How Taxes Work
Today, we’re going to talk the federal budget and tax rates. Let’s start with tax rates—and how they work—a concept I’m not sure most Americans grasp. Here are the federal tax rates for 2012:
|Federal Income Tax Rate||Married or Filing Jointly||Single|
|10%||$0 to $17,400||$0 to $8,700|
|15%||$17,401 to $70,700||$8,701 to $35,350|
|25%||$70,701 to $142,700||$35,351 to $85,650|
|28%||$142,701 to $217,450||$85,651 to $178,650|
|33%||$217,451 to $388,350||$178,651 to $388,350|
|35%||$388,351 or more||$388,351 or more|
The key fact that most Americans don’t understand, is that going up in a tax bracket does not subject all your money to that tax rate. For example, say a married couple makes $80,000 a year. Many Americans would then assume that they are taxed at a 25% rate on all of their income, because that is the bracket they fall into. This is wrong.
Here’s how it works: the first $17,400 is taxed at a 10% rate. Then, every dollar they make from $17,401 to $70,700 is taxed at 15%. Finally, the $9,300 they make from $70,701 to $80,000 is taxed at a 25% rate. Thus, they pay $1,740 in bracket one, $7,995 in bracket two, and $2,325 in bracket three, for a combined total of $12,060 of total federal income tax, which works out to an effective tax rate of about 15%.
Now, as this regards the dreaded “fiscal cliff,” what President Obama and the Democrats are proposing is that we keep the first four brackets at the same percentage, but allow the highest two to go back to the Clinton era rates of 36% ($217,451 to $388,351), and 39.6% ($388,351 or more). Doing this would reduce the budget deficit by about $950 billion over ten years, according the Congressional Budget Office.
Is this really so bad? No, and the simple reason is that high income earners are probably still going to spend whatever money they’d spend anyway. For example, a family making $500,000 a year would pay an additional $10,000 a year in federal taxes if Obama’s plan is put in play. That’s a lot for someone in the middle class, but for someone making $500,000 a year, it’s not much, and it’s a small price to pay considering, again, that it will raise almost a trillion dollars of revenue over a ten year period.
The Federal Budget and the Big Three: Social Security, Medicare, and the Military
Republicans are fond of saying our government does not have a revenue problem—it has a spending problem. With that in mind, let’s look at the federal budget. Now, depending on where one finds their figures, the percentages may vary, but based on all of the data I’ve seen, this pie chart above is fairly accurate. Obviously, the three biggest portions of our budget are Social Security, defense/military spending, and Medicare, Medicaid, and CHIP (children’s health insurance program), so these would be the most likely candidates for cuts.
The problem is that doctors already receive poor compensation for serving Medicare and Medicaid patients, and the people on these programs, namely the poor and elderly, can ill afford to lose their health insurance. Indeed, the poor can’t afford it, and no insurance company in their right mind would insure people 65 and older, unless they were willing to pay exorbitantly high premiums. Both groups would then be left to seek the most expensive care possible at the emergency room, which would ultimately cost the government MORE than simply leaving the programs as they are, because it would be forced to pay doctors and hospitals for providing this care. So cutting Medicare or raising the eligibility age is really stupid.
Moreover, Medicare beneficiaries have paid taxes their whole lives expecting to have this service provided—the same can be said of Social Security. For the government to suddenly take these benefits away would be a tremendous abuse of the American taxpayer.
Now, there are certain steps we could take to make both programs less burdensome on the debt. With Social Security it’s easy. Currently, taxpayers only pay Social Security taxes on the first $106,800 of income. If we simply extended the tax on income after that, we could probably lower the rate and still have enough money to pay out beneficiaries. The other option would be to simply cut benefits (which is actually being proposed now)—and though I know I may sound like a Republican here, that’s not the worst thing in the world, because in essence, what Social Security does is redistribute money from working, young people to non-working, old people, many of whom are doing just fine financially. In other words, cutting Social Security seems to me a MUCH better option than cutting Medicare, Medicaid, or CHIP.
Indeed, finding places to cut these programs is much more difficult, but there are solutions. For example, older adults consume about a quarter of all Medicare costs during their final year of life. Curbing such costs could save billions of dollars, but then, so far any mention of rationing health care dollars has elicited dishonest, whining screams from Republicans about “death panels.”
Any real conversation about how we can control rising health care costs regarding Medicare and Medicaid has to admit that rationing care is unavoidable—indeed it’s necessary. The key is to find ways to reduce the expense of Medicare and Medicaid in ways that A) don’t cut reimbursement rates for doctors and hospitals (because doing so means that many physicians will simply stop accepting these patients), and B) preserve the ability of doctors to provide, and patients to receive, quality health care.
