A Stitch in Haste

Courtesy of Outside the Beltway comes this Los Angeles Times story that the White House may consider eliminating the deductibility of state and local taxes from federal income taxes:

Some conservative activists are urging the Bush administration to scrap the federal deduction for state and local taxes as part of a broader plan to revamp the nation's tax system.

Although the proposal would hurt some taxpayers in nearly every state, it would hit hardest in states with higher-than-average income levels and bigger-than-average state and local tax burdens. High on the list are a number of blue states -- those that were carried by Democrat Sen. John F. Kerry in last month's presidential election.

Taxpayers in California and New York, for example, which have top state income tax rates of 9.3% and 6.5% respectively, would be highly affected; residents of Florida and Texas, which have no state income taxes, much less so.

OTB's Joyner submits:

[I]t's unclear why the federal taxpayer should subsidize high tax rates at the state level. By allowing this deduction, the federal government actually encourages higher state and local taxes, since local leaders can use the deductability of the tax as a selling point.

Some hasty stitches:

--There's a big difference between "conservative activists" advocating something and the White House, or the Congressional leadership advocating it. There is no evidence of the latter. This piece sounds very, well, "sound bitey" to me.

--What does it say about the current political climate that there is talk of "punishing" blue states, when, as was noted immediately after the election, we are really talking about varying shades of purple?

--To ask, as OTB's James Joyner does, why low-tax states should subsidize high-tax states, misses the point entirely. States don't pay income tax -- people pay income tax. The deductibility of state taxes only matters to someone who has taxes to pay. So Joyner's question can easily be turned upside down, and one might ask why a person who is already paying enough income tax for the state deductibility to matter should be expected to pay, unilaterally, an even higher share of taxes, widening even more the hyper-progressive distribution of the federal income tax burden that we already have in this country?

--Partitioning tax burdens (i.e., not allowing deductibility of state taxes) only makes sense if government activities are likewise partitioned (i.e., the national government does national things and pays for them with national taxes, while state governments do state things and pay for them with state taxes and local governments do local things and pay for them with local taxes). Unfortunately that is not the current American model of governance (if you like, "federalism is dead" while "all politics is now national"). Monies flow into and out of Washington from so many different pipes as to be practically untrackable in the aggregate, Social Security taxes pay for non-Social Security programs (i.e., the fraud of the "Lockbox"), tax policy is used for purposes other to raise revenue, etc. To focus on one singular aspect of the system and cry foul is not only myopic, but also impractical.

It's one thing to advocate a comprehensive series of reforms to fuel an across-the-board reduction in tax rates (i.e., "tax simplification"), even though some people will obviously end up paying more and some less. But focusing on individual pet annoyances about deductions is not only unproductive but also unfair. The primary goal must not be on making anyone pair more in taxes, especially when cloaked in specious arguments about "fairness" -- any "reform" that simply raises taxes for one group or another is not reform at all. Only proposals that reduce tax burdens are to be praised. How much "inequity" can be allowed in the reduction of the tax burden is the only realm where honest debate should be entertained.

Related Posts:
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(Guest-posted earlier today at Freespace.)

From the Wall Street Journal (subscription site, but -- unlike Tim -- I can afford such things):

Of all the Democratic complaints about the presidential election, the most interesting and ironic came from Lawrence O'Donnell, a leading party strategist and former aide to Sen. Pat Moynihan. He complained on MSNBC that, "The segment of the country that pays for the federal government is now being governed by the people who don't pay for the federal government." Mr. O'Donnell added for good measure, "Ninety percent of the red states are welfare client states of the federal government."

...
Consider deep blue Connecticut and vivid red Oklahoma. Both have roughly the same number of people, five Congressmen and seven electoral votes. Last year, 1.66 million Connecticut tax filers paid $19.1 billion in personal taxes on $107 billion of adjusted gross income. That makes for an average tax rate of 17.9% in Connecticut. In the same year, 1.5 million Oklahoma tax filers paid $6.6 billion in personal taxes on $54 billion in adjusted gross income; an average tax rate of 12.2%. Democrats like Mr. O'Donnell seem to want the rich to pay more in taxes, but not for rich states with rich people to pay more taxes. It's unclear how one accomplishes this mathematically.
...
But this "blue-state tax blues" problem is much more than just an issue of fairness. It also contributes to a pernicious economic and fiscal cycle for the Northeast and other high-cost, high-tax regions. ...As higher-wage jobs leave the overtaxed, higher-cost areas, both the local economy and the state's tax base decline. This often creates a need to raise state and local taxes still further, making those states and regions still less competitive.

Often, the next step in the lament is to observe that the deductibility of state and local taxes from one's federal income tax exacerbates the problem by creating a moral hazard (i.e., giving high-tax states and cities less incentive to reduce their own income tax rates, since "it's deductible anyway"). Calls to replace the federal income tax with a national sales tax also often highlight the "Red Tax, Blue Tax" phenomenon.

The problem with such an analytical framework is that it only considers tax inflows to Washington and not outlays. Stated differently, it would be perfectly logical to say "Connecticut has more rich people, so of course Connecticut should 'pay' more income tax" -- if and only if we had a strict correlation between "federal versus state taxation" and "federal versus state expenditures" (or, to coin a term, "fiscal federalism").

Under "fiscal federalism," the national government would do national things and pay for them with national taxes, while state governments did state things and paid for them with state taxes and local governments did local things and paid for them with local taxes. In the early (pre-modern?) history of our country, that's exactly how fiscal policy worked (cf., McCulloch v. Maryland, 17 U.S. 316 (1819))

Unfortunately that is not the American model of public finance today (if you like, "federalism is dead" while "all politics is national"). Monies flow into and out of Washington from so many different pipes as to be practically untrackable in the aggregate, Social Security taxes pay for non-Social Security programs (i.e., the fraud of the "Lockbox"), tax policy is used for purposes other than to raise revenue, etc. To focus on one singular aspect of the system and cry foul is not only myopic, but also impractical.

As government gets more expansive in determining what it should do, it also gets more expansive in how it should pay for it. Focusing on individual "inequities" in tax revenues, block grants, subsidies, regulations, etc., miss the point entirely and only serve to distract from the real debate -- just how big should government be in the first place?

To lament disparities, inefficiencies or inequities in tax policy, without simultaneously analyzing the corresponding inequities in government spending, is counterproductive. It's like the old story about a table where one leg is shorter than than the rest, so you try to fix it by shortening the other legs but get it wrong, so you go back to the original leg, and on and on until all you have is a hopelessly ruined piece of wood. Maybe it's time instead to re-examine the factory that produced the defective furniture in the first place.

POST SCRIPT: Connecticut's tax base declining? Where have we heard that before?

Expect a lot of noise over this report that the poor can't afford to live in America:

Most Americans who rely on just a full-time job earning the federal minimum wage [i.e., $5.15 per hour] cannot afford the rent and utilities on a one- or two-bedroom apartment, an advocacy group on low-income housing reported Monday.

For a two-bedroom rental alone, the typical worker must earn at least $15.37 an hour -- nearly three times the federal minimum wage, the National Low Income Housing Coalition said in its annual "Out of Reach" report.
...
The median hourly wage in the United States is about $14, and more than one-quarter of the population earns less than $10 an hour, the report said.

