


Suggestion Submission #3. Change the Economic Debate.

People in America need to understand some basics about economics and tax policies and government spending. Someone (the president) needs to clearly explain that we as a society want a public sector that protects and empowers us. We are empowered by education, by infrastructure, and by policies that give us freedom from financial ruin (e.g., Social Security, Medicare, national health insurance policies, etc.). We are protected by national defense, by police and fire departments, by environmental standards and various workplace and financial regulations. Just lay it all out; if the American people want a certain level of protection and empowerment they'll need to contribute an average of some percentage of their incomes to public spending, through some mix of property/wealth taxes, income-and-gains taxes, and sales-consumption taxes. When you combine the costs of public services from local, state, and federal governments and look at the total income and wealth of America it seems like about 40% (give or take 10 percentage points) of the national economy needs to be cycled through the public sector of taxing and spending.

Most of the arguments about fiscal policies and taxing and spending are between conservative Republicans who want fewer public services and less protection and empowerment, and are therefore willing to live in a society where about 35% of the national economy gets cycled through the public taxing-spending cycle, and those who want more protection and empowerment, and therefore want 45% to 50% of the economy cycled through the public sphere.

Make it clear that we have a consensus where everyone in the mainstream, from the most liberal Democrat to the most conservative Republican agrees that we like economic growth and we want a strong private for-profit sector of the economy to serve as the engine of growth. No one disputes that, but we just disagree about whether that sector of the economy ought to be 30% or 40% or 50% of the national economy. Our differences come mainly from how much empowerment and protection we want from the public sector, and how far we trust ourselves and our private for-profit and non-profit sectors to provide security and empowerment when the government's public sphere isn't doing it.

We need to return to a New Deal style consensus about public spending and taxation in this nation, and so we need to destroy these pernicious myths that there is something wrong with a little bit of income transfer and redistribution of freedom-wealth-income-security from the most fortunate to the rest of us. We need to make it clear that the government is in the business of empowering and protecting, and distributing freedom and opportunity. Yes, there are some inefficiencies in the public sphere, but we can make government efficient and responsive. Taxation can be a good thing. There are fair degrees of taxation. Public spending is a good thing. There are desirable and sustainable levels of public spending. Taxing and spending aren't the problem. The problem comes when taxing is too high, relative to the benefits that are received. Taxation is a problem when the government is very inefficient in delivering empowerment and protection at levels expected from such taxation. Taxing is a problem when so much of the economy is swallowed in the public sector that the private sector shrinks and growth slows down too far. So long as the government is efficient and taxing hasn't ruined the private sector it's okay to tax and spend.

We need to make this clear and understood. It's really basic civics and economics, but the way the Republicans were using the Joe-the-Plumber story and framing the issue as socialism shows that a certain segment of this nation is entirely ignorant of basic concepts underlying our democracy and modern economies. This worries me, as such ignorance leads to ideological fanaticism stripped of knowledge and understanding, and I associate such political attitudes with failures of civil society.

Please, President-Elect Obama, use your position to educate Americans about taxation and some basics of macroeconomics. Help us re-frame the debate about taxing and spending. Help change the poisonous climate of empty hate-filled rhetoric to a situation where people have reasonable disagreements about spending priorities and program efficiencies.

Tax fairness and income inequality

Lately I've noticed letters to the editors of newspapers and blog essays where people complain that the tax system in the United States is really set up to soak the rich. People complain that liberals like John Edwards are lying when they say the wealthy take advantage of the tax system. In fact, the conservative say, the wealthiest households in the United States pay most of the taxes, and the lowest half of the population pays very little in the way of taxes.

First of all, if you accept (as I do) the proposition that the free market tends to exaggerate the rewards given to people near the top of reward distributions and tends to undervalue and underpay people near the bottom of reward distributions, then one sees a certain unfairness in the way people earn income. People near the top of the pay scale (the rich) tend to be overpaid. They get more than they need, and they usually get a bit more than they deserve.

Partly as a means to rectifying this injustice, taxes and government policies can take some money from the wealthy and redistribute it to people who are less wealthy. The poorest people, who can afford very little, can pay very low taxes, or even no taxes at all, while the wealthiest people, who can afford to part with some of their money, can pay higher taxes, and give up a greater share of their wealth. This can be done with a progressive income tax, and it can be done through policies that give more to the poor and give less to the wealthy.

