From Kip Hagopian:
The following is an email exchange I had with David Frum, a friend who expressed certain objections to the notion of abandoning the progressive income tax. David is a Republican, a commentator on CNN, and the author of a blog named, “The Frum Forum”. The email exchange started on April 6 and ran through April 11. My comments begin just below, and continue as inserts (in red) in David’s April 6 email. It is best to read from the bottom up.
From: Kip Hagopian
Sent: Monday, April 11, 2011 6:33 PM
To: ‘David Frum’
Subject: RE: thoughts/trying again
It appears that I was not very persuasive in my last email. Heck.
I will try again. See inserts below.
From: David Frum [mailto:email@example.com]
Sent: Sunday, April 10, 2011 9:39 AM
To: Kip Hagopian
Subject: Re: thoughts/trying again
Some further thoughts:
Sales tax is not the only regressive tax in US. The pension portion of the FICA tax is regressive: a person earning over the cap pays a smaller % of income in payroll taxes than a person below the cap. Property taxes are sufficiently random with relation to income that they will often apply regressively. Excise taxes and tariffs are regressive. The fees proliferating at state and local level are progressive. The interaction of rates and deductions can yield to regressive results.
Re Social Security taxes: The pension portion of the FICA tax (assuming you mean the Social Security tax) is NOT regressive. This is a misnomer. The fact that the SS tax is a lower percent of the income of someone whose income is above the cap, is not relevant in this situation. The amount of money taken out of the SS system at retirement by any particular individual is no more than directly proportional to what the individual paid in; so it can not be regressive. (I say “no more than” because I understand, for example, that someone who pays 4X more in taxes than someone else, does not get 4X the income in retirement that the other person gets; if this is so, the SS tax is progressive from the get-go. I am checking on this.)
Try looking at this from another angle: Imagine there is no SS system now and the government is proposing to establish one. The proposal is that when an individual retires he/she will receive an income supplement. But the government wants to put a cap on the amount of that supplement. Under this scheme, how much tax should be paid into the system by each person during their working years in order to make the system proportionate? Clearly, it would be the system we have now. If the income received in retirement was capped, but there was no cap on the amount of income that was taxed, the system would be progressive (i.e., millions of high income people would pay more into the system than they could ever hope to get back).
You are saying the current system is regressive. If you are right, how would you design a system that is proportionate? The only way I can think of to do it is to lift the cap on both the inflow and the outflow. But the system we have achieves the same result; it just limits the total amount of income anyone can get. Please explain to me what I am doing wrong.
Re Excise taxes and tariffs: I consider excise taxes and tariffs to be sales taxes because they are priced into the products when sold, so I was lumping all sales taxes together. We could also lump almost any consumption tax into that mix. I don’t want to debate the equity or inequity of a sales/consumption tax. Suffice it to say that I disagree with the notion that the inequity of one tax system should be a rationale for sustaining the existence of another system that is inequitable. Instead of keeping the inequitable progressive system, why not eliminate the sales tax?
Re Property tax: With the possible of exception of Calif. (because of Prop. 13), I consider property taxes, in the main, to be proportional taxes on wealth. I think wealth taxes are inequitable, because wealth is accumulated from earnings on savings and savings are the residual of income that has already been taxed. (By the way, I have my own ideas on the inheritance tax which will probably surprise you.)
From David: “NB: I dont disapprove of regressive taxes in all cases!”
My inclination is to be against all regressive taxes. But I have not thought deeply about this. I am interested in hearing your thoughts.
But as you say in your first paragraph below, one consideration in thinking about a supposed inequity is the question : how real is this problem?
I suppose I’d also have to add the question: how real is your solution? If we switched to a flat 25% rate while leaving the rest of the system of government finance in theUSalone, would we have moved closer to “fairness”?
Absolutely. We would have eliminated one of the inequitable systems, meaning up to half the working population (those whose work effort was above the median) would no longer be treated unfairly.
