Goodbye, Tangled Web
A Moral Economy #10. Part III: How do we get from here to there?
This continues a three part series of excerpts from Social Security Basic Income: A Safety Net for All Americans, which I published in March 2020. Part I: What would it look like? concluded with #2 and Part II: What do we have? concluded with #8. This essay includes text from Chapter 3 Nothing to Lose but Shackles and Chapter 5 Slaying the Payroll Tax Dragon. Refer to #1 in the series for a brief introduction of my purpose and perspective on this subject.
As indicated in the introduction to this series, I am updating the data throughout as needed. That is especially the case in this essay and those that follow. Policy proposals are unchanged; however, revenue and cost estimates reflect more recent data. In addition, I have revised the tables comparing funding sources and entitlements to include net cost information that was presented in narrative form in the book.
Free to Work (FTW)
Social Security’s demographic/fiscal problem is well known. Not so widely recognized is the significance of the fact that the associated entitlement is created by contributions. Each retiree’s benefits are paid by taxes collected from several workers. This means those who would rather not “contribute” must be taxed to pay current beneficiaries. It also means that every tax dollar creates an entitlement to future benefits that will in turn require several more people to pay the taxes that fund payment of those benefits. Fiscally responsible changes are resisted by several generations of workers who were promised benefits based on taxes paid over a lifetime of work. They deserve what was promised. However, we need to stop this cycle of dependency by making no further promises. The only way out is to eliminate the tax.
The BIG may or may not gain acceptance, and in any event may take a decade or two to adopt. But we can take the first step now by eliminating payroll taxes and tax expenditures to grant relief to workers with low and moderate incomes. Funding all Social Security obligations and Medicare expenses from income taxes will provide security for beneficiaries and improve the fiscal condition of both programs’ trust funds. I call this plan Free to Work because it lowers the marginal tax rate on wages and self-employment income. As indicated in the table below, which compares FTW to the status quo (SQ), a surtax would apply to the federal income tax.[1] Detailed explanations of the particular features of each proposal follow.
[1]OASDI is Old-Age, Survivors, and Disability Insurance (aka Social Security). HI is Hospital Insurance (Medicare Part A). SSI is Supplemental Security Income. EITC is Earned Income Tax Credit. TANF is Temporary Assistance to Needy Families. SNAP is Supplemental Nutrition Assistance Program.
No brainer
Paying for benefits no longer funded by the payroll tax will require raising other taxes. Tax Expenditures (TE) are an obvious target because they increase inequality and they are large enough to offset most payroll tax revenues. A neutral shift from the payroll tax to federal income taxes would maintain the equal burden distribution between individuals and employers. However, corporations pay just 15 percent of Federal Income Taxes (FIT) and their share of TE is less than 10 percent, so reforms will necessarily rely on taxes paid by individuals.
We should be concerned about the limited oversight of tax expenditures; they continue to receive very little attention from Congress even as demand for evaluation of direct spending programs has increased. Even though we know less about the effects of this type of spending on public outcomes, these programs — by design — bypass the annual budget process. While discretionary programs must receive annual appropriations, tax expenditures are permanent and increase automatically with taxpayers’ personal and business spending decisions.
Many taxpayers count on TE to reduce their tax bill, and they benefit substantially. However, these taxpayers are disproportionately wealthy. It makes little sense to pursue a progressive reform agenda of this magnitude while ignoring TE. The burden of funding government must fall on those able to bear the burden, and it is more equitable to distribute that burden evenly on a progressive scale than to skew it in favor of special interests. Insofar as we have any intention of actually paying for government, every dollar deducted from taxable income necessitates higher tax rates for others. It is unreasonable to ask the majority of taxpayers to shoulder tax increases while leaving intact deductions that apply to a small minority.
My proposal is more ambitious than most, but others have called for reducing tax expenditures. The Obama era Debt Reduction Task Force proposed cutting TE because they provide the largest subsidies to those least in need of financial incentives (to buy a home, send a child to college, or save for retirement, to name just a few of the most popular deductions).
Exemption from income taxation of employer-paid health insurance premiums is the largest TE and it affects more taxpayers than any other. Employers treat premiums like wages, which are fully deductible as a business expense, yet these premiums are not taxable to the insured individuals. Because this policy disproportionately benefits higher income individuals, I propose to eliminate the expenditure, thereby making employer-paid premiums taxable. Due to the high standard deduction, lower income individuals may not see any increase in federal income tax liability; if they do, it will be offset by payroll tax savings. The rationale for retaining the deduction for premiums paid by individuals is that health care is essential — and it is high on the list of household expenses, especially for the poor.
As for the other TE items, it will not work to take on every special interest by arguing the merits of each TE item one at a time. A better approach is to repeal them all at once. Tax fairness, in my view, demands elimination of special exemptions, including broad-based deductions from income (such as home mortgage interest) that favor the wealthy and encourage debt. However, in addition to individual health care expenditures, there are two others that affect a very large number of taxpayers and may be worth keeping.
