Sunday, April 12, 2020

Our Income Taxes Are Not Progressive


The claim we have progressive income taxation has been accepted with no thought given to whether it is true.

It isn’t. Although the wealthy are paying a larger share of total income taxes than ever, they are also wealthier than ever, and Liberals are constantly whining about the growing wealth gap. Far from being progressive, income taxes discourage savings and the accumulation of wealth, and place obstacles in the path to closing the wealth gap. It’s easy to maintain wealth, hard to accumulate it.

To begin, what makes an income tax progressive? The probable answer is that the higher the income, the higher the tax rate. The intent of progressive taxation is to have the wealthy carry the tax load, because: “They should pay their fair share. They need to give back. They receive the greatest benefits. Yada, yada & Etc.”

Because of the “progressive” nature of our income tax system, the wealthy make a lot of tax lawyers and accountants wealthy too by paying them to devise ways to beat high taxes. Even government has leaped into the tax avoidance business, by promoting schemes like tax-free municipal bonds.

Since the top 5% in terms of adjusted gross income pay 60% of income taxes (the top 5% share of the total has increased steadily, up from 37% in 1980 when the top tax brackets were at 70%), and the bottom 50% pay only 3% of the total (less than half of the 7% they paid in 1980).

You can see by the trend, the wealthy need all the help they can buy to avoid fulfilling the Democrat’s dream of wealthy Republicans eventually paying all the income tax. As it is, almost half of our “taxpayers” no longer pay any taxes to the IRS.

Thanks to the Internet, you can also easily find entire nations that provide tax avoidance services, offering off-shore banking in British Virgin Islands, Belize, Dominica, Seychelles, Panama and Gibraltar, and in other less favored states.

As is usual, the unwealthy need not apply.

Can an income tax be regressive? Look no farther than FICA (Social Security) and Medicare payroll taxes for the answer, a resounding “Yes!” The FICA and Medicare rates are the same for all, and FICA is paid equally on the first dollar earned up to the 137,700th dollar, after which the marginal rate is zero. Therefore, the total FICA tax rate for someone earning $275,400 falls to 3.1 percent, exactly half the 6.2 percent rate for anyone earning $137,700 or less.

You do realize your "employer contribution" comes out of your wages too, don't you? It's a sneaky way politicians try to make you think you're only paying 6.2 percent into Social Security. If you were self-employed, you would know you pay 12.4 percent into Social Security, and 2.9 percent into Medicare.

The total FICA tax rate continues to fall once taxable wages pass $137,700  For example, for someone earning $413,100, the tax rate is only 2.07 percent. At $550,800, it falls to 1.55 percent, or approximately the 1.45 percent Medicare tax. Get the picture?

FICA is also regressive because it discourages savings and wealth accumulation. The 12.4 percent of income paid into Social Security earns at about a 2 percent rate, less than the rate of inflation. After a lifetime paying into FICA, mortality tables show that a black male born before 2000 will die just about the time he would collect his first check at about 66 years of age. He will probably be unmarried when he dies, so his Social Security benefits will cease with his last breath. The return on his working lifetime investment is worse than 0.00%, which would be the return if someone was paid what he put in. No, his return on investment is a negative 100 percent (-100%).

Opponents of privatized Social Security accounts don’t spend much time on this feature of the present system, or on the fact it went cash income negative in 2010 and goes bankrupt in 2035.

As added frosting on the wealthy’s tax avoidance cake, a person making a million dollars a year from investments only pays FICA at the 0.00% rate. If, following the example of Ross Perot, the million dollars was all income from tax-free municipal bonds, his federal income tax rate is also 0.00%. Therefore, the wealthy can legally pay FICA and income taxes at the same rate as the drug dealer, who pays none of either unless he is caught, arrested, and convicted, and then only if the government can then find where he stashed his loot (see British Virgin Islands, Belize, Dominica, Seychelles, Panama and Gibraltar), and then find someway to collect from it.

Lots of luck collecting, G-Men.