Of course, why these programs are always put forward as candidates for drastic spending cuts and military is not is beyond a rational explanation. We now spend more than $700 billion a year on our military, or about 4.8% of our GDP. To put that in perspective, China, the world’s next biggest spender on defense, spends a little over $100 billion per year, representing 2.1% of its GDP. If you don’t believe me, do some research, but the point is, U.S. military spending is massively out of control, and whereas the money spent on Social Security and health care programs circulates throughout the domestic economy, military spending largely doesn’t. After all, beyond paying the manufacturers of our weapons for producing them (which does create jobs), the bombs, planes, ships, and tanks do not then convert themselves into money and disperse into the economy. Instead they sit—useless, until they are used up.
The simple reason we won’t address our bloated military budget is that our government is corrupted by lobbyists and special interest money. Politicians know that if they go after military spending, they’re as good as done politically for the rest of their lives, because the corporations that get military contracts will spend millions to unseat them. “Even Democrats?” you ask. Especially Democrats… but especially Republicans. Both parties are beholden to the special interests of military contractors, and until voters of both parties demand fair elections and the end of bribery in our nation’s capital, the military budget is sacrosanct. Go to movetoamend.org if you want to make a difference.
Spending vs. Job Creation
This is of course, assuming that we have to cut the size of government—as I mentioned earlier, Republicans insist that we don’t have a revenue problem, we have a spending problem. Above, I’ve mentioned things we could do either to raise revenue to support programs like Social Security (or cut benefits slightly), or places where we could reduce the cost of Medicare or the military—cutting the military would be best, given that it has the least impact on our economy, and wouldn’t realistically reduce our safety or military readiness if done prudently.
However, there is one reality we have to face as a nation: if we cut the size of government, it will hurt our economy. This is, after all, why the fiscal cliff is so scary; going off of it means we cut military and Medicare spending, and at the same time, reduce the amount consumers can spend because tax rates will go up.
Thus, to focus on cutting spending at a time when our economy is just kind of sputtering along is silly, if not entirely self defeating. So, to directly answer a reader’s question: no, we don’t have to cut the size of government. At least not now.
For one, lenders aren’t concerned about our debt: interest rates are near zero percent on U.S. bonds, meaning people still think our country’s financial house is doing just fine. Perhaps more important to understand is that our deficit IS NOT the reason we have a crappy economy. We have a crappy economy for three reasons: 1) we don’t have enough jobs for everyone who wants to work, 2) many of the jobs we have don’t pay very well, and 3) most of our wealth is controlled by very few people, who are hoarding it rather than spending it. The first two points should be fairly obvious, and I’ll address them in a future blog on why it was horribly stupid to pass the “Right to Work” (for less) law in Michigan—or anywhere for that matter.
Enough cannot be said about the third point. The richest one percent of U.S. citizens currently own 34.5% of the nation’s total net worth. The richest ten percent own 74.5% of the nation’s total net worth. The IMF recently published a study showing that income inequality and the wealth divide between rich and poor are huge problems for any economy. The reason is somewhat simpler than might be expected: one person can’t spend money as fast as ten. The problem with our economy is that that one person owns 74.5% of all the wealth, whereas the other nine are sharing the rest. This greatly limits their ability to spend, and that’s bad since around 70% of our economy is driven by consumer spending. (Great article on wealth inequality by Kristof—really drives home the point)
Indeed, the current obsession with the debt crisis shows the extent to which the interests of the wealthy are driving government policy and our national conversation. Instead of talking about how we can create more good paying jobs, we’re talking about how we can reduce the deficit, which has nothing to do with job creation or the economy, and everything to do with reducing the tax burden for the rich (for, if the rich own 75% of the wealth, it stands to reason they’ll be paying most of the taxes—this is, in fact, true now).
So again, the answer is that we don’t need to cut spending—in fact, we should probably spend a lot more in the form of a stimulus designated to fund infrastructure projects and investments in education. Then, once the economy is back on track—when unemployment is at 5% as opposed to 7.5%—we can talk about how to reduce the deficit. Until that time, the focus should be on jobs—NOT government spending.
Thus, in my personal opinion, Obama shouldn’t worry about the Bush tax cuts right now. It’s much more important to pass a large stimulus package to jumpstart the economy, as well as to start reforming government policies to encourage business investments HERE and increase middle and lower class wages (a great start would be to increase the minimum wage). However, Republicans, the media, and the Washington beltway are SO OBSESSED with cutting the size of government, it’s politically impossible to do this until our long term fiscal house is at least somewhat addressed. And this is why, in my estimation, Obama is insisting that the rich pay more taxes. Simply put, they’re the only ones who can.