Cognitive Dissonance

Another blog had a post yesterday on the election results, which generated a vigorous and wide-ranging discussion in its comment thread. One of the commenters, a successful border state businessman, whom I know to be intelligent from his previous comments, lamented his high tax burden while essentially expressing support for unskilled immigration to deal with "scarce labor" in the U.S. Surprised that he hadn't connected the dots from the one issue to the other, I left him this comment in response:

If memory serves, elsewhere in this thread you were complaining about your tax burden. Here you seem fairly sanguine about the importation of unskilled immigrants, who, research shows, tend to consume more in government resources than they pay in taxes. Further, when they become amnestied (or when their American-born kids turn 18) they will vote to increase your tax burden -- you know most of them aren't going to be joining the Club for Growth, right? There seems to be some cognitive dissonance at work here.

Six Wasted Syllables (for Paul Price)

On the Atlantic's Business Channel, Chris Good posts about the return of Bobby Jindal, noting that, given his expertise in health care policy, Jindal has taken advantage of the current debate over President Obama's proposed health care reform to tiptoe back into the national spotlight, now that memories of his awful response to the President's speech have faded. Good also links to Jindal's op/ed about health care policy in today's Wall Street Journal, "How to Make Health-Care Reform Bipartisan". One paragraph from Jindal's op/ed prompted the title of this post:

•Refundable tax credits. Low-income working Americans without health insurance should get help in buying private coverage through a refundable tax credit. This is preferable to building a separate, government-run health-care plan.

What would William Strunk, Jr. have called "refundable tax credits", if such a thing existed in his time? I'm guessing he'd call them what they are: "grants". I'm not sure why Jindal and other conservatives persist in wasting an additional six syllables on the longer euphemism. Perhaps it's so they can characterize government spending on such grants as tax relief instead of government spending, but, if so, this bit of obfuscation just plays into liberals' rhetoric on progressive tax policy. Most liberals are happy to characterize transfer payments to low-income Americans as tax relief, and to characterize tax cuts for the wealthy as a form of government spending. There doesn't seem to be much benefit to conservatives in conceding the rhetorical and policy ground on this, particularly since, as some smart centrists (e.g., Clive Crook) and even at least one smart liberal (Matt Yglesias) acknowledge, we are approaching the point of diminishing returns when it comes to increasing the progressivity of our tax system.

As both men have noted, if American liberals want to expand the welfare state raising taxes on the rich, by itself, won't be enough to pay for it; they'll have to raise taxes (by at least a modest amount) on everyone else. Yglesias has noted that countries such as Sweden, which have social safety nets envied by American liberals, also have much more regressive taxes than we do.

The Undertaxed American Middle Class

In the Forbes column we quoted in the previous post ("Undertaxed America"), Bruce Bartlett referred to OECD data in making his case. Clive Crook referred to OECD data as well in a post on taxes in his Atlantic blog earlier this week ("America's widening fiscal gap"):

Mr Obama intends to squeeze the rich, but the scope for this may be more limited than US liberals would wish. Few Americans seem aware that the US income tax code, as a recent Organisation for Economic Co-operation and Development study showed, is already one of the most progressive.* Even before the rise in top marginal rates promised by Mr Obama, the US income tax collects 45 per cent of its revenues from the highest-income decile. Compare that with Britain at 39 per cent, Canada at 36 per cent, France at 28 per cent, Sweden at 27 per cent and an OECD average of 32 per cent.

This difference is only partly explained by the less-equal US income distribution. The fact that the US has no broadly based national sales tax - value added taxes make Europe's overall tax codes less progressive still - only underlines the point. The US tax system raises comparatively little revenue; what little it raises already comes disproportionately, by international standards, from the rich.

I have previously argued that the US will need a VAT [value added tax]. Even before Mr Obama unveiled his ambitions for healthcare reform, wage subsidies to help the working poor, better education and the rest, the US middle class was seriously undertaxed. The government's promises, on present plans, will be unaffordable. If they are honoured regardless, the only question is which comes first: broadly based tax increases or fiscal collapse.

I have wondered if there might be a simpler way to tax Americans' consumption than to implement a value added tax. Since income taxes in the U.S. are highly progressive, and IRAs and 401(k)s don't offer deductions for payroll taxes, there is little incentive for Americans in lower income quintiles to save instead of consume. For example, according to CBO data, effective income tax rates for Americans in the bottom two income quintiles were negative in 2005 (i.e., these Americans received more in transfer payments than they paid in income taxes). So why not just increase the payroll tax by some amount and then allow workers to deduct up to that entire additional amount if they make an equivalent contribution to an IRA or 401(k)? Those who contribute less than that additional payroll tax amount to their retirement accounts will be paying a de facto consumption tax.

The image above accompanied the Financial Times column from which Clive Crook quoted himself in his Atlantic post.