"A lot of people continue to be squeezed out," said Judy Levey, executive director of the Homeless and Housing Coalition of Kentucky. "Housing here is relatively inexpensive, but because the wages are so low, people can't afford housing."
...
In only four of the nation's 3,066 counties could a full-time worker making the federal minimum wage afford a typical one-bedroom apartment, the coalition said.
...
California topped all states in the hourly wage needed to afford a two-bedroom apartment, at $21.24, followed by Massachusetts, New Jersey, Maryland and New York.

Notice the sleight-of-hand (actually "bait-and-switch" might be a more appropriate term). First we're talking about the federal minimum wage, then about $14 per hour, then $10, then the minimum wage again. Which is it?

We're told that a minimum wage family cannot afford housing, then we're told that 25% of the population work below the median wage (not the minimum wage), therefore 25% of the population is paying too much for housing.

Three lies for the price of one.

Of course, the federal minimum wage grabs the most headlines, so no wonder it appears first in the report. Just one minor detail -- primary income earners (what were once called "breadwinners") rarely if ever make only the minimum wage.

Indeed, almost no one makes the minimum wage. Those who do fall into three main categories: teenagers, part-timers (e.g., working mothers, retirees), and newly-arrived unskilled immigrants -- none of whom tend to be solely responsible for their own housing costs. For details, see this piece that debunks the "minimum wage = poverty" myth.

Meanwhile, here are some real scandals regarding the poor and housing costs --

--Although poor workers generally pay little or no federal income tax (many actually receive money on balance, via the Earned Income Tax Credit), they do, however, pay Social Security tax (and Medicare tax). Yet "advocates" for the poor are typically the loudest opponents of privatized Social Security accounts. Go figure.

--Affordable housing tends to be the hardest to find where there is rent regulation (e.g., New York City, San Francisco), in a basic application of Economics 101 -- choke off supply with a price ceiling, and you get a shortage. Go figure.

--Similarly, housing tends to be expensive where -- surprise -- property taxes are high, along with local income taxes and other costs of living and doing business. Where are the calls from the "housing advocates" for reduced municipal spending and taxes? Go figure.

It is true that no one in America should have to be bankrupted by housing costs. But the best way to avoid it is by restoring sanity to housing markets, tax policy and municipal finance rather than by deceptively presenting misleading statistics in a call for an expansion of the redistributionist welfare state.

Related Posts:
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New York State Shoots Itself in Foot Raises Minimum Wage

I have blogged previously on the subject of whether it is justifiable to allow state and local taxes to be deductible from one's federal income tax. To review, the argument against deductibility goes something like this: "Allowing deductibility in essence subsidizes high-tax states, which both serves as a disincentive for high-tax states to lower their taxes and also transfers the federal tax burden from high-local-tax states to low-local-tax states."

My previous response, which I reiterate, is that the overall federal-state-local, income-sales-property, tax-and-spend complex is simply too convoluted a labyrinth to look at any one part of it in a vacuum and declare it "unfair" --

Partitioning tax burdens (i.e., not allowing deductibility of state taxes) only makes sense if government activities are likewise partitioned (i.e., the national government does national things and pays for them with national taxes, while state governments do state things and pay for them with state taxes and local governments do local things and pay for them with local taxes). Unfortunately that is not the current American model of governance...

Now comes word from the Urban Institute that the whole "redistribution of the tax burden" phenomenon doesn't even exist. The think tank reminds us of two easily-overlooked facts:

1. Not everyone actually deducts their state and local taxes -- only filers who itemize can claim the deduction. Those taxpayers tend to be higher-income (and therefore more heavily taxed) anyway. Also, many of those filers are hit with the insane Alternative Minimum Tax and lose all or part of the benefit of state & local deductibility even if they do itemize.

In each of the three states with the greatest dollar amount of state & local tax deductions on federal returns (California, New York and New Jersey), the number of filers who are actually deducting is less than 40%; In each of the top ten deduction states, fewer than 50% of filers actually deduct. So the question of "who is subsidizing whom" is far less ubiquitous as some might think. Regardless of interstate comparisons, it's still the rich who are subsidizing the poor, regardless of which state they happen to live in.

2. The high-deduction states still tend to be net contributors to Washington. Consider some examples: California has 13.0% of taxpayers, who pay 13.2% of the nation's income tax; New Yorkers are 7.4% of all returns but pay 8.7% of the nation's income tax. Seven of the top ten deduction states pay more than their proportional share of federal income tax. So much for the argument that low-tax states subsidize high-tax states.

Neither I nor Blogger are good with posting tables, so review the numbers yourself here.

Questions of how best to simplify taxes mean nothing, absolutely nothing, unless the overall tax burden declines. Questions of what should be deductible, which states are subsidizing which states, etc., are mere distractions from the real debate of how high the overall tax burden on Americans should be.

I once heard that the "correct" libertarian position on tax reform is that anything that reduces anybody's taxes is to be supported, no matter how inequitable or discriminatory the policy may be (i.e., "starve the beast" at all costs). I'm not sure I would go that far, but I think there's more truth than error in it.

Related Posts:
Should State & Local Taxes Be Deductible?
Red Tax, Blue Tax
Which States Have the Best/Worst Tax Policies?
New Species Discovered: The Alaskan Tax Vulture

"Taxes are like sacrifices to tribal gods -- just less productive." --Doctor Who

If you need a briefing on the fiscal cancer known as the Alternative Minimum Tax, the New York Times has a fairly good primer today:

[The AMT] is increasingly being applied to families with incomes of $75,000 to $250,000 a year who claim relatively high deductions -- like the ones for property taxes, state and local income taxes -- and the exemption for children. When it does apply, it cancels some of those deductions.

The impact is about to mushroom. Barring a change in the law, almost 19 million taxpayers will be subject next year to the alternative minimum tax, or A.M.T., up from roughly 3.4 million this year and 1.3 million in 2000, according to the Tax Policy Center, a Washington research group whose calculations on this issue are widely accepted.
...
Left unchanged, the alternative tax would produce more revenue by 2009 than the ordinary federal income tax, according to the Tax Policy Center, a joint venture of the Brookings Institution and the Urban Institute.
...
The alternative minimum tax began in 1969, after Joseph W. Barr, the departing Treasury secretary under President Lyndon B. Johnson, told Congress that 155 wealthy families had used loopholes to avoid paying any federal income tax in 1967. Mr. Barr warned of the possibility of a middle-class taxpayer revolt in response.
...
The triggers for the alternative tax have not kept up with inflation, causing it to capture many people whose main deductions come from nothing more exotic than children and local taxes. People in towns with high property taxes sometimes face the A.M.T., while others with similar incomes in the next town do not.

So here's the current Beltway thinking (or lack thereof): A program meant to smack down 155 deadbeat super-rich families now imposes a surcharge -- a "rich tax" -- on households with as little as $75,000. You make $38,000 and your spouse makes $38,000 too? Congratulations! You're "rich"! How does it feel? Oh, and by the way, be sure to pay your AMT.

In four years, the AMT will surpass the "plain vanilla" federal income tax, and yet we still hear claims that taxes aren't progressive enough, that the "rich" (which, if it doesn't alredy, may soon mean you) don't pay their "fair share" -- they can afford "just a few dollars more" in the form of "Scrap the Cap", or the "Nip/Tax," or whatever else the politicians can think of.

