Wednesday, October 15, 2008

Progressive Taxation- Socialism?

Amazingly, I now have people who at first were upset that Obama was going to raise taxes on the middle class (or so they believed) now upset that his tax plan is actually "socialism" and basically class warfare.  And, most of the people telling me this are the people who are supposed to be trickled on by the Bush and McCain plans!  They tell me I've been bamboozled into buying into a socialist agenda and that this is just another step in a plot to make America a socialist country.  Well, I haven't been bamboozled at all and I'd like to tell you why I think Obama's plan is more fair than John McCain's.   As I said in an earlier post, there is a fundamental difference in the philsophy behind the two men's plans. Starting where we are today (without revamping the whole system), Obama wants to increase the marginal tax rates on the most wealthy so he can decrease the marginal tax rates on the middle class.  I'll even concede the argument that Obama's plan amounts to an increase in taxes for the wealthiest even though it's simply not true (and I'll show you why later- histiorically the rates he's proposing are pretty low).  For the sake of argument, let's say it is true.- Obama's plan is a tax increase on the wealthy.  I still say "Big whoop".  John McCain, OTOH, wants to give huge tax breaks to the most wealthy because they are the "movers and the shakers" providing the jobs to the peons of society.  And the peons are defending John McCain's plan.  How ironic is that?

Wow. Where to start? First of all, people have been throwing statistics at me showing how the very tippy top percentage of people pay a huge share of the income taxes. Oh, poor rich people.  Excuse me while I grab a tissue.  I'm being told that they're paying way more than their share.  Let me show you how looking at statistics too simplistically gives you an extremely false picture of what is going on and what is fair.  I'm going to make some very broad assumptions here and do some rounding just to make a point and keep the numbers simple.  The average CEO now makes about 400 times what a production worker in his company makes.  He actually makes in a day about what one of his workers makes in a year.  Let's assume we have a land where all the companies are made up of one CEO and 399 worker bees.  Let's call it Fairtaxland.   The worker bees make $40,000 a year.  That means the CEO is pulling down $16,000,000 a year.  Because we want to be fair, in Fairtaxland  we have a flat income tax.  Everybody pays 10% of their gross. No deductions.  No loopholes.  Just what did you make?  Send Uncle Sam 10%. So, the worker bees each shell out $4,000 a year. And, the poor CEO has to pay out $1,600,000/year.  The CEOs in our land represent just 0.25% of the population.  But, of the total revenue collected from each company, the lone CEO pays $1,600,000 while the rest of the workers (99.75% of the population) pay $1,596,000.  In this illustration, 0.25% of the population pays  50% of the taxes.   If you read this headline "In Fairtaxland, 0.25% of the population pays 50% of the taxes" would you be outraged?  As I said, this is a simplistic example.  In America, we have people making hundreds of millions and even billions of dollars a year.  Oprah Winfrey makes more in an hour than the average workers makes in a year.  Bill Gates and Warren Buffet make more than a lot of countries.  Of course,  they are going to pay a huge percentage of the income tax revenue because they're making gobs and gobs of money. G-d bless America!

Let's take the illustration just a little further.  The worker bees making $40,000 have to spend (let's make a number up) $24,000 just to pay for basic needs.  Food, shelter, clothing, health care, etc.  That leaves them with $16,000 in "disposable income".  The $4,000 they pay in income tax represents 25% of their income not dedicated to basic living expenses.  Let' s allow the CEO twenty times their non-discretionary spending.  We'll give him $480,000 in basic living expenses.  That leaves him with $15,520,000 of disposable income.  His tax burden of $1,600,000 is roughly 10% of his "disposable" income.  Again, that's allowing him twenty times the living expenses of his average worker or 12 times their total gross annual income.  So, as a percentage of their disposable incomes, the worker bees are paying at a rate 2.5X what the CEO is paying.   [Disclaimer again- I'm not claiming these numbers are accurate and taxes are not optional. So, they really should be included in basic living expenses.  I'm trying to keep this simple]  I'm simply trying to illustrate why you can't just look at some of the stats people throw at you and feel sorry for rich people and their tax "burden".  That guy making $16,000,000 a year is not going to even notice an additional $4,000 or $8,000 or $12,000 of his income.  Money that would make up the entire tax burden of several of his employees.