If one accepts this, then there is no moral objection to conditions such as having a group of 5% of the taxpayers, who might take a quarter of the national income, pay more than a quarter of the national taxes. And, if the poorest half of the nation's taxpayers take in 5% of the national income, then they may pay less than 5% of the nation's taxes.

One mistake conservatives make when they talk about taxes is to only count certain types of taxes. Most people, even poor people, pay sales taxes. Many pay property taxes. Many pay registration fees and processing fees and court costs and fines and other forms of revenue to the public purse. People tend to pay taxes to local, state, and federal governments. And, along with the income tax, there are also taxes for social security, workers compensation insurance, and these sorts of things that are taxes on earnings that supposedly differ from the federal income tax. When I've read conservative letters or essays about taxes, they never explain exactly what taxes they are describing, and I have yet to see good references to where they find their data.

I thought I should do my part to investigate the matter of the federal income tax, and how much the wealthy actually pay, and how this compares to people at the middle class. In this blog entry I'm giving references to the documents I'm using, and I'm only talking about the federal income tax.

I began my search at the Census Bureau. My first question was, "what share of aggregate income (all income received in the nation) do the wealthy actually take?" I found the answer when I examined table 675 from the Census Bureau's publication, the Share of Aggregate Income Received by Each Fifth and the Top 5 Percent of Households: 1967 to 2005. It’s available at this page.

According to Census Bureau, the top 5% of American households received about 22.1% of aggregate income in 2000, and about 22.2% of aggregate income in 2005. In 1993, the year Clinton was inaugurated, the wealthiest 5% received 21.0% of aggregate income. In 1981, the year Reagan was inaugurated, the wealthiest 5% received 16.5% of aggregate income. So, the wealthiest have seen their incomes rise from 16.5% of our nation's aggregate income to 21% during the Republican era of the 1980s, then rise one percentage point to 22% by the time Bush was given power by the Republican Supreme Court (Constitutionally, we should have waited for the Republican Senate and House to give him power), and since Bush has been in power the top 5% first lost their percentage and more recently have gained their percentage back to about where it was in 2001. That's the story the numbers tell.

What about the working class, the poor, and the lower middle class? The bottom 40% earned 14.2% of income when Reagan became president (in 1981), they earned 12.6% when Clinton became president (in 1993), and they earned 12.2% when Bush became president (in 2001). In 2005, the most recent year for which there is information, the bottom 40% of households earned 12% of aggregate income. The working class and poor are earning a smaller fraction of national aggregate income, but the trend has been slowing down since the 1990s.

So, it appears that the 1980s and early 1990s were a time of growing inequality, while inequality did not grow much in the Clinton era of the 1990s or in the Bush era of the past six years. At least, this is the story one can take from the Census Bureau report, and this is true of you only look at inequality by comparing the top 5% and the bottom 40%. Is that a good way to compare trends and learn about inequality? It's good, but it's also fallible, and it's wise to use multiple fallible indicators to get teh whole picture. This particular indicators is a reasonable type of comparison, and when you use this comparison, the inequality trend is bad, but nothing is changing rapidly or radically in recent years.

Some conservatives, such as a guy from Naperville, Illinois, named Tom Rand (who wrote a letter to the Illinois Times, a newspaper here in Springfield, where I live) claim that the tax burden for the wealthiest Americans (as a percentage of all taxes paid) has increased relative to their (trivial) increase in earnings (“earnings” as a percent of aggregate income). In other words, if you know that the wealthiest top 5% of the nation has been earning 21% to 22% of all income, and this hasn't changed much at all in the past six years, but you know that the same wealthiest 5% has been paying a higher percentage of the total national income tax, then you can make a claim that the wealthy are paying a greater share of national taxes while their share of national income has been stagnant. Their taxes are going up relative to their incomes at a rate that is faster than the increase for everyone who isn't wealthy. If this is true, then it appears that the wealthy aren't getting a great deal with the Bush tax system, and in fact the economy and taxes we have had since the Bush administration tax cuts of 2001 tend to favor people in the bottom 95%.

That's a story based on this one chart from the Census Bureau, but let's consult another fallible indicators of the situation. Let's see what data we may find at the IRS.