Undertaxed America

Prompted by the recent trend of anti-tax tea parties, Bruce Bartlett writes in Forbes that the United States is a low tax country ("Tax Tea Party Time?"):

The truth is that the U.S. is a relatively low-tax country no matter how you slice the data. The following tables illustrate this fact by comparing the U.S. to other members of the Organization for Economic Cooperation and Development, a Paris-based research organization.

[...]

[T]otal taxation (federal, state and local) amounted to 28% of the GDP in the U.S. in 2006. Only four of the 30 OECD countries had a lower tax ratio. Taxes averaged 35.9% for the OECD as a whole and 38% in Europe. Citizens of Denmark and Sweden paid very close to 50% of their total income in taxes.

I suspect that the complexity of the tax system in the U.S. partly explains why many Americans think they pay higher taxes than they actually do. Also, it's possible that many workers pay more attention to the large amount of taxes that are withheld from their paychecks and pay less attention to the amount that gets refunded to them every year. Bartlett goes on to note that higher taxes in many OECD countries are offset by generous transfer payments. He also notes the effect of government health care spending:

Another way that workers in other countries benefit is in having almost all of their basic health care expenses covered by the government. According to the OECD, 19 of its 30 member countries cover 100% of health care costs, and another eight cover more than 89% of costs. Of the three remaining countries, Turkey covers two-thirds of health expenses, and Mexico pays for half.

In the U.S., however, the government covered only 27.4% of health costs in 2006. And almost all of that went either to the elderly in the form of Medicare or the poor in the form of Medicaid. The American average worker either had to pay for his own insurance in the form of deductions from his pay or go without.

In 2008, employer-provided health insurance reduced the cash wages of American workers by 7.9%, according to the Bureau of Labor Statistics. If businesses didn't have to pay for health insurance, they could afford to pay their workers 7.9% more and be no worse off. If workers paid 7.9% more of their income in taxes to pay for national health insurance, they would also be no worse off.

To a large extent, this is exactly what happens in other countries. Workers see the higher taxes they pay the same way Americans view the deduction from their pay for health insurance--not as money down a rat hole, but as the payment for a tangible benefit.

This isn't necessarily an argument for national health insurance. There are lots of reasons why it may be preferable to maintain the largely private health system we have in America. No one thinks it would be a good idea to pay higher taxes in return for having the federal government provide us with food. Variety and quality would undoubtedly suffer a great deal. The same would be true if the federal government took over the provision of health care.

Revisiting Liberals and Tax Paying

In a post last month we asked, "Are Liberals Less Inclined to Pay Their Taxes". In a post last week, the blogger Audacious Epigone drew on data from the General Social Survey (GSS) to address this question, "Liberals and tax cheating" (Hat tip: Aaron Edelheit). Excerpt:

With the embarrassing number of hopeful Obama appointments running into tax cheating problems (the latest being Ron Kirk), it's natural to wonder if evasion by high profile leftists is illustrative of a real world trend, or just a string of unfortunate anecdotes.

The GSS provides some relief for that wonder. It provides the results for 2,418 people queried on whether or not cheating on taxes is wrong, by political orientation. The first graphic from the GSS shows the distribution of responses. The second graph shows the mean tax compliance score, computed by designating "not wrong" as 1, "a bit wrong" as 2, "wrong" as 3, and "seriously wrong" as 4, and then averaging the responses for each of the seven categories of political orientation (click for higher resolution).

Politics	Compliance
Strong Lib	2.70
Liberal	3.05
Weak Lib	3.00
Moderate	3.07
Weak Con	3.14
Conservative	3.35
Strong Con	3.27

The standard deviation for the dataset is .76, so the difference between self-described conservatives and extreme liberals is nearly one full SD. Amalgamating the responses into three categories yields one-third a SD between liberals and conservatives:

Politics	Compliance
Liberal	3.00
Moderate	3.07
Conservative	3.25

Liberals do not consider cheating on taxes to be as morally problematic as conservatives do. This presents an obvious moral quandary of its own, as, putatively less surprisingly, liberals are more likely than conservatives are to favor greater amounts of taxation and wealth redistribution.

Are Liberals Less Inclined to Pay Their Taxes?

That question occurred to me on reading the news that a fourth Obama Administration nominee, Labor Secretary nominee Rep. Hilda Solis, has unpaid tax issues (The Washington Post: "Solis Senate Session Postponed in Wake of Husband's Tax Lien Revelations"). This news, of course, comes after the revelations of unpaid taxes by Treasury Secretary Timothy Geithner^1,2 (pictured above), former HHS Secretary nominee Tom Daschle, and former "Government Performance Czar" nominee Nancy Killefer. If coincidences don't come in threes, as the saying goes, then they don't come in fours either.