Not so long as tariffs remain in place
Tariffs are bad for all kinds of reasons.
and the inherent advantages for homeowners over renters – not only mortgage interest, but imputed rent –
What is the “inherant advantage for homeowners over renters”? A renter pays every single tax and other expense that a homeowner does, because all of these costs are passed through to the renter by the landlord. This includes mortgage interest expense, property tax, maintenance, and even the imputed return on the owner’s capital (the renter has no capital tied up so he has to pay the owner’s cost of capital–which his profit). There are only two advantages I can think of for owning over renting: 1) the psychic benefit of owning your own home (which I think is very significant); and 2) the potential for capital appreciation. (Of course this latter one is a two edged sword as millions of people discovered in the last few years.)
and the tax exclusion for healthcare and other fringe benefits.
The value of employer-provided health care is generally a higher percentage of the income of a low-income person than it is of a high-income person. As a result, the tax subsidy (it is a subsidy because health insurance benefits are not taxed) benefits lower income people more than it does higher income people. Thus, the subsidy increases progression, it does not decrease it. Do you disagree? Is so why?
As to inequality:
I think we must use money income. Otherwise we get this result
Joe earns $25,000 in 1997 and the same $25,000 in 2007. But he qualifies for Medicaid, and in the interim, the cost to the fisc of his Medicaid benefits have doubled. Joe is not better off! But your measure would make it appear that he i
With due respect, I don’t understand your logic on this one. I think it is clear that Joe is vastly better off because, in the absence of Medicaid, he would have to pick up the tab for his inflated health care cost himself. That is one of the many nice things about Medicaid; beneficiaries do not have to worry about increases in health care cost. Whatever the cost is, Medicaid pays.
Money income is an almost meaningless definition of income for measuring inequality or standard of living. Even the Census Bureau cautions people against putting faith in it.
And using money income, we see not only rising income inequality
Not really. Even the Gini for money income has not budged for about 10 years, and has risen only 3% in the previous 16 years. Using a more meaningful definition of income, the income inequality has declined about 2% in the last 16 to 23 years. You don’t seem to believe the figures I have given you. I urge you to look at the sources I cite (primarily the Census Bureau) and tell me where I have gone wrong.
but -just as you worry – inequality combined with income stagnation at the median income level.
I don’t know why you are so concerned about income inequality. You are not the kind of person that envies and resents other people’s accomplishments, so I can’t imagine that you begrudge Steve Jobs his billions or LaBron James his $20 million salary. If your concern is that Americans will some day rebel if we don’t do something about inequality, I don’t share it. Other than the pundits at the NY Times (Krugman, Herbert, Blow, Dowd, the editorial board, etc.) and almost all Democrats., most Americans don’t seem to care much about inequality. What they appear to care about it their own well being. Of course, I could really be wrong about this. But, in support of that view, here is an excerpt from an earlier draft of my essay that ultimately was cut. The study cited is by no means dispositive, but I think it is important.
Interestingly, according to at least one public opinion survey, the American people do not seem to be very concerned about inequality. In a 2004 paper by Alberto Alesina, Rafael Di Tella, and Robert MacCulloch, entitled, Inequality and happiness: are Europeans and Americans different? the authors reported that:
“Using a total of 128,106 answers to a survey question about ‘happiness’, we find that there is a large, negative and significant effect of inequality on happiness in Europe but not in the U.S….There is evidence of ‘inequality generated’ unhappiness in the U.S. only for a sub-group of rich leftists.”
I concur with everything you say about the innovators you mention. But half the profits earned in theUSin the first decade of the century were earned in the financial sector.
Do you have a source for this? I am not challenging you; I am just really interested in seeing this data.
And those guys’ innovations don’t smell too good these days ….
I agree. But everything goes in cycles. You have to have faith in the free market! :-)
I have three questions: 1) Do you think the current progressive income tax system is fair? If you do, how do you reconcile the treatment of the hardest and most productive workers in our society? 2) If all of the other tax systems (all the regressive systems for example) were left out of the equation (i.e., they didn’t exist), would you still believe our progressive system was fair? and 3) Why are you so concerned about income inequality when theUS standard of living is so much higher than the SOL of all of the other advanced economies?
 Journal of Public Economics 88: 2009-2042,
From: Kip Hagopian
Sent: Friday, April 08, 2011 11:26 AM
To: ‘David Frum’
Subject: RE: thoughts/trying again
These are very useful comments, particularly the ones that disagree with my thesis. It is very good for me to have someone of your intellectual heft challenge me. I have responded to most of your comments by inserting my own in red.