Meanwhile, note the bipartisan gobbledygook on this issue:

--The Democrats: "Look, the AMT is being paid by the Blue States! No fair!" (About half the people paying the AMT live in one of four states -- California, Massachusetts, New Jersey and New York -- all "Blue.")

--The Republicans: "Look, we're still subsidizing those high (Blue) state taxes through their deductibility on traditional federal taxes! No fair!"

Meanwhile, more and more taxpayers get more and more screwed.

As I've said: The "penny in your pocket rule" reigns supreme. And now, with the AMT, they're picking your pocket with both hands.

This is why I'm cynical about tax reform and prefer to focus on Social Security. You can simplify income taxes today, but it just becomes a matter of time before some change is made, some cry of "No fair!" resonates and, in the name of "fairness" and "equity" a provision is made and a deduction allowed (or disallowed) or a rate is changed. Then another. And another. Then inflation and wage growth kick in and the next thing you know the system is right back where it started (i.e., unfair and inequitable).

And, as I've blogged previously, that goes double when it comes to proposals to replace the federal income tax with a national sales tax. Far too dangerous to risk.

Maybe, just maybe, we'll someday have an "Alternative Minimum Budget." One that would make this whole quandary moot.

Someday.

UPDATE: Here's an interesting new piece from the Urban Institute on the AMT. Money quote --

Memories are short, but the AMT was rejected as the best way to reform the income tax under the Treasury’s tax reform proposals in 1984. With a good regular tax, there was no reason to identify items of preference for another tax. By the time that Congress got around to amending the Treasury proposals on the way to the Tax Reform Act of 1986, however, it went through several stages of restoring some preferences to taxpayers, losing more revenues than it could afford, then coming in the back door by adding complex items like the AMT. In some cases, putting items in the AMT was an indirect way of tackling preferences; in other cases, there was little excuse for including the items because they really weren’t preferences in the first place.

In other words, real-world tax simplification is a myth. The politics of pull, combined with the death of fiscal conservatism, makes it simply impossible to effect true tax simplification. There will always, always, be degradation as soon as some group or politician says "we shouldn't tax this" or "we shouldn't exempt this" or "the rich can afford just a little bit more."

The correct course of action is to focus on runaway government spending and regulation -- fighting (or claiming to fight) pork and bloat is always popular, as is promising to ease the regulatory burden on business, especially small business (which is the backbone of the economy).

Reduce the budget, reduce the constraints on the economy, and taxes will take care of themselves.

Related Posts:
More on the Deductibility of State & Local Taxes
Nip/Tax
On Property Taxes and Assessments
Sales Taxes and "Helping the Poor"
Red Tax, Blue Tax

Two follow-ups to my previous post on the Alternative Minimum Tax as a case of "stealth progressivity" --

ITEM: The working poor tend not to have high state and local income or property taxes (e.g., if they're renters, then they have zero property taxes to deduct). So Congress and the IRS have invented phantom state sales taxes for lower-income filers to deduct:

[A] new deduction, available in 2004 and 2005, lets taxpayers deduct state sales taxes in lieu of state income taxes if it helps lower their tax bills.
...
To figure your deduction, you can use a table provided by the IRS or add up the sales taxes paid in 2004.
...
Justin Ransome, a senior manager in private client advisory services at PricewaterhouseCoopers, said the benefits may be rather limited for taxpayers in states with income taxes.
...
"If you bought a couple of Hummers and a yacht with your disposable income, you might very well find that the sales tax deduction is a better bet for you," said Jackie Perlman, a senior tax research coordinator at H&R Block.

Now of course the rich, with their yachts and Hummers, would almost never come out ahead from this new deduction, even in those states with no income tax. Only filers with little or no state income tax or property tax will benefit from this new sales tax deduction -- it's one or the other. So of course it's the working poor who will qualify.

And there's absolutely nothing wrong with that. I'm the kind of libertarian who thinks that any reform that reduces anybody's taxes is a good thing. A dollar less tax paid, whether by me, or Bill Gates, or a minimum-wage bricklayer in Nevada, is to be celebrated.

On the other hand, let's be intellectually honest about whom this change is for and how it will impact progressivity of the federal income tax burden. And let's not turn around and say, after we've implemented yet another way to ease the tax burden on lower-income households, that it's fair on top of that to then say that higher-income households should still be required to pay "just a little bit more -- they can afford it."

That's two bites at the progressivity apple, and it's not fair.

ITEM: People who like to argue for a flat tax or a consumption tax similarly miss the point about the balance between the relative tax burden (i.e., progressivity) and the total tax burden (i.e., fiscal leviathan). Samizdata puts it succinctly:

[A]rguing ... mere flatness is not the point. Just having a flat roof to the graph is a hideous compromise. It must be flattened until it is zero-height roadkill.

Indeed. The same goes for the (misguided) advocates of a consumption tax -- would a national sales tax be such a good idea if it were set at 40%? And of course a consumption tax would, either initially or eventually, also include progressive elements no different than the income tax. Elements that would likely escalate over time. Do you really think politicians will allow food, clothing, diapers, rent, college tuition, etc., to be subject to a national sales tax, either at the outset or for very long?

Look at some of the complex rules at the state level regarding what is and is not subject to sales tax (e.g., soda is taxed but juice is not, hot dinners sold by supermarkets are taxed but frozen dinners are not, bowling shoes are taxed but tennis shoes aren't).

Bottom line, don't be seduced by the "simpler is better" siren song. Lower is better. And simpler does not guarantee lower. And simpler never lasts anyway. So what's the point?

Cut out the middleman. Worry less about tax simplicity and more about tax burdens. Choke off the fiscal leviathan entirely, and egregiously excessive tax progressivity will wither on its own.

Related Posts:
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More on the Deductibility of State & Local Taxes
On Property Taxes and Assessments
Sales Taxes and "Helping the Poor"
Red Tax, Blue Tax

I’ll give the Christian Science Monitor credit: they are probably the most honest proponents of the “Penny in Your Pocket Rule” I’ve seen to date:

[T]he income gap between the rich and poor in the United States has gotten wider again. A reformed Social Security could help readjust that balance.

It's unclear whether President Bush's plan will do that. But Social Security could be altered to accomplish that goal, says Robert Shiller, an economist at Yale University. He frets that the growing rich-poor gap "is going to fester eventually. It will be a source of resentment."

So he suggests that both the federal income tax and Social Security be indexed so that any growth in this income gap be offset by raising the progressivity of the tax and retirement systems.
...
A more modest proposal would be to raise the level of earnings subject to the Social Security tax. Currently, the system taxes only the first $90,000 of income, while a growing number of Americans earn more. In 2001, for example, 15 percent of Social Security contributors made more than the taxable earnings maximum, up from 10 percent in 1983.

Some hasty stitches:

--Why is it fair to talk about the uneven distribution of income but not the uneven distribution of the income tax? The bottom 50% of households pay no federal income tax. So why are the poor entitled to feel “resentment” over their (relative) poverty but taxpayers are not entitled to feel resentment over their (relative and absolute) tax burden? Stated differently, why are the poor entitled to feel “resentment” over the distribution of income but not expected to feel gratitude over the lack of an income tax burden that follows from it?