What I have just shown above is first of all that you have to understand statistics before you start falling for dramatic numbers like X% of the American public already pays Y% of the tax revenue.  They should!  Some of them are making ungodly amounts of money.  Even in our  imaginary Fairtaxland, without a progressive tax rate, if you make 400X more money than the Average Joe, you're going to pay a bigger percentage of the tax burden.   Just one quarter of one percent of the population pays 50% of the taxes.  What I attempted to illustrate in the paragraph  about discretionary spending and living expenses is the reasoning behind progressive taxation.  It's more "fair".  If someone is making more than he can possibly spend in a year (or a lifetime), it's reasonable to expect him to pay a little more in taxes.

The next thing that a lot of people don't really seem to grasp is "marginal tax rates".  The rich don't pay 35% on every dollar earned.  That is their "marginal" tax rate.  For the very poor, the marginal tax rate and the effective tax rate are the same.  For the very rich, they are very different.  The rich pay the same rates as the poor on the first $8,000 as the poor, then they pay the same rate on the next $24,000 as the middle class, then they pay the same rate on the next $45,000 as the upper middle class and so on and so on.  While 35% sounds like a lot, their effective rate (the rate you get when you blend all these and then divide it out) is actually a lot lower than that number.

Lastly, as to the word "socialism" being bandied about.  Absurd.  I have two points.  First of all, a little socialism is not necessarily the worst thing in the world.   But, socialism would be if we capped people's incomes at a certain amount and took the excess and gave it equally to bring everyone up to  same level of income.  I'll concede that progressive income tax rates are more socialistic than a flat tax.  But, they are a long, long way from socialism. We have a blend of economic and political systems in the United States.  Secondly, progressive tax rates are as American as apple pie.  There are some who seem to worship at the altar of capitalism and "free markets".  I can almost hear Gordon Gekko saying "Greed is good.".  Well, greed is good.  America is a shining beacon, due largely to greed.  Capitalism has allowed us to build a nation that is rich enough to help its poor, to protect its citizens and to reach out to the world.  Hallelujah.  But, contrary to what some would like to believe, America has never been a land of unfettered Capitalism or even a pure Democracy for that matter.  Things like anti-trust laws are not purely capitalistic. Without getting bogged down in details, the government has always done things to help the capitalistic system along, to protect the weak the from the strong and create opportunity for a mericracy rather than an aristocracy.  Our Founding Fathers fought some of these things out and we may still disagree on some of them.   When our economics systems get into trouble, the government steps in to help, as we just saw with the $700B bailout, even some of the staunchest "Conservatives" want some government intervention when the market goes off the rails.  Capitalism must be constrained by regulation and sometimes helped along by government programs doing what the government does best.

Obama's tax rates on the wealthy are not some dangerous social or economic experiment, BTW.  Historically speaking, they're not even all that high.  Since the 1920s, we've had marginal tax rates as high as 90% and most of the time they've been, much, much higher than they are right now. (see the chart below). 


Nobody likes to pay higher taxes, including me.  But, you know what?  I'd love to hit Obama's top bracket and be able to complain about all the taxes I'm paying.  If my customers have more money in their pockets, thanks to his tax cuts, just maybe I will hit that bracket.  Barack Obama, under his own plan, will pay higher taxes.  I'm sure that's not something he's thrilled about doing. But, let's call a thing what it is and let's look at what is the most fair plan for everyone and the best plan for the economy as a whole.  If we have disagreements about which philosphy is better, that's OK.


Tones said...

Brian - your tone is interesting here. You sound as though the wealthy in this country got it by winning the lottery or something. Most of the wealthy I know earned it by working their tails off. Most of them EARNED it.

Your reference to CEO's reflect very few people - CEO's from the fortune 500. In the last company I worked for, the C-level officers, including the CEO made good money, but no where near 400 times what we made in production. And they were the brains behind the product line. The company wouldn't have existed without them.