If one goes to the www.IRS.gov website it’s fairly easy to find a detailed analysis of the 2005 taxes paid by various income groups. I found most of what I needed in: this pdf Fall 2007 report on the 2005 taxes (collected in 2006). The best page is page 40 (of 64), where you find Table 2. All Returns: Tax Liability, Tax Credits, and Tax Payments by Size of Adjusted Income, Tax Year 2005. It's also important to look at page 16, at Table 1. All Returns: Sources of Income, Adjustments, Deductions, and Exemptions, by Size of Adjusted Gross Income, Tax Year 2005.

Looking at the IRS data I wanted to see where my household fits in the big picture. How are we doing, relative to others in the economy, and how does our income and tax responsibility compare with that of the wealthy? It turns out I'm in the middle of the middle class. My wife and I file jointly, and our gross income before adjustments is usually in the bracket between $40,000 and $50,000, although some years (when I work through the summers or get a nice grant) we have gross incomes between $50,000 and $75,000 (actually, not much over the lower threshold of that bracket). Our incomes are close to the state median income in Illinois for a male full-time year-round worker. Also, with the 2006 median U.S. household income of $48,201, our income clearly represents the middle class. Anyone with an income in the $40 thousands or $50 thousands is middle class (at least in terms of income). My labor effort is also close to the average for American full-time year-round workers, as I work about 1900 hours per year for my paying job and my wife works about 250 hours per year in her paying job (we have two school-aged children, and my wife's work as a mother and homemaker is ignored in all these official statistics, although tax cuts we get for having children considerably reduces our federal income tax responsibility).

There were in fact 26.8 million returns by persons or households earning, like us, between $40 thousand and $75 thousand. That's almost 9% of our total national population, right in the middle of the middle class. In terms of all the tax returns that were filed, that's about 32% that fall between $40K and $75K. Those 26.8 million tax returns filed with the IRS showed a total income of $1.60 trillion, and these middle class filers paid a total of $179 billion in federal income tax. You can sum up and divde the figures to arrive at a picture of an average middle-of-the-middle-class household earning $55,000 per year, and paying about $6,700 in federal income taxes. That's about 12.07% of adjusted gross income paid to the IRS by people in this range.

Let's compare this typical and middle-class group to the wealthy.

Who are the wealthy? I think households with incomes over $200,000 are affluent or wealthy. According to the IRS, 3.9% of all 2005 filed tax returns indicated incomes over $200,000. So, I suppose the top 4% of the households, or population, or the top 4% of families are what I’d call “the affluent” or “wealthy.” (Actually, I’m not clear on how closely a “percent of all tax returns filed” represents percents of individuals or households or families. I assume households would be the closest approximation. The wealthy must certainly have larger household sizes. For one thing, they are more likely to have at least two income-earners. On the other hand, people’s earnings peak in their 50s or 60s, a time when many taxpayers' children are going off to college or have already reached adulthood and independence. But this is a digression, let’s go back to comparing the wealthy to the middle class.)

If you add up all the incomes of the 3.6 million filed tax returns in which individuals or households reported over $200 thousand income, you get a figure of 2.17 trillion, and these tax returns came with payments of a total of $467.8 billion in taxes. By the way, the IRS reported total adjusted gross income for all returns at $7.422 trillion, and total tax returns of $1.084 trillion. That means the people earning over $200,000 earned about 29.2% of all income reported to the IRS and paid about 44.9% of all taxes (much higher than the Census Bureau's report!). That works out to an average of $608 thousand in annual income for an average affluent person in the top 4% of the American income distribution. But what do these 3.6 million taxpayers pay in federal income taxes? In total, they paid a total of $468 billion. That works out to an average of $131 thousand per tax return.

In other words, the average middle class person is getting about 9% of what an average affluent person is getting, but is paying in federal income taxes only about 5% of what an affluent person pays. To put it another way, a typical person in the middle class is paying about 12% of income in federal income tax, while a typical affluent person is paying just under 22%. This affluent top 4% that gets over $200 thousand per year is paying 45% of all federal income taxes paid to our government, while the middle 32% of all taxpayers (those earning between $40 thousand and $75 thousand) are paying only about 17% of all taxes.

I mentioned above that the average affluent person is paying under 22% of income in federal taxes. This is a slightly misleading. The 2.7 million returns showing incomes between $200 thousand and $500 thousand pay on average 19.35%, while the rest of the affluent making over $500 thousand per year tend to pay 22.6% up to 23.7% (the average for persons getting between 2 and 5 million). So, really, the super-rich are paying between a fifth to a quarter of their incomes in federal income tax, while the merely affluent, who earn between $200 thousand and half-a-million are paying, on average, slightly less than a fifth of their incomes in federal income taxes.

