Wednesday, November 14, 2012

Don't Bite the Hand that Feeds You: The Truth about Taxes

by Madeleine Kando

We have all heard the expression ‘In this world nothing can be said to be certain, except death and taxes’, but even though they are both certain, we don’t spend weeks on end agonizing over death every time April comes around. It is taxes that gives us heart palpitations, high blood pressure and other physical ailments. Death actually has the advantage over taxes of being non-negotiable. We cannot fudge the books or take any deductions on death. You cannot hide in an off-shore account, death will find you, trust me.

But what death mostly has going for it is that it’s a lot less complicated than taxes. I found that out the moment I started doing research for this article. So, rather than pretend that I know what I am talking about, I will admit up front that this essay resembles a piece of Swiss cheese with more holes than cheese.

Let me start with the 47%. Was Romney right about the 47%? Yes. There is a large proportion of Americans that do not owe money to the government because they either don’t earn enough, they have too many expenses or because they have a lot of deductions.

Was Romney wrong about the 47%? Yes. The 47% pays payroll tax, state, local and sales tax, gas and property tax. Not only do they pay all these taxes they pay a larger share of their income towards these taxes than the rich. It’s called a ‘regressive tax’.

Progressive or Regressive?
If 47% of Americans don’t pay income tax, then where does the income tax come from? You guessed it, it comes from the 53% that makes more than the 47%.  In other words, America has a much narrower income tax base than most other Western countries. In Holland, for example, tax liability extends across the board. They tax the poor more. It may sound counter-intuitive, but America’s tax system is more progressive than the Dutch one. It gets even worse if you take into account that European welfare states rely on consumption tax more than on income tax to fill their coffers. A poor person pays the same amount of tax as a rich person when they consume bread. It just takes a much bigger bite out of their income. Consumption tax is regressive.

Taxing the Poor to Pay the Poor
One has to look at what the taxes are spent on to determine if the whole system ends up being ‘progressive’. In Holland, almost all of the taxes go toward Social Security and Health Care, two items that benefit everyone. The Robin Hood of Social Welfare might take from the poor as well as from the rich, but he gives it all back to the poor in the form of child subsidy, health care, education and retirement.

Taxing the Middle Class to Pay for the Middle Class
Not only is the top tax rate in Holland a whopping 52% (compared to the 35% in the US), but it starts to kick in when someone is making a measly $72,000. Compare that to the American Fat Cats that can get away with making $388,349 before they qualify for the 35% bracket.

Dutch income tax brackets

Tax income
Tax bracket
$ 0 - $ $24,066
1.95 %
$ 24,066- $43,016
10.80 %
$43,016- $71,755
42 %
52 %

Tax income
Tax bracket
$0 – $17,400
10% Bracket
$17,400 – $70,700
15% Bracket
$70,700 – $142,700
25% Bracket
$142,700 – $217,450
28% Bracket
$217,450 – $388,350
33% Bracket
Over $388,350
35% Bracket

Even though America’s tax collection system is more progressive at the lower end, it certainly isn’t at the high end of the income ladder. For some obscure reason, the top 0.1% only pays 18% income tax. Someone should explain that to me. It certainly would fill one of the gaping holes in my Swiss cheese. Since the top tax rate doesn’t kick in until much higher on the income scale, a much smaller portion of Americans pay the bulk of income taxes. Doesn’t that make the Government overly dependent on this group? No one wants to bite the hand that feeds it.

The Robin Hood Effect
The surprising conclusion is that the taxation system of a country like Holland is more ‘regressive’ in its collection, but more ‘progressive in its reallocation. It is more ‘47% friendly’. It gives the government more revenue without taking away from people’s ability to be productive. So should we expand our tax base, rely more on consumption tax and redistribute more progressively? I doubt any politician would want to go there, but it’s worth looking into…

Income Inequality
Income inequality is the highest in the US of all Western nations. There is an instinctive revulsion in the Social Democracies of Europe to let income inequality get too large. So, in essence, even though taxation on income might not be as progressive, income itself is not that unequal to begin with. In Holland, the poorest 5% of the population is twice as affluent as in the US. On the Genie index (a measure of income equality worldwide), Holland is at the very top, the US at the very bottom. **

The Sheriff of Nottingham Effect
Did America make the mistake of asking too much of the few? European social democracies use efficient consumption taxes to pay for their programs and they ask a lot more from the average earner. On top of it, if you get taxed on your savings and on capital income, you start resenting paying taxes all together and you don’t see the benefits of redistributing money. The trick is to find the right formula: Once people see the benefits of redistribution, what’s there not to like? leave comment here

** A major source for this piece of Swiss cheese can be found in an article in The Economist: ‘Democracy in America’