Not only FICA is regressive, but our “progressive” income tax system is too. It also discourages savings and wealth accumulation, by taking a portion of the income before it can be invested, and then taxing interest and profits which, during inflationary periods (i.e. most of the time), means the IRS is reducing your capital base.

Taxing both interest earned on investments and capital gains are particularly regressive and oppressive forms of taxation. In the first instance, interest usually doesn’t keep up with the rate of inflation, so taxing interest earned just adds to capital shrinkage.

On the other hand, capital investments usually increase with inflation, and often at a faster rate. However, that still means that most of the value of the asset is original cost plus inflation. If the value only goes up by the amount of inflation, and the asset is then sold, the investor has not made a profit, he has just gotten back the value of his original investment.

“Not so,” says the IRS. "You have made a profit, i.e. selling price – original cost = profit, and on that profit you will pay capital gains tax." In other words, your investment not only did not beat inflation, but after paying tax on the “capital gain,” you lost money. Such a deal! Courtesy of your IRS.

I am waiting for a Liberal to explain to me why a system of taxation that discourages savings and investment is considered “progressive.”

The most illogical and regressive part of income taxation is the double taxation of corporate profits. Corporations are taxed at a very high rate (basically 21%, formerly 35%, with possible add-ons) when profits are earned, and then those profits are taxed to individuals when distributed as dividends.

Liberals have justified this double taxation by once again clothing it in the mantel of “fairness,” declaring that corporations must pay their fair share. Either through deceit or ignorance, the Liberals don’t admit that corporations don’t actually pay any income, property, or any other form of taxes; we who buy their products pay their taxes.

That’s right, when you’re calling for corporations to take on more of the tax load, what you are really demanding is government to tax us more. To a corporation, corporate taxes are just another cost of business to be passed on to their customers along with the costs of labor, materials, and overhead.

When the government collects corporate taxes, it reduces the capital the corporation can use for investment. Therefore, instead of funding growth internally through increased retained earnings, the corporation has to replace the funds lost to corporate income taxes by borrowing.

I’ve heard many Liberals dispute this, but without demonstrating to me how corporations could pay their taxes unless they receive money from their customers when they sell them their products. Some have told me that corporations sell a lot to other corporations, and to government, as if that proved a human being was not the ultimate link in the tax paying chain.

For the accounting illiterate among you, I would like to explain that corporations who buy anything from anyone include those costs as material or overhead charges, and recover them through charges such as depreciation, amortization, professional services expenses (such as tax lawyers and accountants), & etc. The only time they “eat” the taxes instead of passing them on is when they are operating at a loss. However, at that point taxpayers subsidize their loss because tax law provides for corporations to carry losses back against prior period taxes paid, and then forward against subsequent year profits.

The bottom line is there is nothing progressive about “progressive” income taxation. It is an artifact created from class envy and taxpayer ignorance by legislators to fool taxpayers. While the taxpayers are gloating and celebrating how politicians have “socked it to” the wealthy and to the evil corporations, the politicians are gloating about how easy it is to fool ignorant and envious citizens and get their votes.

Meanwhile, instead of benefiting from the stronger and healthier economy that sensible taxation would promote, the taxpayer congratulates the politicians for distributing tax misery equitably.

Income taxation problems such as discouraging investment, wealth accumulation and savings, slowing economic growth, and placing American business at a competitive disadvantage in the world marketplace, would be solved by a national sales tax along the lines of the Fair Tax proposal.

Just as regressive income taxation has been called “progressive,” the progressive Fair Tax proposal has been labeled regressive.

Newspeak lives.

Please click on the label below to see all my articles on this topic.

Friday, April 10, 2020

Tax Day Lament

Day after day in years past I have struggled against waves of remorse to sit before my computer and painstakingly compose Alice and my income tax returns. My sole objective every year is to arrive at all ways this side of outlaw to reduce our tax “contribution”. However, I realize that our efforts to minimize our contribution might seem selfish to many: “Where’s your spirit of sharing?”