Personally, I'm not alarmed by this in either direction. I don't think the rich are getting a raw deal, nor do I think they're getting a grossly unfair advantage. I do think the rich are paying less than their fair share as it is, but not a dramatically unfair share. I wouldn't mind if a household earning over $1 million paid 30% or 35% of their income in federal income taxes (instead of the 23.7% to 22.1% that such wealthy people currently pay). As for the middle class, I think paying about 12% of one's income to the federal government through federal income taxes is about right for the middle third of the income earners in a nation. Really, anywhere between 10% and 15% seems fair to me for the middle group.

If the middle class was paying 10% instead of 12% of their income to the federal government, the federal government would lose about 19 billion in federal income tax revenue (and put that much money into the hands of the 32% of the taxpayers in the middle incomes). To balance the revenue loss from this massive tax cut for the middle class we could increases taxes on the wealthy. If we increased taxes on the wealthiest 4% so they, on average, paid 28% of their incomes in federal income taxes instead of what they pay now (about 22%), it appears to me, from the IRS data, that the federal government would gain about 140 billion from the tax increase. This 140 billion increase makes up for the 19 billion loss from the middle-class tax cut, and would give our government about $121 billion more revenue. I'd like to see such additional revenue used to balance the budget and pay down the national debt. More public money should be spent on medical research, alternative energy research, and pure science research. I think we also need a more generous government program to make higher education generally more affordable. Nationalized health care would be a great thing, and we could scrap Medicaid and Medicare, replacing those with a new National Health Insurance. A gain of $121 billion in government revenue, combined with sharp decreases in military spending (down to 3% or 2% of current GDP, as opposed to the 4% to 4.5% of GDP our nation currently allocates to defense and defense-related expenses), really could make a national health insurance scheme quite feasible, and if the government paid for billions of dollars in medical and energy research, and then let American taxpayers enjoy the resulting benefits without paying royalties to private companies or universities who used the money to do the research, that would also give us a more efficient economy and health care system.

I don't think raising taxes for people earning over $200 thousand per year up to a point where they pay, on average, 28% of their income in federal income taxes rather than 20% or 23.5% (as they do now, on average) is "class warfare" or a "soak the rich" scheme. I also don't buy the conservative argument that this would ruin incentives for good corporate executives and inventors and risk-taking investors. Would the highest paid executives make more stupid decisions or become less creative because 28% of their compensation and reward was going to the federal government rather than 22%? I don't think the wealthiest and most talented people would start goofing off and ruining their companies. Maybe if the federal income taxes were up at 50% or 60% rather than the 27% to 35% that I think fair, then rich people would flee or become demoralized. But an increase to 28% isn't going to encourage wealthy fair-weather-patriots to give up their American citizenship and move to tax havens and take up citizenship in the Cayman Islands.

A spreadsheet to model the economy.

Back in January of 2005 I spent a week (in January, during my winter vacation) researching public spending at the federal, state, and local levels in the United States. I gathered all the numbers I could from various government web sites and the research papers available from think tanks and information clearing houses. I took all this information and used it to think through some of the problems of our economy with the use of an Excel spreadsheet.

In this spreadsheet I tried to create a rough approximation of the American economy, and then invited myself to figure out how I would set taxes and allocate public spending to meet the needs of my society.

I’ve shared this spreadsheet with some students, and now I’ll share it here on this blog. Let me give some explanation of the various worksheets and things in this spreadsheet.

Download the Spreadsheet in Microsoft Excel format by using this link here. If you are using iWork'08 instead of Excel you can still download that file and edit it.

There are seven worksheets.

The first worksheet is called SET UP QUESTIONS. A orange band runs down the center of this worksheet. On the left side of this band are questions and variables where you the user may change dollar amounts and percentages to set up your taxation schemes and spending allowances exactly as you would like to. On the right side of the orange bar are some facts about the economy modeled in this spreadsheet. There are also some facts about America and American public sector spending from 2004 and 2005.

