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The federal income tax centennial: No reason to celebrate

April 12, 2013 By Leave a Comment

By D. Eric Schansberg, Ph.D.

Despite establishing a blue ribbon commission, Gov. Beshear’s administration failed to make any progress in reforming Kentucky’s antiquated and burdensome tax code during this year’s General Assembly.

But Kentucky is not the only place where tax reform is needed. It’s badly needed on the federal level, as well.

This year marks the 100th anniversary of the federal income tax, which was implemented as the 16th Amendment to the Constitution in February 1913 during the final days of William Howard Taft’s administration.

It granted Congress “the power to lay and collect taxes on incomes, from whatever sources derived.” It was unprecedented and marked the first change to the U.S. Constitution since 1870.

At its inception, only 15 percent of households paid any income taxes at all, and they were grouped into one of only seven tax brackets; the highest marginal rate was 7 percent for incomes exceeding $500,000 (about $10 million in today’s dollars).

The number of brackets increased dramatically during World War I. Though the threshold to reach the top rates rose to $1 million (about $16 million today), the top marginal tax rate rose dramatically to 77 percent. By the 1920s, marginal tax rates decreased four times – bottoming out at 24 percent – but with a much lower threshold of $100,000.

The Great Depression saw government increase income taxes four times with a rate of 79 percent for the top bracket. [Read more...]

Filed Under: Reduce Government Spending, Smaller Government Tagged With: ,

Fiscal cliff notes compose ominous melodies

November 30, 2012 By Leave a Comment

By Eric Schansberg, Ph.D.

With an ominous “fiscal cliff” looming on the horizon, the stakes in Kentucky and across the country can’t get much higher.

It doesn’t take a Ph.D. in economics to realize that the combination of cuts in the planned growth of federal spending and the large increases in federal taxes scheduled to take place on January 1 is going to cause problems for America’s limping labor markets and stunted macroeconomy.

The underlying issues are our massive federal budget deficits and rapidly growing debt, but the potential solutions are also problematic. Actual reductions in government spending – however unlikely – and big increases in tax rates will make economic growth even more difficult.

What’s worse, all of this contributes to what economists call “regime uncertainty.” Nobody knows what solutions – or temporary Band-Aids – Congress and President Obama will embrace.

Regime uncertainty also exists closer to home as entrepreneurs struggle to decipher just how Kentucky’s elected officials will address our $34 billion pension crisis.

If investors perceive the size and uncertainty of our debt to be unmanageable, they will either refuse to loan money to government or require a higher rate-of-return to offset the higher risks of making their capital available. This means higher debt payments, more trouble for our economy and tighter austerity measures in the future.

Actually, any investment becomes more difficult when risk and uncertainty increase. Consumers are less likely to buy cars and homes. Businesses are less likely to hire workers and expand their scale of operations.

Which one of these reduces economic growth? All of the above.

But there are further cliffs visible on the horizon, especially within healthcare. In 2014, we can look forward to sliding down the cliffs of the economic Matterhorn that is Obamacare.

Government already provides a massive indirect subsidy of more than $100 billion to purchase insurance through your workplace since it’s a non-taxed form of compensation.

Soon, Obamacare will provide direct subsidies to the working poor and middle income class for healthcare – regardless of most lifestyle choices or pre-existing conditions, driving up healthcare costs.

The good news for these employees is that they have access to a larger subsidy; the bad news is that this cliff creates a strong incentive for employers to offload those employees onto Obamacare.

Plus, since Obamacare imposes larger costs on firms with more than 100 employees, smaller businesses will try to avoid growing over that threshold while larger firms will look for opportunities to spin their activity into smaller, less-regulated entities.

Business growth will inevitably slow, especially in Kentucky, which has already accepted $67 million – more than any other state but New York – to establish Obamacare exchanges.

We can also locate looming cliffs for Kentuckians approaching income levels where benefits are dramatically reduced by earning one dollar “too much.”