Oddly though, before I plumb the depths of guilty feelings too deeply, I rationalize that it’s only me and trusty TurboTax against a well-paid IRS army; in years past Democrats like John and Teresa Kerry, John Edwards, and Bill and Hillary Clinton, who were generous to a fault with public funds, were known to sic armies of tax lawyers and accountants onto the IRS to make sure that they too contributed as little as possible. Then, if still burdened by feelings of selfishness, I take solace knowing we donated more to charity in a year than Joe and Jill Biden did in a decade.

At this point waves of smug, self-satisfaction wash over me, until I realize that I live in a community where generosity takes many forms, and is a way of life. Whereas the taxes we pay leave our community to be frittered away, in our communities the Lions, Rotarians, Soroptimists, Gualala Arts volunteers, school boosters, restaurateurs, and donations by generous businesses and individuals do what the bureaucrats won’t and can’t: find our real needs and fill them.

For over twenty years it’s been my privilege to work with many other Lions and Rotarians to round up donations for our fundraiser raffles and auctions, so I am constantly made aware of the generosity of neighbors and business owners.

We render unto Cesar, but our hearts give voluntarily and happily to friends. 

Thursday, April 09, 2020

Social Security Privatization Made Easy

Privatization of Social Security is still a hot topic in the Combs house. I started drawing Social Security at my normal full entitlement age, in my case 65 years and 10 months (I was born in 1942). However, Alice waited  until she was 68 before starting.

Both of us knew that Social Security wouldn’t pay me much, even though I earned above or near the maximum for FICA contributions for almost all of a working life now approaching fifty years.

Over the years Alice and I have heard Democrats putting down Social Security privatization, saying that it wouldn’t pay as much and was too risky. As a test, I thought it would be a good idea to use real income and contribution amounts to get an accurate estimate of how a person would have fared if Social Security had always been privatized. Fortunately for my project, Alice had “Your Social Security Statement” in one of her voluminous files (she never throws anything away) and I copied her Social Security income by year onto an Excel spreadsheet, beginning with the $40 she earned in 1959.

The next part, calculating how much Alice contributed to Social Security each year, took a little research. Happily, such research in the Age of Google is the essence of simplicity, and I immediately found a Social Security page on that provided a table of Social Security tax rates:

Year Social Security Tax Rate
1950 3%
1960 6%
1970 8.4%
1980 10.2%1990 12.4%
2000 12.4%

By multiplying Alice’s Social Security earnings each year by the tax rate for that year I calculated how much Alice contributed each year. Since Alice earned more than the Social Security ceiling since 1977, I projected her income and contributions through the end of 2008 and found she had contributed a total of $220,254.56 from 1958 through 2008.

The next part was simple, but a bit tricky since it required me to select a table of values for stock market investments covering at least a half century. I selected a table of the Compound Annual Growth Rate (CAGR) of the S&P 500 for two reasons. The CAGR gives about a one percent lower rate of return than using simple averages, but avoids the valid criticism that a simple average method mechanically distorts the effects of year-to-year fluctuations. The other reason I chose it was that an index of the S&P 500 reflects a simple, inexpensive mutual fund investment option that has been available for a long time.

I used the date range calculator for each of the fifty years 1958 through 2007 (I valued 2008 FICA contributions at face value). It was laborious work, but now you don’t have to do it, because I’ve done it for you.
(For example, a dollar invested in the S&P 500 in 1958 is worth $32.57 today. Multiply your FICA contribution in 1958 by $32.57, and you would have its value now.)

