No Taxation without Representation

Tue, Aug 2, 2011 - 8:08am

Now that I have your attention, despite the political euphoria that will likely accompany the deal to raise the debt limit, a more careful examination suggests that once again our elected officials have opted for policies dictated by their desire to ensure their reelection rather than caring for the needs of the country. Before delving into those issues, however, I want to address some concerns that a few readers raised about my last commentary, which focused on the “fairness” issues surrounding the debt debate.

That piece generated a lot of comments, many of them passionate. While the vast majority of responses were favorable, some accused me of selectively citing data that might be interpreted as arguing that high-income people were bearing an “unfair” proportion of the tax burden, while ignoring data on the proportion of income earned and wealth distribution. My point in that piece was that simply looking at the data on tax burdens doesn’t help one to judge what is or is not “fair.” That is a value judgment and a political assessment and is not one that I tried to make. The comments, however, did pique my curiosity and triggered a more in-depth look at the facts.

I must confess that my intuition wasn’t confirmed. Let me just cite a few key figures. In that piece, I noted that variations in revenues collected by the government were essentially unrelated to variations in the highest marginal tax rates. In addition, the most recent data suggested that those in the top 5% of the income distribution paid 59% of the personal income tax collected and those in the top 1% paid 38%, while the bottom 50% paid 2.7%. Looking at the distribution of income, comparable data from the IRS show that the top 1%, who paid 38% of the taxes, earned 20% of the income and the top 5%, who paid 59% of the taxes, earned 34% of the income. In contrast, the bottom half earned 12.5% of the income but paid only 2.5% of the taxes.

The assumption of the critics was probably that the top income brackets earned a larger share of the income than they paid in taxes, but that is not borne out by the data. I would also note as an aside that out of a population of over 300 million people, 1.4 million tax filers were in the top 1% of adjusted gross income. Seven million returns were filed by those in the top 5% of adjusted gross income distribution while 70 million returns were filed by the bottom 50% of the income distribution. Any way one cuts it, the few are carrying the many, and the fairness issue that is bothering some special interest groups is whether the few should assume even more of the burden.

Now what about the distribution of wealth? Much has been made recently about the concentration of wealth in the hands of the few. Again, the facts are informative. From 1920 through 2007, the share of wealth held by the top 1% of the population peaked in 1929 at 44%. That share then fell steadily to a low of 20% in 1976. The share increased gradually and peaked at 39% in 1995 before falling off again to 35% in 2007. While information is not readily available about what taxes the wealthy pay, it does seem that the wealthy are not in a significantly different position today than they were in the 1920s and in the mid-1960s. Indeed, the distribution of wealth holdings has varied significantly over time but hasn’t steadily increased as some might have guessed.

The bottom line from this more in-depth exploration of the data shows that looking at either the wealth distribution or the distribution of income taxes paid relative to income earned doesn’t indicate that the wealthy are either significantly better off than they were a long time ago or that they are paying disproportionately less in taxes relative to income earned. What this implies for the debt discussion is that focusing on the distributional dimensions of the revenue side of the deficit issue is a second-order problem. It is a diversion of attention from the critical issues of establishing criteria for determining the appropriate size of government and bringing government spending down more in line with revenues received.

Against this backdrop, it is appropriate to take both Republicans and Democrats to task for their conduct in dealing with the current debt crises and how they have chosen to frame the issues. The present debt extension agreement makes only token cuts and punts on the critical issue, which is the projected unconstrained growth in entitlement spending. It leaves all the hard decisions for the future and makes a trivial dent in the yearly federal deficit, while continuing to add to outstanding public debt.

Keep in mind that the number being thrown around as the cut in the deficit represents only the incremental effects that the sum of the “promised” spending reductions (over the next 10 years) would have on the need to issue additional government debt. The cuts hardly dents what the new debt issuance needs will be and they are far from eliminating the yearly deficits. The numbers also don’t include the present value of those cuts and hence ignore the time value of money and the fact that a dollar of cuts today is worth more than a dollar of cuts in the future. Furthermore, most of the so-called cuts are only “promises” (and those promises are dependent upon the ability to deliver future spending cuts). Truth-in-government would say that the Congress should come clean and tell us what the estimated cumulative total of the remaining yearly deficits will be and what the likely need will be for increases in the debt ceiling in the future. The requests for increases won’t be long in coming, and the ten-year horizon for addressing the key issues will arrive long after this and the next debt-ceiling crisis. On net, both sides settled for an agreement that does little to address the key problems, though it may preserve some cover during the upcoming election season. This is short-termism at its worst.

Having castigated Congress in general, let’s focus next on the Republicans. Due to Tea Party influence, a line was drawn in the sand concerning cuts in spending and raising taxes as a way to partially address the mismatch between spending and revenues. This is all well and good, but they played Russian roulette with domestic and international financial markets. In the end they took the easy way out by accepting small cuts in domestic spending, whereas the real problems lie with entitlements, namely Social Security and healthcare spending. In short, the Republicans got relatively little of substance for the taxpayer, except for highly-valued political ammunition to use in the coming election when compared with the risks their actions posed for the country.

As for the Democrats, their objective was to grow the budget and fund its increase with more taxes, thus avoiding the need to address either the entitlements issues or the rationale for continuing other pet spending initiatives. Theirs was a cake-and-eat-it approach.

But perhaps the group that deserves the most criticism is the recipients of entitlements, and in particular Medicare, Medicaid, and Social Security. These are mainly the elderly and, to be totally transparent, that group includes me and some of my Cumberland colleagues. To be sure, we relied upon payments promised to us by legislators long departed, who didn’t put in place the necessary funding to deliver on those promises. We relied upon the promises and despite the many warnings we failed in many cases to provide sufficiently for our own retirement and healthcare needs.

Our predecessors created a Ponzi scheme that would make Bernie Madoff proud. They pledged tax revenues to be collected from future generations under the assumption that the population would continue to grow and that more people would always be available to fund the programs. This is just like assuming that housing prices will always go up, and we know what that is costing us. Now, however, the pool of future taxpayers is smaller than the present one, and the burdens they must assume are proportionately greater. In short, this is “taxation without representation.”

The current recipients claim they have paid into the plan, which they have. But their payments were not contributions that prefunded their own retirements or their need for medical services. Rather they were part of a pay-as-you-go scheme. Their tax payments were given to those who already retired or had medical needs. Now, the present generation of retirement age also refuses to recognize this problem, which is on track to absorb the whole of projected government revenues and then some. Instead we seek to do what our parents did by passing on an even more burdensome set of obligations to our children and grandchildren.

If this isn’t “taxation without representation” then I don’t know what is. We are making commitments today for those who will have to pay but who do not have a say in what those burdens are. Not only does this go against the grain of the sentiments that helped to trigger the American Revolution, it is also naïve to think that future generations will continue to honor promises made by past generations. What makes us believe they won’t simply decide to renege on the promises we have forced upon them when the choice might be whether or not to put food on the table for their own families?

We can’t continue to grow government and transfer payments forever, and the time to address those issues is now, while they are still manageable. Nor can we avoid the problem by cutting only discretionary spending, as is the approach in the current deficit agreement.

Unfortunately, the course taken by the leaders of both parties and the administration fails on all counts. They have placed us on the risky path of financial fragility rather than stability. A ratings downgrade might be the needed wake-up call for the country, our politicians and its senior citizens.

About the Author

Chief Monetary Economist
Bob [dot] Eisenbeis [at] cumber [dot] com ()