Do you really want government to control an individual's income like this? That's what board members do. CEO's don't mandate their pay - the board appoves the CEO's pay. There's a check and balance there. If you don't like how the board votes in a company that you work for or invest in, you are free to go or move your investments elsewhere! It's funny - when a company is doing well and its workers are getting paid well, and their 401K's are doing well and getting matched, and the companies stock plans are kicking butt, nobody cares about the big money that the CEO makes. Put the shoe on the other foot, and everyone screams fowl. It's really rather short-sided if you were to ask me. For many, it's nothing more than good old-fashioned envy.

We can allow government to control CEO's take-home pay, and also tax the daylights out of corporations, and they will simply move their operations elsewhere. That will lead to job loss, requiring more tax increases on the top-end to pay for the folks on the end of the scale. Will the government then penalize companies for taking their operations overseas? Yes they will, but China will receive their goods and services with open arms.

Continue to tax the top-end and watch what they do with their former chariable contributions (the top 25% of wage earners in America donate over 80% of the total 501(c) contributions. Government will have to pick up the tab on that one too at an efficiency rate of 30 cents per dollar.

Socialism doesn't happen over night - it will take time. There is no doubt that this (and steps from most of the former administrations - both left and right) will be a step in that direction.

Don't get me wrong - to me socialism isn't so bad. I have friends overseas who thrive in the system and are as happy as I can be. It's my personal desire to let the free market's checks and balances reign. The government mandates on Fannie and Freddie certainly resulted in quite a mess - we need to learn from our mistakes.

Brian said...

Tony, Tony, Tony,

No need to read in stuff that's not there. I made no comments on the merits of the rich having their money. I'm glad we live in a company where they have that opportunity. I've got a secret for you, Tony. I wanna be rich, too. That's one reason I own my own company. I have worked for small companies where the CEO made no where near 400 times what the average employee made. But, you're quibbling with the details of my analysis. That's not really the point. BTW, I picked 400 because that's pretty close to the AVERAGE of what it is in America right now. I've worked for very large companies, very small companies and now own my own little TINY company.

Tony, I said nothing about controlling an individual's income. Zero, zip nada. I want everybody to be free to make as much as they want/can. I do think that a lot of corporate executives are overpaid. Grossly and obscenely overpaid. But, let me make this clear, I do not want to control their compensation either by statute or by taxation. I do resent the old boy network that they use to get that way, sitting on each other's boards, collecting millions and millions for not much work, sometimes for running a company into the ground. And, yes, I find some of their compensation obscene. I worked for one company that hired a CEO that worked there literally for a few weeks, negotiated a deal to sell out to our most hated competitor (which he swore he would never do),then walked away with over $10M. But, again we digress. That is not the point of my post at all. Talk of the government curbing executive compensation is sticking their nose in where it does not belong (unless we're taking stock in the company). If the shareholders are stupid enough to pay those bozos, the bozos deserve it. That's the free market and that's the way it should be. The shareholders own the company. As long as they are paying the workers fairly, they can pay their executives whatever they want.

Again, you're going just a little berserk here Tony. I said nothing about controlling take home pay or providing incentive for people to move their operations elsewhere. I'm beginning to wonder if you actually read what I did say since you're pretty much responding to a bunch of stuff I didn't say. Income tax rates in European countries (for example) are much higher than our tax rates are here. Are you scared all our CEOs are going to move to Europe?

Tony, socialism and capitalism are not either/or propositions. We do not live in an entirely capitalistic country and if you think so, my friend, you are very much misinformed. We have checks and balances, government regulation, anti-trust, etc., etc. The fear mongering about socialists trying to take us would almost be amusing if it were so reminiscent of the fear of the 1950s and the communists. No one is talking about putting caps on income. No one is talking about redistributing wealth. I simply tried to explain the logic behind progressive income tax, which we've had for decades and you seem to have missed the point entirely. Raising the top marginal tax rates back to where they were just a few years ago is a long, long, long way from socialism.

Sorry I didn't make my point better. A swing and a miss! Oh well, I took a shot.

Brian said...

See my comment under the ACORN post. I think I understand where you're coming from now.

Tones said...

Brian Brian Brain - Government taxation is a form income control, especially when it's done because the government thinks it's "unfair" or "obscene". I know that you disagree, but that's fine. And no, I am very aware that we do not live in a complete capitalistic society. Socialism is intervoven through it. I don't want the socialist aspect of our republic to take over, and I believe that Mr. Obama does. But again, that's my opinion based on my analysis of what he says and who I think he is.