--On the other hand, if there is “resentment” to be felt by the working poor, shouldn’t it be over the 12.4% of their paycheck that is confiscated by Social Security taxes?

--Social Security is already an extremely progressive redistribution scheme. I have blogged about this repeatedly, but the simple way to remember it is that someone who pays twice as much Social Security tax over his working life receives far less than twice as much in benefits. That’s progressive redistribution of income, folks.

--Lamenting the Social Security cap of “only” $90,000 ignores the fact that the cap has increased every single year and will continue to do so from here to eternity. So with each passing year Social Security becomes ever more progressive in its redistribution of income. And still Shiller and the CSM want more. Penny in your pocket...

--Since the Social Security “trust fund” is a fraud, the entire federal tax framework is set to become ever more progressive than it already is, beginning in 2018 2017, as the trust fund “assets” (i.e., mere promises to raise income taxes in the future) are “redeemed.” In other words, when income taxes start going up to satisfy the “trust fund,” does anyone honestly believe they will increase in a regressive way? Of course not.

--And don’t forget the Alternative Minimum Tax.

One final thought:

When first proposed, Social Security was billed as insurance, even though it clearly redistributed income, especially to many early recipients of pensions who had paid little or nothing into the system. The reason, one key drafter of the bill told Frank Genovese, an economist emeritus at Babson College in Wellesley, Mass., was that Americans did not believe in redistributing income to the poor. They did believe in insurance.

In other words, the government deliberately lied to taxpayers back in the 1930s.

What is that called again? Oh yeah – “FDR’s legacy.”

Related Recent Posts:
Social Security: Doomsday Comes a Year Earlier
Just Because the Trust Fund "Exists" Doesn't Mean It Exists
Who Faces the "Risk" of Social Security Reform?
Has Social Security Been a "Success"?
What is the Purpose of Social Security?

Still think that "tax simplification," without more, is a neat-o idea?

As taxpayers recover from finishing their annual filing chores, a presidential commission studying the tax laws has reached the conclusion that there are just too many deductions and credits.
...
"We have lost sight of the fact that the fundamental purpose of our tax system is to raise revenues to fund government," according to President Bush's Advisory Panel on Federal Tax Reform.

The commission's chairman, former Florida Sen. Connie Mack, said its nine members have been surprised at the number of tax deductions and credits.
...
Tax breaks also provide benefits without creating a government spending program. But the proliferation of tax breaks end up costing the public because they mean lawmakers cannot lower income tax rates...

This article exposes two distinct fallacies of "tax simplification" from the libertarian perspective. First is the bait-and-switch between "tax simplification" and "tax reduction." Tax simplification means eliminating deductions. Eliminating deductions means higher taxes. While acknowledging the deadweight loss of tax preparation, we must also acknowledge the "starve the beast" factor: anything that keeps anybody's money in their own pockets and out of the government's coffers is a good thing. Deductions may be complicated, they may create unintended consequences, they may even be "unfair" by some vague criterion. But if they help to constrain government, then they are a good thing.

The second trap of tax simplification is that it's somehow permanent. Hogwash. Simplify taxes today, and you merely give hungry politicians a less cluttered slate from which to craft new tax complications. And as they're doing so they will invoke the Politics of Pull and the Politics of the Warm Fuzzy Feeling and the Politics of "Or Else!" And in a few years time we'll be right back where we started.

"Tax simplification" is a false god that libertarians have no business worshipping. I certainly acknowledge the outrageous deadweight loss created by the estimated 6.6 billion hours Americans spend preparing tax returns. But that is not enough to justify a blind championing of tax simplification. Tax rates must also come down. Tax reduction should always be the priority: reduce tax burdens, and "tax simplification" will take care of itself.

POST SCRIPT: Of course, any talk of "tax simplification" that does not include the complete elimination of the Alternative Minimum Tax is a contemptible fraud. Keep that in mind as you (don't) hear talk of it from this Advisory Panel or from politicians generally.

I've blogged repeatedly on the "death of fiscal federalism" (i.e., the notion that federal taxes should only pay for federal government functions) and the inequities of federal taxation of, versus subsidies to, various states. In one sense the phenomenon is one of "blue states" subsidizing "red states" (i.e., blue state residents tend to have higher incomes and therefore higher federal tax rates). But in another sense it's red states subsidizing blue states (since blue states tend to have higher state and local taxes and therefore their residents benefit disproportionately from the deductibility of those taxes). It's also the Politics of Pull (i.e., which politicians can generate the most pork). And of course everybody subsidizes Alaska.

Here's one small example: The Tax Foundation has an updated study on which states' residents pay the Alternative Minimum Tax (click image to enlarge):



New Yorkers (myself included) get disproportionately hit by the AMT. Which got me to thinking -- what are my loyal public servants in Washington doing about it?

So I jaunted on over to senior Senator Charles Schumer's (D) website to see how he's fighting the AMT:

I urge the President to work with Congress to reform and simplify the AMT. Frankly, dealing with it should be a higher priority than making all of the President's tax cuts permanent...

Not abolish it, but "reform and simplify" it. I guess Schumer's perfectly content with some New Yorkers paying the AMT, so long as they're not "his" New Yorkers. And of course, what's far more important to Schumer is increasing taxes on some New Yorkers by raising regular federal income rates (remember: going from a lower tax rate to a higher tax rate is a tax increase, regardless of what sophistry -- i.e., "making cuts permanent" -- you hide it behind).

How about the junior Senator, Hillary Clinton (D)? What does her website say about the AMT?

Your search returned no results.

Maybe if the AMT included gains on cattle futures she'd be more interested.

If you can find five pages worth of free time, then be sure to review the latest brief, courtesy of the Congressional Research Service, on the increasing prevalence of liability under the Alternative Minimum Tax.

Here are some highlights:

--The number of taxpayers subject to the AMT will mushroom from about 3 million in 2004 to an estimated 21 million in 2006. That's a sevenfold increase in just two years!

--In 2006 more than one-third of taxpayers making between $50,000 and $100,000 will be subject to the AMT.

--Unlike the standard exemption for the regular federal income tax, which is indexed to inflation, the standard exemption for the AMT is scheduled to decrease in 2006:

For 2005, the AMT exemption is $58,000 for joint returns and $40,250 for unmarried taxpayers. In 2006, the basic AMT exemption is scheduled to decrease to its prior law levels of $45,000 for joint returns and $35,750 for unmarried taxpayers.

--As a point of reference, in 2006 a family of four will be subject to the AMT with just $67,500 of income. That's right, if you make $67,500 per year, then you're "rich." Congratulations!

--By 2010, more than 95% of taxpayers with adjusted gross incomes between $100,000 and $200,000 will be subject to the AMT (a program originally designed to tax a mere 155 hyper-rich individuals).

--The AMT will increasingly have little or no impact on the truly "rich" since they are already penalized under the traditional federal income tax, through progressive reductions in both deductions and the standard exemption. It will increasingly become a strictly middle-class phenomenon.


Click to enlarge.

We have seen the capacity of this Congress to do nothing in the face of fiscal disaster more than once. The Pension Benefit Guaranty Corporation crisis comes to mind, as of course does Social Security.

Explain to me again why legislators are somehow "better" or "more connected to the people" than judges are?