An overall comment I would make is that, as far as I could tell, there is very little in what you have written that challenges the intellectual foundation or merits of my basic arguments to the effect that progression is inequitable. The thrust of your comments seems to be that: 1) when other taxes are taken into account, the system is not all that progressive; and 2) income inequality is a festering, growing sore on the body politic that is dangerous to our democracy and must be redressed. Did I get that right? If so, it seems that are you saying that even if our current federal tax system is, in fact, unfair (particularly to those who were born with the fewest gifts), it’s not unfair enough to run the risk of alienating the public. Is that about right? If so, we may have a philosophical difference of opinion on this point, which are the hardest differences to reconcile. I believe the federal system is quite progressive and it hurts people with more lowly valued aptitudes much more than it hurts rich people. Moreover, I believe that any system we put in place should be based on an equity principle that supports it. In all my reading of the literature, I could not find any such principle that persuasively supports progression.
It is true that there are other tax systems that are regressive–the most prominent of which is the sales tax (is there another one?). It is also true that a strong argument can be made that regressive taxes are unfair. But if such a system is unfair, that should give rise to an effort to reform that system; not to efforts to sustain another system that is unfair in the other direction. (By the way, I have not thought deeply on this, but I am not a big advocate of consumption taxes. I think income is a decent proxy for the value of the benefits we receive from our government. Thus, we should pay for those benefits out of income through a proportionate tax. Just as taxing investment income is distortive, I believe taxing consumption is distortive. I have a running dialectic going on this topic with two of my U of Chicago trained economist friends.)
By the way, I inferred from some of your comments that you may not have read the most up-to-date version of the paper. If that is true, I urge you to read it; it is much better than the draft you read a year ago. If you decide to read, please read the unabridged version. (For what it is worth, the unabridged includes a section on “social justice” on pages 25-27.)
Thanks for all of your time and help.
From: David Frum [mailto:firstname.lastname@example.org]
Sent: Wednesday, April 06, 2011 8:06 AM
To: Kip Hagopian
Subject: Fwd: thoughts/trying again
Begin forwarded message:
From: David Frum <email@example.com>
Date: April 5, 2011 8:56:01 AM EDT
To: “Hagopian B. Kipling & Mary Anne” <KHagopian@appleoaks.com>
Some thoughts that may be useful for you, then comments that maybe less useful afterward.
DAVID’S INITIAL “THOUGHTS” BECAUSE THEY WERE PERSONAL.
David’s comments: Now as to my own views:
I’m in an ironic position here, since I prefer a tax code with a few simple rates. I think we got it close to right in 1986, and the falling away since then has been troubling to me. I agree with your key point that progressivity can work horizontal injustice to people who apply more work effort.
I worry a lot about the economic costs of tax avoidance in a progressive system. They are very visible on the corporate tax side, but no less real on the individual side.
So why don’t I concur with the full conclusions of the paper?
Some of the reasons:
1) Your argument applies more forcefully the more steps there are in the progression, and especially for the intermediate brackets, where most incomes are found. In the 1970s, there were (I recall) 11 brackets, bunched closely together. Your situation exactly. But I don’t think it applies very forcefully to our world, where the top bracket hits at $373,000. The overwhelming majority of Americans earn incomes that will be taxed at either the 15% or 25% rates – the universe between $8000 of taxable income and $80,000.
I may not understand your point here. Having more brackets only smooths out the curve, it doesn’t change the basic fact that harder workers receive lower average, after-tax income per hour than workers who don’t work as hard. The Class brothers are basically in the category you describe and yet, the outcome is clearly inequitable. I have run the case for the three brothers where their respective incomes are: $25,000, $50,000 and $75,000 and Harry still comes out on the short end of the stick. Thus, I don’t see how this impacts my argument. Moreover, as you can see from footnote 1 of the paper, the tax brackets are only part of the equation; when you add in the various tax credits, the degree of progression is much higher.
2) Your argument ignores deductions, which in the real world are the real workers of horizontal inequity. If the brothers in your story all earned the same salary – all chose equally desireable dwellings – but one chose to buy his home in cash, the second to buy his home with a mortgage, and the three to rent – they would report much more dramatic differences in their tax treatment than 3 brothers earning the salaries most Americans earn. Ditto for state & local taxes. Ditto for one with a generous health plan vs one with no health plan at all.