Year Compound Annual Growth Rate
1958 $32.57
1959 $24.78
1960 $23.22
1961 $24.19
1962 $20.18
1963 $22.88
1964 $19.28
1965 $17.06
1966 $15.65
1967 $17.98
1968 $14.97
1969 $14.05
1970 $15.87
1971 $15.85
1972 $14.37
1973 $12.43
1974 $15.00
1975 $21.29
1976 $16.23
1977 $13.63
1978 $15.37
1979 $15.42
1980 $13.71
1981 $10.90
1982 $12.12
1983 $10.53
1984 $8.98
1985 $8.85
1986 $7.01
1987 $6.07
1988 $5.92
1989 $5.27
1990 $4.14
1991 $4.43
1992 $3.51
1993 $3.36
1994 $3.14
1995 $3.18
1996 $2.37
1997 $1.97
1998 $1.51
1999 $1.19
2000 $1.00
2001 $1.11
2002 $1.27
2003 $1.66
2004 $1.31
2005 $1.21
2006 $1.17
2007 $1.04
2008 $1.00

Now all you have to do is post this to your Excel spreadsheet, and multiply your contribution each year by the CAGR value for that year. When you’re finished, just sum the total and you will find how much your contributions would be worth through 2008 if they had been invested in an S&P 500 index fund. (This fund would be much larger if you assume that dividends are reinvested.)

Alice would have had a fund worth $765,722.90. If she drew on it now, at the rate of the $2,000 per month Social Security would pay if she started now, it would last her 32 years, or until she was 98 years old, even if she never re-invested a penny. That’s a good thing, since Alice, then at age 66, had a life expectancy of another 18 years to the age of 84. If she only made it to 84, by drawing out $2,000 a month she would still have about $333,000 left to pass on in her estate.

(Unfortunately, in our current government-run system, as soon as you die, your Social Security disappears unless you have the unlikely situation of a spouse who does not qualify in their own right, or unmarried minor children.)

Alice, being a very successful businesswoman, would of course re-invest her privatized Social Security funds, and would probably just leave it in an S&P 500 index fund.
The average rate of return for all holding periods beginning in 1926 (the year the S&P 500 was actually founded) is 11.0%. The average rate of return for all holding periods beginning in January 1945 is 11.6%, and since January 1980, the average rate of return for all full-year increment holding periods is 13.9%.

Let’s keep it simple and say that the market can only do 10.0% per year, so in each month of 2009 Alice leaves the principal alone and only takes out as income the average monthly increase of $6,380 ($76,560 per year), which is about 3.2 times larger than she would have been paid under Social Security.

Don’t forget, Alice can keep drawing on her funds at this rate for years and still have over $765,000 untouched to pass on tax-free one day to her heirs (assuming that politicians don’t get greedy, as they usually do, and levy an exorbitant Death Tax on these previously taxed funds).

So why don’t we have privatized Social Security? To answer this question, ask another question. Why aren’t there any funds in the Social Security Trust Fund?

There aren’t any funds in the Social Security Trust Fund because Democrat politicians realized that historical Social Security surpluses could be diverted to finance current spending through the simple device of replacing the Trust Fund surplus dollars with special Treasury Bonds (or government IOUs).

In essence the government said, “I’ll borrow from myself, spend the money, and when Social Security goes into deficit spending in 2010, I’ll increase payroll taxes plus borrow from the General Fund – excuse me, sell back the IOUs, causing the General Fund to borrow and increase taxes to make up the deficit - while pretending the whole time that Social Security is solvent until 2035. By then I’ll be long retired, and some other poor suckers will have to try to clean up the mess.”

Our government has always trusted that we are primarily too stupid, and secondarily too greedy, to privatize Social Security. Too stupid to realize Social Security is a horrible investment for workers, but a great cash cow for politicians to tap for funds to spend to buy our votes. Then we have to be too greedy to stop them from buying our votes and to phase in privatization to pass down a better system to our descendants.

As a final point, and one deserving of a post all its own, if we all had been paying into a privatized account, an S&P 500 index fund (the S&P 500 contains 70% of our stock market capitalization), instead of a government deep in debt, we would have an economy awash in capital. All of our contributions invested in our economy instead of frittered away by politicians would be powering economic growth, and high levels of research, development, and innovation.

As an incidental consequence, the high level of economic activity would also be generating high tax revenues, especially at reduced tax rates.

We would have universal health care through personal Medical Savings Accounts, not a bankrupt Medicare system and Medic-Aid that has been cut so much that doctors are refusing Medic-Aid patients.

We have seen the future, and it works, but only if we can take back control of it from the politicians.