The President's Advisory Panel on Federal Tax Reform is charged with presenting a report, by September 30, with proposals to simplify the federal income tax.

The panel's work has led to debates over fancy-sounding alternatives such as "flat tax," "fair tax" and "consumption tax."

A huge problem with the federal income tax (besides of course the fact that it's too high) is that it is too riddled with special provisions to special interests, groups that use their influence and resources to buy from politicians particular credits, exemptions and deductions. Some call this "rent seeking," while others call it "corruption." I call it the Politics of Pull.

But the real question, the one that most taxpayers care about, are not the individualized provisions of the tax code that unfairly benefit farmers or oil companies or auto manufacturers, but the broader provisions that affect large swaths of the taxpayer base. People may be annoyed about whatever tax breaks Halliburton may be getting, but they care far more about the tax breaks that they themselves have received in the past and hope to receive in the future. If the Advisory Panel recommends eliminating huge chunks of the Internal Revenue Code that only apply to small chunks of the economy, Main Street America won't really care. But propose tinkering with their tax returns and the Panel's work will occupy quite a few news cycles, op-eds and blogposts.

"Tax reform" and "middle class America" really only intersect at two points: the deductibility of state and local taxes, and the deductiblity of mortgage interest. In anticipation of the Panel's report, here are some hasty stitches on those two major topics.

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The nonpartisan Urban Institute has analyzed the potential impact of eliminating the deductibility of state and local taxes from federal income taxes. Bottom line, there would likely be little impact: about $65-70 billion in tax receipts are lost from the deduction.

This is actually not surprising. Consider:

--The poor pay no income tax to begin with (the lower 50% of households by income pay no income tax at all).

--The lower middle class tend not to itemize their deductions and opt instead for the standard deduction, so their state and local taxes become moot.

--The rich already can't deduct state and local taxes either, because of either the progressive reduction in deductions built into the tax code, or the Alternative Minimum Tax, which does not allow the deduction at all.

--Those who live in no-tax/low-tax states of course receive little benefit from the deduction as well.

Bottom line, only upper middle class taxpayers in high-tax states receive any benefit from the deduction. In fact, New York and California alone account for 20% of tax returns claiming the deduction.

Which, as the Urban Institute observes, invites a intriguing possibility: Eliminate the deduction of state and local taxes while also eliminating the Alternative Minimum Tax. Such an move would be relatively revenue-neutral (UI estimates that tax receipts would increase by a nominal $21.4 billion in 2006) and could be politically viable (e.g., all us rich New Yorkers wouldn't care, since it would be essentially a wash). The increasing resentment toward the AMT, even just on grounds of the extra time and paperwork, could make such a proposal palatable, despite the likely knee-jerk reaction to the elimination of a "sacred cow" deduction.

Such a plan could be dismissed as a Hobson's Choice, but with AMT liability set to explode starting in 2006, this reform could be successfully sold to taxpayers. On the other hand, this Administration has been especially pathetic at selling Social Security reform, so who knows.

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The other "sacred cow" tax deduction is the write-off for mortgage interest on a primary residence. The President imposed the following constraint on the Panel:

"Options should...share the burdens and benefits of the Federal tax structure in an appropriately progressive manner while recognizing the importance of homeownership and charity in American society..."

Some have interpreted this to mean that the mortgage interest deduction is off the table, but as the Tax Foundation, reports, others are not so sure:

Linda Goold, tax counsel for the National Association of Realtors, said it's possible that the tax panel may recommend replacing the interest deduction with a tax credit that would be more beneficial to lower-income Americans. They usually don't have enough deductions to justify itemizing, a prerequisite for taking advantage of the mortgage interest deduction.

The Tax Foundation is ambivalent:

Unfortunately, that would make a bad tax policy worse by likely carving even more out of the federal tax base, requiring higher overall tax rates, and further entrenching its political support, all of which make fundamental tax reform even more difficult than it already is.

They would rather see no tax benefits of any kind, with lower tax rates for all instead.

I can certainly sympathize — as I have blogged previously, "take care of tax rates and tax simplification will take care of itself." But there's another consideration, both economic and moral, that makes eliminating the existing deductibility of mortgage interest problematic.

Yes, tax policy distorts economic decisions, and subsidies (which tax deductions essentially are) result in overconsumption (housing bubble, anyone?). But even greater distortions and misallocations can result from breaking the promise of deductibility for those who have already financed homes.

There's a analogy in the law that makes my point. All lawyers and many lay people know that a mere promise, without more, is not a contract and is not enforceable as a contract, with one important exception: the case of detrimental reliance.

Here's an example of detrimental reliance. Let's say an impoverished nephew earns a partial scholarship to attend a particular private university. His rich uncle promises instead to pay in full for the nephew to attend the uncle's alma mater. The nephew turns down the partial scholarship and enrolls in the uncle's college. There is no contract and the nephew is under no obligation to the uncle, who is merely making a promise. Halfway through the nephew's education, the uncle changes his mind and cuts the nephew off. Can the nephew sue the uncle for the remaining tuition even though there was no contract? Yes! If the nephew reasonably relied, to his detriment, on the uncle's promise, then that promise is legally binding even in the absence of a contract.

When it comes to the deductibility of mortgage interest, the law may be different from the nephew-uncle example, but the logic isn't. It is fundamentally unfair to induce taxpayers to purchase and finance a home based in part on the current tax code, and then suddenly change the rules on them in the name of "tax reform." Eliminating mortgage interest deductibility would be far more disruptive to many taxpayers than tweaking their marginal rates or removing some minor deduction. It must not be done lightly.

I don't know what the answer is and I am not saying that mortgage interest should indeed be a "sacred cow" within the tax code. Grandfathering existing mortgages is probably unworkable and is arguably even more unfair than the detrimental reliance problem. Perhaps the "credit instead of deduction" idea could be structured in a fair way for existing mortgage payers. I don't know.

But I do know that it is incomplete to lament only the macroeconomic effects of a tax policy going forward while ignoring the impact of changing that tax policy on those who have already made life-altering decisions in reliance on it. And to do so in the name of a "fair tax" is especially obnoxious. The Internal Revenue Code may not have to be permanently immutable, but neither should it be a crap-shoot.

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Finally, there are some who think the Panel may propose a national sales tax or consumption tax. I certainly hope not.

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UPDATE: In the aftermath of Katrina, the Commission has delayed the release of their report until the end of October.

Perhaps the single leading advocate of economics as a tool of social control these days is my old graduate economics adviser from Cornell, Robert H. Frank.

Frank's research over the past 15 years or so can be summed up as follows: You're an ass. He repeatedly concocts theories of "consumer irrationality," meaning that people engage in behavior that he summarily designates as, um, "wrong" and in need of correction by economic or other government policies.

Now Economist's View alerts us to Frank's latest decree as a would-be central planner:

I argue here that low U.S. savings rates are in large part a result of pressures to keep pace with community spending standards, pressures that have been exacerbated by rising income and wealth inequality. Replacing the income tax with a progressive consumption tax would stimulate additional savings by reducing the price of future consumption relative to current consumption as compared to its price under the current income tax. Perhaps more important, a progressive consumption tax would stimulate savings by altering the social context that shapes spending decisions.