At first blush, it might seem counter-intuitive that affluent liberals would be less inclined to pay their taxes, since they tend to advocate for higher taxes on the affluent. Advocating for higher taxes on the affluent and being eager to pay them yourself are two different things though. Warren Buffett, for example, has famously lamented that he doesn't have a higher tax liability, and yet he deliberately avoids the capital gains tax on the shares of Berkshire Hathaway he donates to the Gates Foundation. I would be interested in any data that compared the level of tax compliance by conservatives and liberals, but I wonder if a similar dynamic is at work with taxes as with charitable donations.

Just as liberals tend to advocate for higher taxes on the affluent, they also tend to advocate for more government assistance to the less fortunate. While this might lead one to believe that liberals are more generous than conservatives, Arthur C. Brooks, professor of public administration at Syracuse, found that conservative households donate 30% more to charity than liberal households. Could it be that liberals feel less obligated to donate to charity or fully comply with tax laws because they feel that their advocacy for more progressive taxes and more generous welfare spending absolves them of some of their responsibility to contribute personally? Perhaps they feel they "gave" at the ballot box?

The photo above, of Treasury Secretary Timothy Geithner, is from the Affordable Housing Institute's website.

¹I suspect Geithner's tax avoidance may have been motivated by what David Brooks has termed Status-Income Disequilibrium. As a high official at Treasury, the IMF, and then the New York Fed, Geithner earned a comfortable salary -- one higher than perhaps 99% of Americans -- but a pittance compared to some of the CEOs over whom he wielded authority. He probably thought he was sacrificing enough for the common good by renouncing more lucrative prospects in the private sector and working for the IMF instead, so why should he lower his take-home pay even more by paying his self-employment taxes?

²Atlantic blogger and journalist James Fallows, a former Carter Administration official and liberal in good standing, Had this to say about Timothy Geithner's non-payment of his taxes ("A Word about Timothy Geithner" -- scroll about a quarter of the way down for this):

I do not believe, and will never believe, that his failure to pay his own self-employment tax while at the IMF was an "oversight" or a "mistake." I have many many friends who have worked for this and similar organizations. I have myself over the years juggled the complexities of what is self-employment income and what is W-2 income and how to handle income from non-US sources -- and I have a lot less financial acumen than any Treasury Secretary aspirant should and must have. (Though I also use Turbo Tax!) Not a single person I have known from the IMF or similar bodies, not a one, believes that Geithner could have "overlooked" his need to pay US self-employment tax. When I have received similar income from international sources, the need was obvious even to me -- and I wasn't receiving and signing all the forms to the same effect Geithner would have gotten from the IMF. I could go on with details but I'll just say: if this were a situation more average Americans had experienced personally, he would not dare make his "mistake" excuse because everyone would say, "Are you kidding me???"

A Tale of Two States: Utah versus Rhode Island

An article in last week's Economist (The Mormon work ethic: Why Utah’s economy is soaring above its neighbours") noted that Utah's unemployment rate is 3.5%. A few days later, a New York Times article ("Leading in Job Losses, Rhode Island Struggles On") noted that Rhode Island's unemployment rate is 8.8%. A number of factors contribute to this disparity, but a smart Republican strategist would focus on two of them: energy costs¹ and taxes on businesses². According to The Tax Foundation, among the states, Utah ranks 17^th in business tax climate, and Rhode Island ranks 50^th. According to the Energy Information Agency, Utah had the 5^th cheapest industrial electricity rates in July, with an average cost of 5.26 cents per kilowatt hour, and Rhode Island ranked 47^th, with an average cost of 15.53 cents per kilowatt hour.

Neither article mentions the Tax Foundation or EIA data I just cited, but the Economist does mention Utah's low energy costs, noting that "The state has experienced a minor semiconductor boom in part because of its cheap, coal-fired power", and the New York Times article mentions taxes, noting that "Many economic analysts and state officials say Rhode Island has long had a high tax burden for businesses, discouraging them from moving here."

¹Energy is one issue the GOP initially had some traction with a couple of months ago (e.g., "Drill here, drill now, pay less"), before the steep correction in oil prices.

²Republican candidates, such as McCain, generally focus on personal income taxes, which doesn't give them much traction anymore, since the federal income tax code is so progressive that most Americans pay little if any net federal income taxes, and Democratic candidates can always promise to make the income tax even more progressive, as Senator Obama is currently doing. Better to focus on business taxes, and explain how high taxes on business discourage job creation.

ExxonMobil and Taxes

A Los Angeles Times editorial yesterday ("Give Exxon a Break") noted that,

Exxon already faces a stiff tax bill -- nearly 50% of its taxable income went to the government in the most recent quarter.

