Topic: Social Security

Much Higher Tax Rates in 2013 Left Top 1% Taxes About the Same

Top Tax Rate and Taxes Paid

A timely new blog post from the Tax Foundation points out that, “taxes on the rich are much higher than they’ve been in recent years. Between 2008 and 2012, the top 1 percent of households paid an average tax rate of 28.8 percent. However, in 2013, this figure spiked to 34.0 percent, as a result of tax increases in the “fiscal cliff” deal and the Affordable Care Act”.

“Readers should check out the new CBO report,” the authors suggest, “and reflect for themselves about whether or not high-income Americans are now paying their fair share of taxes.”

The trouble is that the tax rate alone can’t tell us how much the Top 1% paid in taxes: To know how much taxes were paid by the Top 1% requires knowing how much income they reported to the IRS.  The reason this matters is that there is ample evidence that the “elasticity of taxable income” is very high among top taxpayers, which simply means they find ways to report less income if marginal tax rates go up.  This doesn’t require lawyers or loopholes: Avoid capital gains tax by not selling assets and/or shifting into exempt assets (housing up to $500k); avoid the dividend tax by holding tax-exempt bonds; defer personal tax on business income by retaining earnings within a C-corporation; avoid punitive tax rates on second earners by becoming a one-earner household; retire early, etc.

Looking at the same thing from a different angle, the graph shows that average taxes actually paid by the Top 1% grew rapidly after the tax rate on capital gains was cut from 28 percent to 20 percent in 1997. Taxes paid by the Top 1% grew even more rapidly after 2003 when the tax rate on capital gains and dividends was further reduced to 15 percent and the top tax on salaries and unincorporated businesses was cut from 39.6 percent to 35 percent.  If you want the rich to pay more taxes, cut their tax rates.  

As it turns out, 2013 showed that we can’t just assume higher tax rates mean docile taxpayers will simply write bigger checks to the U.S. Treasury. On the contrary, when the average tax rate on the Top 1% increased by 18.4 percent in 2013, the amount of income reported by the Top 1% fell by 15.4 percent – from $1,856,000 in 2012 to $1,571,600. The net effect was almost a wash, in terms of taxes actually paid. According to the CBO, average federal taxes paid by the Top 1% were $530,128 in 2013 –virtually unchanged from $529,056 in 2012. 

Presidential candidates Bernie Sanders and Hillary Clinton propose even more increases in top tax rates on income and capital gains (to 54.2 percent with Sanders, 43.6 percent with Clinton), ostensibly to finance their lavish government spending plans.  But even a relatively small dose of this same poison failed to raise significant revenue from the Top 1% in 2013, partly because of the drag on the overall economy from reduced incomes and incentives. 

Obama’s Misguided Reversal On Social Security Expansion

In a speech this week, President Obama called for an expansion of Social Security, saying “it’s time we finally made Social Security more generous, and increased its benefits.” Obama was undoubtedly influenced  to some degree by the developments in the Democratic primary, where both Bernie Sanders and Hillary Clinton have expressed support for some form of expansion.  This represents a reversal in part for Obama. While he had always supported increasing payroll taxes on higher-earning Americans, he had also previously supported a change in the way benefits were adjusted each year that would have reduced the growth rate of benefits over a long timeframe in the interest of improving the program’s fiscal trajectory. Social Security’s long-term oultook has only gotten worse in the intervening years, but in his speech he signalled that he no longer believed “all options were on the table” to address solvency concerns  and instead supports further expansion. This reversal is misguided. If his favored reforms are implemented it will increase the economic distortions introduced by Social Security and do nothing to address its serious fiscal problems.  The more likely result is that with this retrenchment, policymakers will continue to make promises but fail to actually do anything. Younger workers will bear the brunt of the cost resulting from failures to put forward constructive reform.


We’ll Never Improve the Tax System by Clinging to Partisan Folklore

top marginal tax rates over time

A stubborn myth of the pro-tax left (exemplified by Bernie Sanders) is that the Reagan tax cuts merely benefitted the rich (aka Top 1%), so it would be both harmless and fair to roll back the top tax rates to 70% or 91%.

Nothing could be further from the truth. Between the cyclical peaks of 1979 and 2007, average individual income tax rates fell most dramatically for the bottom 80%  of taxpayers, with the bottom 40 percent receiving more in refundable tax credits than paid in taxes.  By 2008 (with the 2003 tax cuts in place), the OECD found the U.S. had the most progressive tax system among OECD countries while taxes in Sweden and France were among the least progressive.

What is commonly forgotten is that before two across-the-board tax rate reductions of 30% in 1964 and 23% in 1983, families with very modest incomes faced astonishingly high marginal tax rates on every increase in income from extra work or saving (there were no tax-favored saving plans for retirement or college).

From 1954 to 1963 there were 24 tax brackets and 19 of those brackets were higher than 35%.  The lowest rate was 20% -double what it is now.  The highest was 91%.

High and steeply progressive marginal tax rates were terrible for the economy but terrific for tax avoidance. Revenues from the individual income tax were only 7.5% from 1954 to 1963 when the highest tax rate was 91%, which compares poorly with revenues of 7.9% of GDP from 1988 to 1990 when the highest tax rate was 28%. 

The Fundamental Fallacy of Redistribution

The idea that government could redistribute income willy-nilly with impunity did not originate with Senator Bernie Sanders. On the contrary, it may have begun with two of the most famous 19th Century economists, David Ricardo and John Stuart Mill.   Karl Marx, on the other side, found the idea preposterous, calling it “vulgar socialism.”