In other words, conspicuous consumption (i.e., "keeping up with the Joneses") is now a systemic economic crisis that needs to be combatted by replacing the income tax with a consumption tax (that such a consumption tax should presumptively be progressive is merely a gratuitous add-on to placate Frank's unrepentant socialism).

Some hasty stitches:

--There are people antediluvian enough to believe that the purpose of taxation is to fund the operations of government, and not to control people or correct behaviors that are deemed, um, "wrong" by self-appointed philosopher-kings (economist-kings?) who overlay their own subjective value judgments on to other people's decisions.

--Many of those same individuals are so old-fashioned as to think that people actually have a right to make decisions, even "irrational" decisions, for themselves, without interference from the government or would-be central planners and economist-kings.

--By the same token, there are individuals whose thinking is so obsolete that they believe people might buy things because they actually want them, and not merely because their next-door neighbor bought them yesterday.

--While it is broadly true that, all else equal, a consumption tax would tend to promote personal savings more than the income tax does, that can easily corrected by changing the income tax rather than replacing it. Simply exclude all returns to savings (i.e., interest, dividends and capital gains) from taxable income. Presto -- a tax-based incentive to save, exactly what Frank is calling for. If even more incentives are needed, then other options also present themselves: remove caps on deductibility of contributions to retirement vehicles such as IRAs and 401(k) accounts, eliminate the bizarre "use it or lose it" rule for flexible savings accounts, and scrap the deductibility of interest expense on second mortgages and home equity loans.

--Finally, I doubt that would-be central planners such as Frank really care too much about the savings rate of the rich. The real concern is always only with lower-income individuals. Well, if you want to stimulate savings by the working poor, then the best way to do so would of course be to enable them to participate in voluntary partial privatization of Social Security. It is hardly surprising that lower-income workers choose not to save when one-eighth of their paycheck is confiscated in Social Security taxes, while at the same time they are told that they will receive "guaranteed" retirement benefits through Social Security. Not saving when the government goes out of its way to get you not to save? Hardly sounds like "irrational consumer behavior" to me. Irrational government policy, perhaps, but not irrational consumer behavior.

Advocates of central planning always envision themselves as the central planners. Frank is no different. His "conspicuous consumption" canard is merely a convenient tripwire to advocate his pet policies and his need to see people "corrected" and "controlled."

He may be selling, but I'm not buying (which I suppose means that I'm "saving" after all).

For many people, the worst thing about the Alternative Minimum Tax isn't necessarily that it makes some people pay more tax, but rather that it makes lots of people compute more tax.

If you're anywhere near the threshhold for AMT liability, then you are expected (i.e., legally required) to compute your potential tax bills under both the traditional federal income tax and the AMT. This dual-computation system has made either a professional tax preparer or tax preparation software mandatory for essentially anyone who files a return.

And as I have blogged previously, AMT liability is set to explode beginning with 2006 tax returns.

Which invites the question: Perhaps instead of scrapping the AMT, why not scrap the regular income tax instead? Does it really matter which system we use, so long as we're only using one?

This unorthodox proposal actually gains some traction when you consider that the AMT actually incorporates some elements of the flat tax / fair tax proposals being posited by people such as Steve Forbes.

Consider:

--There are, nominally, only two brackets under the AMT: 26% and 28%.

--There are generous exemptions (e.g., $33,750 for single filers).

--Most major deductions under the regular income tax are excluded under the AMT.

Well, the nonpartisan Urban Institute has analyzed the issue in more detail.

The study points out some problems with the idea of simply making everyone pay the AMT, however: there is a massive marriage penalty under the AMT, many savings-oriented credits are disallowed, and one huge deduction — residential mortgage interest, is still allowed under the AMT (note: but only for first mortgages on primary residences; the AMT disallows interest on most second mortgages and home equity loans).

And, more importantly, the biggest problem with using only the AMT is what makes the AMT a problem in the first place: the exemption and the tax brackets are not indexed for inflation (i.e., the AMT subjects taxpayers to "bracket creep"). This is precisely why AMT liability is set to explode in the next two years. Without fixing this unacceptable flaw, the AMT is simply not an option, either as a second, "supplemental tax" or as the only income tax.

I also suspect that advocating "making everyone pay the AMT" would not be politically smart, since many people still think of it as a "tax on the deadbeat rich." Still, the general framework of the AMT, if not the actual taxes it imposes, could be a useful as a prototype for a truly original "flattish tax."

This much is certain: the status quo is no longer acceptable.

The Internal Revenue Service has released 2003 data on income tax returns. The numbers show that, despite all the histrionics about the phantom "Bush tax cuts," the federal income has become even more progressive than in previous years:


(Click to enlarge.)

Some hasty stitches regarding these numbers:

--The idea that "the rich don't pay their fair share" is ludicrous. People who want to raise taxes on higher-income households should be pinned down: Exactly how much more progressive should taxes be? Give specific percentages — what exactly should this table look like in your "fair share" paradise?

--On the other hand, the upper tiers of this table (but not the lower 50% who pay no income tax) will shift quite a bit in the coming years as the Alternative Minimum Tax freefalls into the middle class. For details see my previous post. Those who are comfortable with such high progressivity should be the most vocal champions of abolishing the AMT, which will greatly reduce progressivity while raising overall tax burdens.

--For the most part, state and local income and property taxes only make this chart even more progressive on a government-at-all-levels, taxes-at-all-levels basis.

--Those who blame our federal budget deficit woes on the phantom "Bush tax cuts" are misguided. The problem is not that people are taxed too little, but rather than government spends too much.

--Of course, most of those filers in the "tax-free" lower half of returns are only free of income tax. They are not exempt from Social Security taxes. The rich are oppressed by income taxes; the working poor are oppressed by Social Security taxes. Therefore, those who champion the working poor ought to be less interested in income tax reform and more interested in Social Security reform. Indeed, they ought to be the most ardent advocates of Social Security reform, including voluntary partial privatization. Go figure.

Hat tip to Government Bytes; prior year data here. Other thoughts at DefCon:Blog.

UPDATE: A far better presentation of the data available here, including a debunking of the assertion by Tom in the comments that the distribution of federal income tax burdens merely replicates the distribution of income (see Table 5) -- higher-income filers pay a higher percentage of tax receipts than they receive in income. That's progressivity, folks.

Were you really naive enough to think that the President's Advisory Panel on Federal Tax Reform, about which I blogged previously, was actually going to recommend, um, reform?

One change discussed would lower the $1 million limit on mortgages eligible for the interest deduction to an amount closer to average housing prices, with adjustments for geographical differences. The panel also considered converting the current deductions into a credit, among other ideas.

On health insurance, the panel recommended capping the unlimited tax breaks available to businesses and workers. Current tax laws let employers take a deduction for their employees' health insurance, and employees pay no tax on the value of the insurance.
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The panel considered an idea limiting tax breaks for health insurance to the roughly $11,000 benefit provided to members of Congress and their families, but reached no consensus. The panel also could not agree whether to subject businesses or workers to the limitation.

To review, a panel of so-called experts each bring their own subjective list of "inadequacies" in tax policy (most of which boil down to whining about how the rich don't pay enough tax) and come up with -- surprise -- a list of new ceilings, limits, exclusions and rules (not to mention a new twist: geographic favoritism) for the very tax code that they were supposed to "reform." Go figure.