For instance, at 400 percent of the poverty level – about $90,000 in income – subsidies are suddenly reduced from about $5,000 to zero. At 133 percent of the poverty line, earning an extra dollar results in contributing 3 percent rather than 2 percent of your income to insurance premiums.

Since the general public often doesn’t pay much attention to political economy, politicians have a strong incentive to ignore the subtle, but substantial, costs of expanding our debt and pushing it further into the future.

If politicians continue to push the country and commonwealth ever closer to that impending fiscal cliff by neglecting to make the tough decisions related to our debt, perhaps we should make the decision to send them over an electoral cliff at the next possible opportunity.

Eric Schansberg, Ph.D., has served as professor of economics at Indiana University Southeast in New Albany, Indiana since 1992, and is a member of the Bluegrass Institute Board of Scholars. Reach him at DSchansb@ius.edu.

Filed Under: Media, Reduce Government Spending, Smaller Government Tagged With: , ,

Tax Day and the Titanic

April 16, 2012 By Leave a Comment

By D. Eric Schansberg, Ph.D.

Today, April 15, is the 100th anniversary of the sinking of the Titanic. Of course, April 15 is more famous as the deadline for submitting our income tax forms. But it falls on a weekend this year, so procrastinators get a brief reprieve.

The Titanic was sunk by an iceberg. And every grade school child learns that most of an iceberg (about 90 percent) is hidden below the water’s surface – part of what makes them so dangerous to ships.

Taxes and government spending have the same characteristic. They are often “hidden” to us. Sometimes, it’s because the tax is subtle like, for example, the various taxes on cell phones. (Have you looked at your bill lately?)

Sometimes, it’s because we don’t pay much attention to politics, focusing on a few policies because we’re busy mowing our lawns and raising our kids. Maybe we get upset about a certain tax – federal income taxes or local property taxes, for example – but largely ignore other taxes. Maybe we get irritated with some aspect of government spending – like military or welfare programs – but miss the bigger picture.

What is important but overlooked with the icebergs of government spending and taxation?

First, consider federal income taxes.

With complaints that the wealthy do not pay enough taxes, many people want higher marginal tax rates on the rich. (Interestingly, our federal income tax system – with marginal tax rates ranging from 1 percent to 7 percent – debuted the year after the Titanic sank.)

But the larger issue is tax loopholes – income deductions and tax credits – that lower the amount of taxes paid, independent of tax rates.

Second, consider state and local income taxes.

At the federal level, families with children don’t pay much in income taxes until their earnings are in the upper-middle class. In many cases, their state and even local income taxes are higher. In fact, those with income at or below the poverty line still pay state income taxes in 15 states.

Third, federal “payroll” taxes on income (FICA) are far larger for most taxpayers than federal income taxes of the 1040 / April 15th variety.

More than 80 percent of wage earners pay more in federal payroll taxes on their income than they pay in federal income taxes. We don’t notice it since the money is quietly sucked out of our paychecks and we don’t fill out any forms for it.

How can this happen?

FICA has no deductions and no exemptions. So, unlike income taxes, the 15.3 percent tax is applied to every dollar earned. And most people believe the fiction that the employer pays half of FICA. But the employer shifts most of the burden to employees, as surely as the local gas station shifts the burden of gas taxes to customers.

Fourth, debt amounts to future taxes.

We’ve had a decade of impressive debt at the federal level. With Medicare and Social Security, we have huge entitlement programs and retiring baby boomers. And many states have unsustainable pension programs. Although it’s politically attractive to spend money now and push taxes into the future, there is a limit to what can be done to delay.

What will it take to sink the American economy? How much debt is too much? No one knows.

But the icebergs are getting larger and our ship is getting closer. Who will steer us away from doom?

D. Eric Schansberg is Professor of Economics at Indiana University Southeast in New Albany, IN and an adjunct scholar of the Bluegrass Institute. 

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