Wednesday, February 4, 2015

You can belt-tighten your way out of a 5% fluctuation in tax collections

Thomas Edsall has an opinion piece, The Problem With Middle Class Populism in the NYT. His argument is that Democrats are going to be challenged in their redistributionist goals because most people don't view themselves as affluent and, more importantly for his argument, more people who are traditional Democrat supporters are now affluent than in the past.

The piper has to be paid and it is convenient when the piper belongs to some other group, an out-group. Edsall's argument is that it is very hard to make someone in your in-group pay the piper and that that is the position in which Democrats find themselves. When rich people were out-group Republicans, it was morally easy - you just tax them more, punishing them for being rich or for being Republican, it didn't much matter as they were treated as synonymous. Now that your in-group, Democrats, include a lot of former out-group members, the rich, it is much, much harder to raise taxes.

All true as far as it goes.

But there are three other items I think are relevant to this critique.

First, many people who are nominally affluent are not in fact affluent. You have to take into account both the cost of living in a particular location as well as the after-tax income of the household. $200,000 living in Manhattan is probably the equivalent of $75,000 in Springfield, Illinois. In addition, the nominally affluent Manhattanite also has a significantly greater tax burden than the nominally middle class denizen of Springfield. When you do the math to get to the PPP (purchasing power parity) of their respective after-tax incomes, I believe it will be obvious that the $200,000 affluent Manhattanite has a significantly lower real after-tax income than the middle-class resident of Springfield. So if you are a Democratic operative going after the "affluent" base in New York, Los Angeles, Chicago, and San Francisco, their top line affluence is highly misleading.

There is also a perception issue which is discussed in Who’s Really Middle Class? by David Leonhardt. For any of a variety of reasons, many people who are objectively affluent, still consider themselves as middle class.

The third issue is complex but of significant magnitude. There are four components 1) The affluent in the US are already highly taxed compared to most other OECD countries. That doesn't make it wrong to increase their taxes yet further but it does suggest that if there is a limit to how much you can use the affluent as the golden goose to cover freebies to everyone else, then we in the US are closer to that limit than others. 2) The more you tax the affluent, the more incentive they have to design their financial affairs in such a way as to minimize their tax bill, thus distorting investment and consumption decisions in ways that are almost always sub-optimal for them and for the economy. 3) A too great reliance on the very wealthy is financially risky. While the very wealthy as a group have been doing exceptionally well over recent decades, theirs is also the group whose annual income is also the most volatile, rising and plunging as much as 30% in a given year. The more a government depends on the very wealthiest for the bulk of its taxes, the more volatile will be that tax base consequently making the state tax income stream both uncertain and precarious.

You can belt-tighten your way out of a 5% fluctuation in tax collections. You have to slash your way out of a 30% swing.

4) Finally, the fourth issue is that numerically the middle class is big, 50-75% of all households depending on you define it. You have to take an awful lot from the 10% in order to pay for something that is going to cover the 75%. That is just math and regardless of how hard the math might be, it is still an unavoidable reality.

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