Mill wrote, “The laws and conditions of the production of wealth partake of the character of physical truths.  There is nothing optional or arbitrary about them… . It is not so with the Distribution of Wealth.  That is a matter of human institution only.  The things once there, mankind, individually, can do with them as they like.”[1]

Mill’s distinction between production and distribution appears to encourage the view that any sort of government intervention in distribution is utterly harmless – a free lunch.  But redistribution aims to take money from people who earned it and give it to those who did not.  And that, of course, has adverse effects on the incentives of those who receive the government’s benefits and on taxpayers who finance those benefits.

David Ricardo had earlier made the identical mistake. In his 1936 book The Good Society (p. 196), Walter Lippmann criticized Ricardo as being “not concerned with the increase of wealth, for wealth was increasing and the economists did not need to worry about that.” But Ricardo saw income distribution as an interesting issue of political economy and “set out to ascertain ‘the laws which determine the division of the produce of industry among the classes who concur in its formation.’

Lippmann wisely argued that, “separating the production of wealth from the distribution of wealth” was “almost certainly an error. For the amount of wealth which is available for distribution cannot in fact be separated from the proportions in which it is distributed… . Moreover, the proportion in which wealth is distributed must have an effect on the amount produced.” 

The third classical economist to address this issue was Karl Marx.  There were many fatal flaws in Marxism, including the whole notion that a society is divided into two armies – workers and capitalists.[2]  Late in his career, however, Marx wrote a fascinating 1875 letter to his allies in the German Social Democratic movement criticizing a redistributionist scheme he found unworkable.  In this famous “Critique of the Gotha Program,” Marx was highly critical of “vulgar socialism” and considered the whole notion of “fair distribution” to be “obsolete verbal rubbish.”  In response to the Gotha’s program claim that society’s production should be equally distributed to all, Marx asked, “To those who do not work as well? … But one man is superior to another physically or mentally and so supplies more labor in the same time, or can labor for a longer time… . This equal right is an unequal right for unequal labor… It is, therefore, a right to inequality…”  

Finland to Break New Ground with Basic Income Experiment

Despite some of the breathless headlines, Finland is not adopting a national universal basic income. That is, Finland is not scrapping the existing welfare system and distributing the same cash benefit to every adult citizen without additional strings or eligibility criteria. Finland is moving forward with one of the most extensive and rigorous basic income experiments in decades, which could help answer some of the lingering questions surrounding the basic income. The failures of the current system are well documented, but there are concerns about costs and potential work disincentives with a basic income. Finland’s experiment could prove invaluable in trying to find an answer some of these questions, and whether it is possible some kind of basic income or negative income tax would be a preferable alternative to the tangled web of programs in place now.

The Finnish Social Insurance Institution (Kela) will lead a consortium of think tanks, universities, and businesses in surveying the existing literature, analyzing past experiments, and designing different models to test in Finland. They will present an interim report next March, where the government will decide which models to develop further. The consortium will present a final report in November, after which the government will choose which models to actually test. The experiment will begin in 2017 and last for two years, after which the consortium will begin to evaluate the results.

One of the most important issues with any basic income proposal is deciding whether it would replace the current system or be added on to the existing structure. (The latter, of course, does not have much appeal from a limited-government perspective.) The consortium is considering multiple models, as Kela’s presentation shows: 

Social Security Technical Panel: 75-Year Shortfall Might Be 28 Percent Larger

A recent report from the Social Security Advisory Board’s Technical Panel found that the 75-year shortfall could be 28 percent (roughly $2.6 trillion) larger than the estimate in this year’s Trustees Report due to changes in some of the underlying technical assumptions. This disparity is more the product of the difficulties related to projecting the trajectory of a program as large and complicated as Social Security so far into the future, with the chair of the Technical Panel taking pains to reiterate that “the methods and assumptions used by the Social Security actuaries and Trustees are reasonable.” Even so, the report reveals the uncertainty related to the long-term projections for Social Security, with relatively small changes to some of the underlying assumptions significantly changing the program’s financial solvency outlook. Social Security is the largest government program in the world, and changes in its fiscal outlook could have a large impact on the government’s overall finances.

The changes in the Technical Panel report that would have the largest impact are concentrated in a few variables:

  • Higher fertility rate
  • Higher life expectancy
  • Higher interest rates

Other changes to inflation and real earnings growth rate assumptions have a small negative impact, while changes to immigration assumptions slightly improve the program’s financial picture.  Some of the changes reflect developments that are good overall but have a negative impact on Social Security’s finances, like higher life expectancy.


Some of the panel’s recommendations focus on making the methodology of the Trustees’ Report more transparent and the degree of uncertainty more clear.  While it’s possible that unforeseen changes to underlying variables like the fertility rate could improve the program’s financial outlook, it is much more likely that the trillions in unfunded obligations published in the Annual Trustees’ Report understate the shortfall, if anything.


Government Workers More Satisfied with Retirement, Health Insurance, and Vacation Benefits

A recent Gallup poll finds that government employees are considerably more satisfied than their private sector counterparts with their compensation fringe benefits–namely government retirement plans (+25), health insurance benefits (+23), and vacation time (+17).

The poll compared satisfaction with 13 different job aspects for both government and nongovernment employees, ranging from stress on the job, flexibility, recognition, salary, relations with coworkers and bosses, etc. In 9 of the 13 characteristics, government and private sector workers reported similar levels of satisfaction (all above 60%) with job stress, recognition, flexibility, safety, salary, hours, promotion opportunities and job security.