On the other hand, the early reports are that the panel will not recommend a value-added or consumption tax, but will recommend the abolition of the Alternative Minimum Tax. Remind me what was at the bottom of Pandora's Box?

As the tax-and-spend Republicans in the White House and Congress have made painfully clear, there is no interest, none whatsoever, in simplifying or reducing taxes (or spending, for that matter). This pathetic tax reform panel is just the latest embarrassment from a perpetually embarrassing Washington.

I've blogged before about the President's Advisory Panel on Federal Tax Reform, which so far has come up with a whole lot of nothing except to make the income tax even more complicated and even more progressive. Is anyone really surprised?

Here's the good news:

President Bush's tax commission has rejected the idea of a national sales tax and has voiced strong misgivings over European-style consumption taxes, drawing complaints of timidity from critics who wanted the panel to scrap the income tax.

Contrary to uninformed claims that a revenue-neutral national sales tax would be approximately 23%, the actual rate has been calculated at 44%, and possibly as high as 82% — see my previous post.

Here's the bad news:

When it meets again Tuesday, the members will revisit the possibility of recommending a value added tax — a levy used widely in Europe that imposes a tax on increased value of a product at each stage of production and passed on to consumers.

Tax reform is one thing; tax replacement is a whole different apocalypse. As I've warned regarding the national sales tax nonsense: We would wind up going from having an income tax today, to a sales tax tomorrow, to both the day after tomorrow. All in the name of "reform."

Don't believe me?

Ed McCaffery, law professor at University of Southern California, said the panel could yet embrace tax systems that combine income and consumption taxes, a hybrid that uses the best of both ideas.

With reform like this, who needs stagnation?

(Also no definitive word yet on whether the Panel will recommend the abolition of the monstrous Alternative Minimum Tax — the one undeniably good thing that might come from all this huff-and-puff.)

Though their website has yet to be updated, the President's Advisory Panel on Federal Tax Reform has reportedly crafted its final set of recommendations.

Some hasty-stitchy highlights:

--Reduce the number of tax brackets to four from six. Thesis: Tax reform should actually mean tax reform.

--Structure the brackets such that 75% of households are in the lowest tax bracket. Thesis: Unclear — the lower 50% of filers already pay no federal income tax. Will they start paying some tax?

--Eliminate the Alternative Minimum Tax. Thesis: Tax reform should actually mean tax reform.

--Eliminate the deductibility of state and local taxes. Thesis: Soak the rich.

--"Myriad personal and family tax breaks would be replaced with one family credit." Thesis: Tax reform should actually mean tax reform. (Note, however, that since, under federal DOMA, gays are not legally "families," this could be potentially bad for gays.)

--Convert the deductibility of residential mortgage interest into a credit, and limit it. Thesis: Soak the rich, cool the housing bubble.

--401(k) and traditional IRA accounts eliminated repackaged in favor of "Roth IRA" style accounts funded only with after-tax dollars. Thesis: Soak the rich.

--Cap the tax advantages of private employer health care benefits. Thesis: Soak the rich.

More details and commentary as events warrant.

Only one quick thought now: Tax reform has been tried many times before and is always fleeting. The ink will barely be dry on any revised tax code before the Politics of Pull and the Politics of the Warm Fuzzy Feeling kick in and a steady stream of preferences, surcharges, exceptions, exemptions, penalties, caps, floors and interpretations lead us right back into the muck.

The alternative is to worry less about tax reform and more about tax reduction. Take care of tax rates, and tax simplification will take care of itself.

I have a few more hasty stitches to supplement my post yesterday on the proposals of the President's Advisory Panel on Federal Tax Reform. Recall that these are based strictly on media reports and the Panel has not issued any formal statements recently.

--Dividends would be tax-free to individuals (capital gains would be taxed at a preferred rate). Thesis: So much for "tax simplification." Also, this would be a rabbit punch to state and local governments, which would lose their advantage of tax-free interest on state and local bonds. Their borrowing costs would increase substantially. If this forces them to be more fiscally responsible, then fine. But who really expects that?

--Charitable contributions would lose their preferred status and would be treated the same as medical and miscellaneous deductions, in that only those contributions above 1% of income would be deductible. Earn $40,000 per year? Then only your charitable giving above $400 would be deductible. Thesis: Again, so much for "tax simplification." I know what the chilling effect on my giving will be. Also, what about corporate giving? Why should a dollar of charity from Google receive better tax treatment than a dollar of charity from a Google shareholder? Again, this is somehow "tax reform"?

--Regarding the deductibility of state and local taxes, I want to clarify and defend my claim that this is a "soak the rich" proposal. Keep in mind that any removal of any itemized deduction is a "soak the rich" proposal, since only the rich itemize deductions. Lower-income tax filers, even in high-tax states, are covered by the standard deduction and receive no extra benefit from the ability to deduct state and local taxes — see my previous post. If the removal of a deduction is offset by some significant reduction in tax rates, then fine. But there is no evidence of that in the initial anecdotes that are coming from the Panel — the top marginal rate only falls from 35% to 33% (whether the brackets would change, favorably or unfavorably, is unclear).

It really does seem like the only true "reform" or "simplification" coming from this Panel is the elimination of the Alternative Minimum Tax. Which is potentially quite a lot — but did we really need a Panel for that? Perhaps the Panel would be willing to submit its proposal to a sort of "time scoring" — how much less time would taxpayers spend preparing their tax returns each year? From what I'm seeing, other than being spared the hassle of computing potential AMT liability, this all seems like shifting around the deck chairs while the iceberg looms ever larger.

How disappointing.

The President's Advisory Panel on Tax Reform has issued its final report — all nine chapters and 307 pages of it (plus appendix). Highlights of the panel's recommendations had been released previously; I critiqued them most recently here; see also the chain at the bottom of this post.

The final report is far too long to be of any real use, and no official summaries have yet been made available. Here, however, are some excerpts from the Panel's original "Statement on Federal Tax Reform," dated April 13, 2005 (PDF - 6 pages), with my comments in italics:

--Since the last major reform effort in 1986, there have been more than 14,000 changes to the tax code. (And why should we think that, were a new round of tax reform enacted tomorrow, a new batch of 14,000 or so changes wouldn't be bolted on in future years?)

--[Tax] complexity is costing the U.S. economy about $140 billion per year. To put this amount in perspective, it is roughly the same as giving $1,000 to every family in America or the amount of money needed to fund all of the following: the Department of Homeland Security, the State Department, NASA, HUD, the EPA, the Department of Transportation, the United States Congress, our Federal courts, and all foreign aid. (But don't fall into the trap of thinking that a national sales tax would be any less complex.)

--One particular problem that cannot be ignored is the rapidly growing reach of the AMT. The AMT imposes a stealth tax system that is separate from, but parallel to, the regular income tax system. ... The AMT will catch almost 4 million taxpayers this year and 20 million taxpayers next year. (I think abolishing the AMT is the only proposal from the Panel that is truly "reform" and will quickly become the focus of any tax reform proposals in Congress. It will provide a convenient litmus test to separate the fiscal conservatives and moderates from the "tax for the sake of taxing" radicals, especially going into the 2006 congressional elections).

--[A] broad-based, low-rate tax system would provide the greatest economic efficiency, simplicity, and ease of administration. (Okay, fine, provided that this utopian "broad-based, low-rate tax system" doesn't decay into a broad-based, high-rate tax system." Don't expect the Panel's report to include ways to prevent that from happening.)