The second worksheet is called COMPARISONS.
This compares the total dollars you’ve allocated to various public goods and policies and shows what percentage of the GDP you’ve put into these things. Then, to the right of that I have tried to get the most accurate figures I could for total public spending (all Federal, State, and Local government spending, not double-counting grants to states or local governments given by federal or state governments). These figures are as accurate as I could make them with just a few days of research, but I found figures that seemed to be fairly accurate. My figures differ slightly from some authorities. In 2004 it seems to me that I found indications that all public spending on education was about 5.3% of the US GDP, but an authoritative source in 2007 claimed we spent 4.8% of our GDP on education. I added the spending on military pensions, veterans hospitals and benefits, and those sorts of budget items to the defense for a total military budget rather than putting those pensions and health care spending categories in with things like health coverage, old age pensions, or disability benefits. My figure ended up being about 4.35% of GDP on defense spending, which ought to be a little high because I included some things that aren’t usually included, but in fact I found some authoritative sources claiming the USA spends 4.5% of its GDP on defense, so I’m not sure how people arrive at that higher figure. But, where I was able to check my final figures with those from other experts, it seemed my figures were quite close to what others had reached, and I’m satisfied that my numbers are approximately correct.

A huge part of state government spending is put into the pensions for retired state workers. Many states cover this by withholding a portion of state employee pay and using these funds to pay state employee pensions. Since the withholding from state employee salaries isn’t really “tax revenue” it seemed unfair to count state worker pensions as a sort of public spending based on tax revenue. Nevertheless, I think I stuck the state worker pension estimates in with miscellaneous aspects of public spending or administrative costs of running the government, and I did not include those in the category of “old age pensions.” If I were doing this again I would have put state worker pensions in with the social security payments.

Anyway, that comparisons page has a column where you can compare how your spending compares to actual public spending. When you get the spreadsheet as I have set it up the total military spending is about $124 billion, or a little over 1% of our GDP, this is about a quarter (or less) of what our government actually spends on military defense and associated costs, so in the comparison table (as it exists before you change anything) the “difference” number for military spending is -75.7%. That’s a pretty steep cut.

The third worksheet is WELFARE CALCULATIONS.
This page takes stuff given to the simulation on the page of set up questions and calculates how much the old age pensions and education system will cost. There are also some facts I found about labor force participation and food budgets. Some cells on this page help calculate the food supplement payments as well.

The fourth worksheet is INCOME DISTIBUTION CHARTS
It’s really just a single chart showing the income distribution of the United States in 2003 or 2004 and comparing it to the income distribution of the model I’ve made. My model has more poor people (actually quite a few more) and fewer super-rich. So, the economy model I’m using with this simulation is not really as wealthy as the United States. But, I think my model is pretty close to what we have.

The fifth worksheet is INCOMES AFTER TAXES AND PENSIONS
This is a chart where the x-axis is a person’s income before taxes and benefits, and the y-axis is a person’s take-home pay after taxes and benefits. You can see that in the model you get (before you change any of the variables) there is this great leveling effect where as earnings go up from $30,000 per year to $85,000 per year (for able-bodied working-aged persons) actual take-home income only increases from $30,000 to $43,300 (after taxes and benefits). This means that people take home only about 24 cents for every dollar raise they earn between the incomes of $30,000 and $85,000, but once they get to the maximum tax rate at $85,000 (of 50% in the opening settings) they start keeping 50 cents for every dollar increase they enjoy in wages. It’s just a mathematical fact that if people at the lower tax rates get more in benefits and income than do people in the middle tax rates, and if there is a flat tax at some highest level of taxation, then at some point in the income distribution between the lowest rates and the highest rates people will be paying more than the highest rate on every additional dollar they earn. Someone must pay a higher marginal rate of taxes on their increases of income as the tax rates increase from zero to some highest point. See if you can play with the model and get around this. You can’t. It’s impossible.

The sixth worksheet is INCOME DISTRIBUTION.
This is the model economy. I used this to make the chart in the income distribution charts.

The seventh worksheet is POPULATION INCOME MODEL
This is the sheet where I model the whole population in terms of their earnings and their benefits.

Some more about this model.