The specific effective income tax rate ExxonMobil paid for Q2 was 49%, according to p. 5 of the company's earnings press release PDF. A commenter on Matthew Yglesias's post on this ("The Good Times Roll") on his Atlantic blog was skeptical that Exxon paid this much in taxes and asked how the math worked out. After looking at the company's income statement (on p.8 of that earnings press release), I was curious, so I called the company's investor relations department to find out. The I.R. representative didn't know the answer offhand, but called me back with the answer after an hour or so. Here's how the math works out:

The numbers below are in millions of dollars and come from p.8 of the company's press release PDF.

The "income before income taxes" number [22,206], includes post-tax income from Exxon's equity companies, so you have to add the taxes those companies paid [888] to that number. You also have to add that 888 to the main income tax number, 10,526. So here's the arithmetic:

(10,526 + 888) / (22,206 + 888) = .494 or 49%.

Left unsaid by the Los Angeles Times editorial is that ExxonMobil pays other taxes in addition to income taxes. P.8 of the earnings press release notes that the company paid $32.36 billion in total taxes last quarter, including sales and other taxes.

Does Warren Buffett's Secretary Have a Higher Effective Tax Rate than Him?

On her Atlantic blog ("Tax talk"), Megan McCardle writes,

And [University of Chicago Economics Professor and erstwhile Obama economic adviser Austan] Goolsbee justly points out that under the current system, Warren Buffet's secretary has a higher average tax rate than he does.

To be precise, Megan writes "average" tax rate, but since the effective tax rate represents the percentage of one's income that one actually pays in taxes, I assume she meant effective tax rate¹. Does Buffett's secretary (I've also heard the claim made about his housekeeper) have a higher effective tax rate than him? I'm skeptical about this.

According to these data from the non-partisan Congressional Budget Office, effective federal tax rates in America (taking into account payroll taxes as well) are highly progressive. In 2005, the lowest quintile of earners had an average effective federal tax rate of 4.3%, and the highest quintile had an average effective federal tax rate of 25.5% (the top 1% paid 31.2%). It's possible that the ultra-wealthy such as Buffett have lower effective tax rates than the top 1%, because nearly all of the income of the ultra-wealthy comes from capital gains, but I doubt the ultra-wealthy have lower effective tax rates than housekeepers and secretaries. I'd be more inclined to believe that Buffett's physician has a higher effective tax rate than him than that his housekeeper does. Perhaps Buffett will make public his and his secretary's and housekeeper's tax returns so others can verify this.

In the meantime, the issue of Buffett's taxes versus his secretary's taxes raises a couple of meta-questions:

- Does it make sense to make tax policy based on a small number of outliers such as America's multi-billionaires?

- Would proposed changes in tax policy materially affect these billionaires?

The answer to both questions appears to be "no". Multi-billionaires have far more control over how and when they get paid -- and how and when they get taxed -- than any other tax payers. I doubt Buffett's taxes will be materially affected by any tax code changes made in Washington next year.

The real impact of any changes in tax policies will fall mostly on the "working rich": the surgeon, high-end salesman, or other worker making $250k-$500k+. There will be little if any impact on the Buffetts of this country. Buffett, I would think, knows this, but he is politically savvy enough to position this as an issue of the super-wealthy such as himself paying their 'fair share'. Whether Buffett really thinks he doesn't pay enough in taxes is another question. Two data points suggest otherwise.

The first is Buffett's occasional boasting in his annual letters to Berkshire Hathaway shareholders about how much Berkshire (of which Buffett remains the largest individual shareholder) pays in federal taxes. This, for example, is from his 2006 Letter:

Berkshire will pay about $4.4 billion in federal income tax on its 2006 earnings. In its last fiscal year the U.S. Government spent $2.6 trillion, or about $7 billion per day. Thus, for more than half of one day, Berkshire picked up the tab for all federal expenditures, ranging from Social Security and Medicare payments to the cost of our armed services. Had there been only 600 taxpayers like Berkshire, no one else in America would have needed to pay any federal income or payroll taxes.

The second data point that suggests Buffett isn't really worried that he pays too little in taxes is the method in which he makes his generous donations to the Gates Foundation. Currently, Buffett donates shares of Berkshire Hathaway to the foundation. If Buffett were truly concerned that he didn't pay enough in taxes, he could easily remedy this by selling his Berkshire Hathaway shares first, paying the capital gains taxes on the sales, and then donating the net cash proceeds to the Gates Foundation. Presumably, Buffett donates the shares instead because he feels he pays enough in taxes already, or because he feels that the Gates Foundation will spend his money more wisely than the federal government will. Whatever the reason, avoiding the capital gains tax by donating the shares is inconsistent with Buffett's lamentations about not paying enough in taxes.


¹Update: The phrase "average tax rate" is a synonym for the phrase "effective tax rate". Thanks to commenter Jason for indirectly pointing that out.