As you can see in footnote 1 of the essay, I don’t entirely ignore deductions. As noted in the footnote, many of them tend to increase the degree of progressivity. It is true that the brothers’ respective tax obligations would be different if they chose the routes you describe. (By the way I think the deduction for mortgage interest should be eliminated. Ditto for state and local taxes. I also think that employee-provided health insurance benefits should be taxable income to the employee; either that, or the field should be leveled so everyone who purchases his or her own insurance should get a tax deduction.) But how does the existence of deductions change anything with respect to the inequity of progression. Are you saying that it is OK to tax progressively if mortgage interest or state taxes are deductible? What if it is Tom and Dick that gets a mortgage and Harry doesn’t; in that event Tom and Dick would each pay even lower taxes than they do now. As to state and local taxes, the deduction would be more or less proportional, so how does this change anything?
To do an honest analysis of this, I believe you have assume that all the brothers do the same thing (e.g., get a mortgage). If they did, Harry might do better because he has more income to shelter. But but he has that extra income solely because he works harder. Why should he be penalized for this?
3) Finally as I said on the phone, the American tax system as a whole is not very progressive. The federal income tax is not even half of federal revenues! Then you have to consider the state burdens… There is only one taxpayer after all.
Excluding payroll taxes (see comments below), it is much more than half of the taxes paid by individuals. Isn’t this what counts?
Combine the progressive federal income tax with the (at least for now) Medicare tax and the outright regressive Social Security tax – the regressive sales tax regimes of the states – and the more or less arbitrary with regard to income system of property taxes – and you get a different picture. And that’s before we consider the ease with which the very wealthy can redesignate income as capital gains … So I am left wondering at the real world relevance of your argument.
We may have a real philosophical difference on this point. As I say above, I don’t think it makes any sense at all to create or sustain a tax system that you know is inequitable for the purpose of mitigating the inequities or reducing the “burdens” of some other tax system. (As to the “burdens” of state taxes, remember that those taxes are being paid for benefits just like federal taxes are. That is the principal reason that they should not be deductible.) If sales taxes or property taxes are unfair ways to pay for the benefits of the state, change the system.
As to “the ease with which the…wealthy can redesignate income as capital gains”: I know this is a view held by the press and many politicians, both Democrat and Republican. It is also commonly believed that rich people can hire lawyers and accountants that will substantially reduce or even eliminate their taxes. If that is true, I feel stupid. I am what some would call “rich”. And I employ some of the best tax people on the planet. But I and my tax advisors really don’t know how to convert my earned income into capital gains income. I also don’t have a clue as to how to reduce my taxes below the amounts indicated in the tax tables (I am in AMT, so I don’t even get deductions). The notion that rich people can shelter substantial parts of their income is largely a myth. The only shelters for individuals (as contrasted with corporations) that exist anymore are the ones that Congress has deliberately built into the system under pressure from special interest groups to encourage certain behavior deemed important to the economy, or “the greater good”. Incentives to invest in real estate is a prime example, but the benefits are quite small and most, if not all of them, should be abolished. Another example are subsidies for buying “green” cars and other green things.
The “real world relevance” of my argument is that the vast majority of federal taxes paid by individuals in the lower and middle classes are the product of an inequitable system that primarily hurts people with more lowly-valued aptitudes. That is the real world in my view.
I know you argue that the payroll tax is not a tax but a system of forced saving. I doubt you ‘ll persuade many people with this argument. The payroll tax creates no individual property rights. Benefits can be adjusted at any time by simple act of Congress, even abolished outright. (As Paul Ryan now proposes to do for much of the Medicare claims of everyone under 55.) In 1937, the Supreme Court formally adjudicated the payroll tax a tax. That’s why it’s constitutional. (And why the individual mandate in healthcare may not be … unless it’s redesignated a tax, in which case it clearly would be.)
Re Social Security: OK, let’s call it a tax. But please explain to me why you think it’s regressive? Despite the lack of a guaranteed contract, and despite the fact that different cohorts have been, and may in the future, be treated differently, each individual in a particular cohort will be treated the same as every other individual in the cohort with respect to the relationship between money paid in and money taken out. The point is that the payments made into the system are directly proportional to the benefits each individual ultimately receives. Thus, the tax is not regressive. Moreover, when Social Security income is paid out, 85% of it is lumped in with other income (if any) and is taxed at progressive rates. I don’t think any of this is in dispute by tax experts. If you know such an expert who disagrees with this, I will definitely be interested in hearing his or her rationale.