In the real American economy the "public cycles of money" collect revenue from you in a wide variety of ways. You may pay property taxes, registration fees, user fees, sales taxes, income taxes, and various special taxes on specific products. These taxes are imposed by local, state, and federal governments. It’s difficult to keep track of all the various taxes you’re paying. In this simulation, we’re saying for the sake of simplicity that the government has abolished all sales taxes and property taxes aside from a few taxes on luxury items or items that injure health. Second houses, vacation houses, and boats might be taxed. There still might be taxes on gasoline, cigarettes, alcohol, gambling winnings, and that sort of thing. But in general, for most purchases, sales taxes have been abolished. The only main tax that people must pay are income taxes. And all incomes taxes are rolled into one big income tax, from which revenue is divided among the local, state, and federal government. So, the only tax you need to set is this one income tax. Currently people in the highest tax brackets might pay something like 35% of their income in federal income taxes, 3% of their income in state taxes, the equivalent of 4% of their income in property taxes, and the equivalent of 5% of their income on sales taxes and special fees for government services, toll roads, and so forth. Imagine rolling all those taxes into a single tax rate of 46% (this is assuming that about 1% of their income still went to the government in luxury taxes on their second houses or gasoline taxes, and that's included in the 46%). Talking about a 45% or 46% income tax to someone who is accustomed to paying only 35% of their income in federal income taxes might seem like a terrible tax increase, but in the case I’ve outlined above this would be a revenue-neutral shift of all tax burdens into one simple income tax, and the rise from 35% to 46% in income tax would be matched by a drop in property and sales taxes.

How to play with the numbers

The model starts with the big ticket items. After you have set your tax rates and your Earned Income Tax Credit (a sort of negative income tax that gives money to people who earn very little instead of taxing them, but gives more money to people who earn some income and less money to people who earn nothing), you get to decide about issues like retirement age, size of retirement pensions, disability incomes, national health insurance, education spending, unemployment insurance, housing allowances, food spending allowances, and defense spending. When all these are done, you are told how much money you have left, and you allocate it among the remaining categories by deciding what percentage of the remaining money should go toward various things.

Be sure not to short-change your public safety and justice spending or your basic infrastructure spending. Public spending on courts, police, fire protection, and prisons in the USA was over 200 billion in 2004, and you probably don’t want to cut spending too much here (although legalizing marijuana and taxing it would cut some of these costs and raise revenues, but I don’t know how much that would actually cut law enforcement expenses.) Spending on infrastructure was also just above 200 billion. If you pay much less than this for infrastructure your bridges will start collapsing, your roads will become full of potholes, and sewage treatment and water treatment will become unsafe. Don’t short-change enforcement of regulations, either. You want to ensure people aren’t eating feces and bacteria when they buy their food. If you don’t enforce workplace safety, food safety, or drug and medical standards you are going to have some angry people kicking your head when their children die from eating rotten hamburgers or tainted cough medicine.

See if you can balance the budget, figure out a “fair” system of taxation, and eliminate poverty!

For the sake of simplicity, everything in this model assumes a very simple welfare system. Everyone gets the same old-age pension, no matter how much you paid in taxes. That’s not the way it works now. For health benefits, there is one standard health plan that covers everything you can cover based upon your national health spending budget. A certain amount is allocated for the nation’s health care needs based upon the average cost per person for all health care (at least all health care covered by the national health care plan. Maybe in your fantasy health care plan something isn’t covered). Public housing has been abolished and the government just gives poor people a “housing allowance” (money that can only be used to pay for housing and utilities). A similar system exists for food security, with every person at a certain income level getting food money (like food stamps) that can only be used for food. If you’re not disabled, not unemployed, and younger than retirement age, then you get an EITC to supplement your income plus the housing money and the food money. That’s it. There’s nothing like TANF or AFDC.

In this model every child is given an education voucher equally to 100% of the costs you’ve set for various levels of education. A public school is any school that offers an education that has total costs equal-to-or-less-than the costs you’ve set for education, and does so while obeying the constitution (no establishment of religion, so no forcing any particular religious beliefs on students, and no discrimination in violation of the equal protections amendments). Any school that requires any money in excess of the officially set cost of school is by definition a private school. Any student enrolled in such a school does not get to use a voucher at that school. School vouchers are only good at public schools. Public schools are welcome to spend more on their students than they raise through vouchers (if they raise additional resources through alumni giving, donations by benefactors, and so forth). A national set price for public education at each level would create a powerful incentive for schools to keep costs down to the (hopefully reasonable or generous) levels you have set. If schools allow costs to exceed what they bring in through vouchers they can’t pass on the extra costs to the students and their families, nor can they coerce local residents to pay for the increased educational costs through broad-based local property or sales taxes.

The assumptions and simplifications limit the accuracy of this simulation, but it’s still a fun game. Go ahead and download the spreadsheet and have some fun pretending you’re the president and the legislature all rolled into one. I’d be interested in knowing whether this game gives you any new insights into how taxing and spending really works.