--We have lost sight of the fact that the fundamental purpose of our tax system is to raise revenues to fund government. (Amen.)

The Urban Institute has a one-page report suggesting that income inequality has deteriorated in the United States during the period 1979-2002. They provide a pair of graphs:


(Click to enlarge.)

I don't necessarily dispute the accuracy of UI's data (but see my note below) — in a semi-capitalist semi-meritocracy such as ours there is simply going to be income inequality. Having said that, any time series analysis of income inequality in the United States will inevitably be flawed for two reasons:

1. Such studies ignore the astounding mobility of income segments in the United States over time. The individuals in the top 1% of incomes in 2002 are not the same people who were in the top 1% in 1979. The same cannot generally be said about socialist economies, where "class" is a far more enduring concept.

2. Worsening income inequality in the United States does not mean that "the rich get richer while the poor get poorer. It means that the poor get richer, just not to the same extent as the rich get richer.

In any case, I'm more interested in the change in tax progressivity represented by UI's numbers. (NOTE: Here I actually am annoyed with UI's data, because they never specify exactly which taxes they're talking about. I'm presuming they mean the three major federal individual taxes — the federal income tax, the Alternative Minimum Tax, and the federal gift and estate tax. Of course, the highly progressive nature of Social Security benefits, not to mention the progressivity of state and local taxes, mean that any analysis of federal tax progressivity will be understated.)

Here's a table showing tax progressivity (i.e., pre-tax share of income minus after-tax share of income) in both 1979 and 2002. A negative number means the segment is burdened by progressive taxation, while a positive number indicates the segment is benefiting from progressivity:


(Click to enlarge.)

The column labeled "Change" shows how much worse the progessivity burden has grown from 1979 to 2002 (so, again, a negative number is bad).

Some hasty stitches:

--Progressivity has increased for high-income segments. The idea that "the rich don't pair their fair share" is simply false.

--Note who benefits from tax progressivity: not the poor at all, but the middle 20%. To some extent this is not surprising, since the lower 50% of households pay no income tax. It's hard to get more progressive than "the poor pay zero."

Meanwhile, look at the middle 20% row (i.e., the middle class). They are actually beneficiaries of progressive taxation, not contributors to it. And the taxation subsidy they are receiving has increased during the 1979-2002 period. Indeed, not only is the tax burden of high-income households rising to subsidize the middle class, but so is the relative tax burden of the poor -- all to support the middle class, not the rich.

The pending retirement of the Baby Boom generation, not to mention the new Medicare prescription drug benefit will only exacerbate this trend, as would the expiration of the Bush tax cuts.

If you care about the poor, then it's not the rich you should be indignant towards, but the middle class. They are the ones who, to use the obnoxious lexicon of the progressives, "don't pay their fair share."

As I predicted, the recommendations of the the President's Advisory Panel on Tax Reform appear destined for the circular file:

The White House had initially considered having Treasury prepare a plan by the end of the year that could form the basis for a proposal in Bush's State of the Union address.

But several Republicans with close administration ties said it now seems likely Bush may only speak generally about tax reform in the address and not unveil specifics.
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Time Magazine, in its latest edition, quoted a White House official as expressing doubt that a major proposal to change the tax code could attract Democratic support in a mid-term election year.

The Panel's recommendations were — with one major exception — meaningless nip/tucks that really wouldn't have changed anything about the federal income tax system that truly needs changing.

The one exception, the one reform that the President might find bipartisan support for, is the abolition of the Alternative Minimum Tax. Simple, succinct, important. Surely there's room in the State of the Union Address to squeeze that in.

Either that, or wait for doomsday. (UPDATE: More on doomsday here.)

Hat tip to Tom Rants.

POST SCRIPT: I wonder how much money was spent on this Panel and its dead-on-arrival report.

The New York Times had a fluff piece over the weekend on how the pending explosion in liability under the Alternative Minimum Tax will affect New York taxpayers.

The piece contains no new news really, but I found the following omission interesting:

The tax was enacted in 1969 to keep the rich from completely escaping taxes by disallowing certain deductions.

Well, yes, sorta kinda, but there was actually more to it than that. Perhaps the New York Times should read ... the New York Times:

The alternative minimum tax began in 1969, after Joseph W. Barr, the departing Treasury secretary under President Lyndon B. Johnson, told Congress that 155 wealthy families had used loopholes to avoid paying any federal income tax in 1967. Mr. Barr warned of the possibility of a middle-class taxpayer revolt in response.

The "possibility of a middle-class taxpayer revolt." How the world turns.

In any case, there's an important difference between "the rich" generally and a mere 155 deadbeat families (in 1969) that bent over backwards to avoid paying any federal income tax at all.

This convenient omission — that the AMT was a tactical tax targeting a puny but embarrassing handful of families rather than a strategic tax on "the rich" generally — allows the concept of (yet another) surcharge and yet another level of progressivity to remain "legitimate" in political discussion. The problem, we are told, isn't that the AMT has completely lost all correlation to its original purpose, but rather that it's now hitting "not just the rich." If it were just applicable to "the rich," then apparently it would be okay.

The fact that the AMT was never about "the rich," but about tax deadbeats, should not be lost. An AMT that is revised to apply "just to the rich" is still a monstrosity.

If you want to soak the rich, fine — then raise ordinary federal income tax rates at the higher brackets. Do it openly and brazenly. But don't cloak your animosity toward success behind the curtain of revisionist AMT history.

Senate Majority Leader Bill Frist has indicated that the Senate will probably not take up AMT reform (let alone AMT abolition) this year:

"I feel strongly that capital gains and dividends should be in the bill when it comes back to the Senate floor," Frist told reporters. Of the minimum tax, he said that "in all likelihood, we'll not be able to finalize that until we get back" in 2006.

On the other hand, when another 18 million or so middle-class taxpayers get hit with the AMT starting in 2006, I suspect that they will be the ones who "feel strongly" about which is more important — tax rates on capital gains and dividends, or fixing the monstrous AMT.

From 155 taxpayers in 1969 to almost two-thirds of all taxpayers making less than $100,000 in 2010.

That's hardly what most people would consider an "alternative."

More thoughts at Government Bytes.

The Tax Foundation provides an update regarding the sharp progressivity of the federal income tax:

[R]oughly 43.4 million tax returns, representing 91 million individuals, will face a zero or negative tax liability. That's out of a total of 136 million federal tax returns that will be filed. Adding to this figure the 15 million households and individuals who file no tax return at all, roughly 121 million Americans -- or 41 percent of the U.S. population -- will be completely outside the federal income tax system in 2006. This total includes those who pay no tax, and those who pay some tax upfront and are later refunded the full amount of the tax paid or more.

Some hasty stitches:

--The 41% figure is understated because it includes children claimed as dependents. If one thinks strictly in terms of the adult labor force, then the percentage is much higher -- around 50%.

--These numbers do not reflect Social Security taxes. Whatever fraction of these 121 million Americans -- who, remember, tend to be relatively poor -- actually work for a living may be spared an income tax burden, but not a Social Security tax burden. Yet, of course, the best way to help the poor is by not taxing them. This long, broad and deep contradiction in the concept of "Social Secu