Warren Buffett notes that he pays a lower rate of tax than his secretary. Because of the combined workings of the payroll tax and the capital gains tax, there are many, many wealthy people in theUnited States who can say the same.
As I say above, it is a misnomer to equate payroll taxes to income taxes. Social Security taxes are paid in return for very specific benefits that are proportional to the amount the individual pays into the system. In the case of Medicare, the tax is redistributive (the tax is proportional to income, but the benefits are basically the same for everyone). In the opinion of my tax expert, neither of the payroll taxes are regressive.
As to capital gains taxes (and all other income from savings), most economists believe (I can’t imagine who would not) that such taxes violate the principle of horizontal equity. To wit: if two people have the same lifetime earned income, tax equity requires that they each pay the same amount of taxes. But if one person uses all of his income for consumption, and the other forgoes consumption in favor of saving, the latter will pay higher lifetime taxes simply because he saved for his future. This is inequitable. Moreover, all capital gains from corporations are second taxes on corporate income, which is already is taxed at 35%. But I don’t want to debate this ( let’s save it for another paper). It is just something to keep in mind to remind you that there are a lot of things wrong with the current tax system.
4) I’m left to wonder: if not the progressive income tax, what IS the policy response to the intensifying inequality within theUS? In the 2000s, we lived through a decade where virtually all the benefits of economic growth were claimed by the wealthiest few. (GDP/capita rose sharply, but wages stayed flat, even for college graduates.) I think that’s a problem.
I guess you don’t agree with my analysis in the section on “Reducing Income Inequality” (pages 17- 22). If you measure income inequality by the Gini Coefficient (which is the most commonly accepted measure), there was no change in money income inequality from 2000 to 2009. But money income is really a poor measure of either income income inequality or standard of living. If you used a comprehensive measure of income, the Gini declined by almost 2% during the period 1993 to 2009. Moreover, if you look at consumption inequality (which the consensus of economists believe is the best measure of standard of living over the long term) it doesn’t not appear to have increased for 16 to 23 years.
As to flat wages, this also does not appear to accurate, at least over the last 25 years (I haven’t looked at the 2000s). Please go to page 20 of the unabridged and you will see data from the CBO that indicates that when using a comprehensive measure of income (as defined), during the years from 1983 to 2005, real median household income grew 35%. The economy was strong in the years 2006, 2007 and the first half of 2008, so I would think (but am not certain) that this growth would have continued.
I am not sure where you got the facts you cite above, but I am pretty sure mine are accurate. If you have other sources that show my data are wrong, I would like to know about them.
The progressive income tax is a poor instrument to deal with this problem, but along with the even more dysfunctional estate tax, it’s the only one we’ve got. If not that, then what? Nothing? ANd what happens to our democracy if nothing is done?
I don’t know why you are worried about income inequality. Isn’t it more important to worry about the median standard of living while ensuring that our truly needy citizens are taken care of? By the way, there was a huge study done in 2004 (?) that indicated that Americans were not really worried about income inequality. I can get you the cite if you are interested.
The richest man in the US in 1960, J Paul Getty, could not possibly have funded a presidential election campaign himself. (Joe Kennedy’s crack about “not paying for a damn landslide” applied to a single primary, and in one of the country’s poorest states.) But George Soros or the Koch brothers or Sheldon Adelson could buy negative ads to equal the entire billion-dollar Obama campaign – and still have multiple billions left over. We’re getting into the territory here of the late Roman Republic, where as the triumvir Marcus Licinius Crassus said, no man should be considered rich unless he could field a private army.
This is another area where we may see things differently. It would be fun to discuss it some day over a cocktail. Suffice it to say for now that, if the cost of achieving the massive world-wide productivity gains that have been brought about by Intel, Apple, Microsoft, FedEx, Google, etc., is that Bob Noyce, Gordon Moore, Andy Grove, Steve Jobs, Bill Gates, Fred Smith and Sergey Brin and Larry Page, all end up becoming multi-billionaires, then I am really happy with income inequality. By the way I know or knew most of these people and they are all as decent and compassionate as you and I are (or think we are). And they give/gave much more to charity.