I would retain individual deductions for retirement savings because encouraging taxpayers’ voluntary efforts to provide for their own income security will reduce reliance on the federal safety net. Child care is another area that deserves exceptional treatment. I do not believe we should encourage or discourage having children. However, a neutral, fair policy would treat children and their parents at least as well as others. We’re not doing that now, because our social welfare programs are stingy and impose unreasonable work requirements. And besides, the purpose of a federal safety net is to help people emerge from and avoid falling into poverty.
FTW would eliminate the child tax credit (currently $2000) because it is insufficient for low income households and unnecessary for those with high incomes. Instead, I propose a child allowance of $5000 per child, which is close to the estimated marginal cost of each additional family member in the Federal Poverty Guidelines. It would operate as a negative income tax, meaning the benefit is reduced by income. The full amount is available up to the poverty threshold; thereafter, it is recovered by a surtax of 10 percent on income above that amount until the full allowance is recovered. For example, a married couple with two children and income of $20,000 per year would receive the full $10,000 child allowance because the threshold for their household (family of four) is $30,000. The same family with an income of $40,000 would receive $9000 ($10,000-(0.1 X ($40K-$30K)); at $80,000, the benefit is $5000; at $130,000 and above, it is zero.
As indicated in the table above, in 2021, TE were $1.467 trillion. FTW would eliminate all corporate TE and all but two individual TE: pension contributions and earnings ($225 billion) plus individuals’ health care expenditures ($27 billion).[1] Eliminating the $2000 child credit would save $73 billion (plus $43 billion in outlays for refundable credits), but FTW would replace it with a $5000 child allowance that would cost about $300 billion. For simplicity’s sake, the entire amount is treated as a tax expenditure in the table. This brings the FTW total TE to $552 billion and the net revenue to $915 billion per year. An additional $71 billion would be saved by eliminating the Earned Income Tax Credit, which also has a TE component but is mostly refundable and therefore included as an entitlement outlay in the table.
[1] FY 2021 estimates by the US Treasury. The pension figure includes defined benefit and defined contribution employer plans, IRAs, savers’ credits, and self-employed plans (#140–44). The health care figure includes self-employed premiums, HSAs, and deductible medical expenses (#123–25).
Progressive surtax
FTW will need far more than this to fully fund Social Security and Medicare payments, which were estimated at $1.972 trillion for 2021 ($1.133 trillion and $839 billion, respectively). All but $69 billion of the gap would be closed with an FI surtax on incomes that starts at 5 percent and rises to 10 percent and 15 percent at income levels well above the poverty level ($50,000, $100,000, and $200,000, respectively, for single filers and twice these amounts for married couples), which would increase income tax revenue by about $849 billion.[1] It is worth noting that this improves upon the status quo (deficit financing of entitlements) by about $600 billion.
Lower taxation of capital gains props up stock prices and reduces taxes on the wealthy. Especially when dividends and interest have all but disappeared, corporations hardly need help attracting investors to equities. Retaining this benefit would make higher FI surtaxes necessary, and it would be unfair to taxpayers who do not own equities outside of retirement plans.
Charities and other non-profit organizations rely on the charitable deduction to encourage higher donations. They will scream for an exception. However, if we are serious about helping the poor, we cannot justify funding middlemen selected by individual taxpayers. Eliminating this TE is not cutting assistance by the amount of the tax deductions; it’s transferring targeted donations (charities) to universal donations (the BIG). Some organizations will struggle and many taxpayers will find it unpleasant to dig deeper or curtail charitable giving. But the status quo is inefficient and unfair compared to marginally increasing cash assistance to the needy. And just as with capital gains, this exception would require raising the FI surtax on everyone, not just those who give a lot of their income. It would also continue to subsidize activities that are neither charitable nor available to all, such as education and religious practices.
TE reductions will redistribute about $1 trillion from special interests to (all) employers, workers, and small businesses, boosting consumption and stimulating tax revenue. But this is speculation; ideally, we would collect a few years of data before increasing federal income taxes to make this reform revenue neutral. At the same time, we should explore adjustments to tax brackets and marginal tax rates, especially since 1) we now have a bloated an annual deficit exceeding $1 trillion; 2) some tax expenditures proposed for elimination may be retained; and 3) with no apparent appetite for reduced spending, Congress needs to take a close look at revenues to balance the budget. Serious consideration of FTW will require application of a sophisticated tax model that would improve upon my crude estimates and help address such complications.
[1] Surtax calculations use IRS Table 1.2 for 2020. Revenue (FIT and payroll tax) source is Table 2.1 in the FY 2023 President’s Budget.
The next essay in this series will continue Part III: How do we get from here to there? It will include text from Chapter 5 Slaying the Payroll Tax Dragon.