Brian said...


We're so close to agreement, I can almost taste it.

You say Obama is a socialist. That's a subjective call. So, what can I say? He's more socialistic than John McCain or George Bush. We can agree on that. Whether he crosses that magic line of 51% socialist versus 49% capitalist, I disagree with you there. I'd say he's mostly capitalist.

What I do have to take exception with you on is calling a progressive tax rate "income control". I knew I was making a mistaken when I interjected my personal opinions about the obscenity of CEOs making millions and millions of dollars into it. (BTW, I have no problems with business OWNERS making bazillions. I have a problem with stupid companies paying "executives" bazillions). So, let's just separate that out for a moment.

The intent of a progressive tax rate is to be more fair, not to punish the wealthy. It's to give a slightly larger burden to those who can easily bear it. The government needs a certain amount of revenue. We have to figure out how to divide that up. We can do a number of things (many of them much better than an income tax BTW but that's what we have for now). There is no desire to tax control income or reduce the lifestyle of the rich and famous. Income control would be if we said, take everything you make above a certain amount and send it Uncle Sam. Income redistribution would be saying take everything you make above a certain amount and send it to Joe the Plumber (before he got rich). Nobody is talking about anything even remotely like that. And no one is talking about penalizing the rich for being successful. We're talking about paying a LITTLE more out of your huge excess so we can get our country back on track by allowing people who can't afford decent housing or health care to afford it.

BTW, maybe you missed my question. Would you be in favor of a flat tax? Do you think that would be more fair? More capitalistic?

Tones said...

Yes, I'm a proponent of a flat tax, and a grossly simplified tax code that eliminated loop-holes.

Brian said...

I see. Flat tax. Sounds good. I used to be in favor of it until I understood how unfair it would be to the poor.

I am definitely in favor of a greatly simplified tax code. Make it so simple we don't need the IRS and I can fire my accountant. I'd like to see a consumption tax instead of an income tax. Something not regressive. Exceptions on things like food and other things. But, something that people paid when they spent rather than when they have income and something that doesn't penalize people for investing and saving.


Someday said...

While all of this talk has gone on about the progressive tax structure in the US, what has been missed is the part that I am calling Socialism with a capital "S". Progressive taxes are socialism with a small "s", unless it is heavily weighted as was called for in the Communist Manifesto.

The part that I am talking about is where handing money out as "tax credits" and calling them tax cuts, even though they can be given to people who do not even pay income taxes to begin with. I don't believe in calling welfare "tax cuts".

The fact is that I am against raising any body's taxes , mine, yours, my neighbors, my boss', Bill Gates, etc etc. How does one even talk about raising taxes in these economic times to begin with, especially without providing proof that raising taxes has raised revenue in the past few decades. I'm not calling the raising of taxes as a necessarily exclusively socialist thing. But socialists do love to raise them on the rich, and that's a fact.

Brian said...

OK. So you are against the tax credits for the poor. That is socialism with a capital "S". The working poor should not get help in the form of a tax credit.

Honestly, this is a part of Obama's plan that I'm unfamiliar with. I'm familiar with the Earn Income Tax Credit because my father used to do taxes for low income people. I'll have to do more research on how Obama's plan is different from that.

Everybody's against raising anybody's taxes, Someday. But, someone's gotta pay the bills. And, since no on in Washington, including Senator McCain, who has been there for close to 30 years, seems to know how to control spending, we all get to pay higher taxes than we would like.

Tones said...

I agree - actually, I read an interesting proposal some time ago about a very low flat tax with an exception for the very low in income) combined with a use tax. The models that were run were pretty incredible. I'll try to find it again.

Brooks Lindsay said...

The issue is not punishing the wealthy. And, indeed, they do often earn higher pay. But, a modest progressive tax system leaves plenty of cash for the wealthy to fully exploit the American dream they have achieved. But, it takes just enough to make it possible to relieve the poor from tax burdens that would make the American dream possible. You may want to have a look at the cumulative pros and cons in the progressive vs. flat tax debate on Debatepedia.