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Archive for the ‘Income Tax Rates’ Category

The 1950s 91% Income Tax Rate Virtually No One Paid

In Income Tax Rates, Obama Administration on March 12, 2013 at 12:46 am

Economic commentator Peter Schiff, nicknamed Dr. Doom for his prediction of the 2008 economic crisis [1], wrote in the Wall Street Journal about the so-called 91% tax rate of the 1950’s. The rate applied to very, very few and due to deductions, was paid by nearly no one. [2] The article is linked below and is free, no paywall.

I quote excerpts below:

Liberal pundits point out that in the 1950s, when America’s economic might was at its zenith, the rich faced tax rates as high as 91%. True enough, the top marginal income-tax rate in the 1950s was much higher than today’s top rate of 35%—but the share of income paid by the wealthiest Americans has essentially remained flat since then.

In 1958, the top 3% of taxpayers earned 14.7% of all adjusted gross income and paid 29.2% of all federal income taxes. In 2010, the top 3% earned 27.2% of adjusted gross income and their share of all federal taxes rose proportionally, to 51%.

So if the top marginal tax rate has fallen to 35% from 91%, how in the world has the tax burden on the wealthy remained roughly the same? … Lower- and middle-income workers now bear a significantly lighter burden than in the past. And the confiscatory top marginal rates of the 1950s were essentially symbolic—very few actually paid them.

In 1958, an 81% marginal tax rate applied to incomes above $140,000, and the 91% rate kicked in at $400,000 for couples. These figures are in unadjusted 1958 dollars and correspond today to nominal income levels that are about eight times higher. That year, according to Internal Revenue Service records, about 10,000 of the nation’s 45.6 million tax filers had income that was taxed at 81% or higher.

In 1958, approximately two million filers (4.4% of all taxpayers) earned the $12,000 or more for married couples needed to face marginal rates as high as 30%. These Americans paid about 35% of all income taxes. And now? In 2010, 3.9 million taxpayers (2.75% of all taxpayers) were subjected to rates that were 33% or higher. These Americans—many of whom would hardly call themselves wealthy—reported an adjusted gross income of $209,000 or higher, and they paid 49.7% of all income taxes.

In contrast, the share of taxes paid by the bottom two-thirds of taxpayers has fallen dramatically over the same period. In 1958, these Americans accounted for 41.3% of adjusted gross income and paid 29% of all federal taxes. By 2010, their share of adjusted gross income had fallen to 22.5%. But their share of taxes paid fell far more dramatically—to 6.7%…

In 1958, even the lowest-tier filers, which included everyone making up to $5,000 annually, were subjected to an effective 20% rate. Today, almost half of all tax filers have no income-tax liability whatsoever, and many “taxpayers” actually get a net refund from the government. Those nostalgic for 1950s-era “tax fairness” should bear this in mind.

The tax code of the 1950s allowed upper-income Americans to take exemptions and deductions that are unheard of today. Tax shelters were widespread, and not just for the superrich. The working wealthy—including doctors, lawyers, business owners and executives—were versed in the art of creating losses to lower their tax exposure.

For instance, a doctor who earned $50,000 through his medical practice could reduce his taxable income to zero with $50,000 in paper losses or depreciation from property he owned through a real-estate investment partnership. Huge numbers of professionals signed up for all kinds of money-losing schemes. Today, a corresponding doctor earning $500,000 can deduct a maximum of $3,000 from his taxable income, no matter how large the loss.

When Ronald Reagan finally lowered rates in the 1980s, he did so in exchange for scrapping uneconomical deductions.

It’s hard to determine how much otherwise taxable income disappeared through tax shelters in the 1950s. As a result, direct comparisons between the 1950s and now are difficult. However, it is worth noting that from 1958 to 2010, the taxes paid by the top 3% of earners, as a percentage of total personal income (which can’t be reduced by shelters), increased to 3.96% from 2.72%, while the percentage paid by the bottom two-thirds of filers fell to 0.51% in 2010 from 2.7%. This starker division of relative tax burdens can be explained by the inability of upper-income groups to shelter income.

1950s pictures from Wikipedia Commons.

[1] http://www.webcitation.org/5oz96pIPX (Fortune: “Peter Schiff: Oh, he saw it coming.” Brian O’Keefe, January 23, 2009.

[2] http://online.wsj.com/article/SB10001424127887324705104578151601554982808.html

Taxes Matter

In Corporate Taxes, Income Tax Rates on December 18, 2012 at 1:17 am

Taxes matter. When Warren Buffett says otherwise, we have to assume he’s lying to advance his partisan agenda. Famous investor Clifford Asness of AQR says of Buffett’s bizarre claim taxes are irrelevant, “In the field of economics and finance you’d be hard pressed to find something more patently wrong.” [1]

Municipal bonds are tax-free .  They’re at a lower yield than taxable bonds.  This is Finance 101.  The very reason they’re tax-free is to give municipalities a break when they borrow. Investors accept a lower rate on an AA-rated municipality’s bond than from an AA-rated corporation’s bond purely based on the tax benefit. If taxes didn’t matter, they’d be priced the same.

You can find the mathematical equation how tax benefits cause the municipal bond to be lower at Wikipedia. [3]

Asness mentions the fact companies are speeding up sales, share repurchases, regular and special dividend payments
(e.g. see Costco). Buffett helped someone with an unusual Berkshire Hathaway $1.2 billion share buyback in December 2012. [5]. If taxes didn’t matter, why would hundreds of companies bother to speed up January 2013 payments into December 2012? Marketwatch reports, “Companies are largely motivated by a likely upcoming change in the tax rates on dividends.” [2]

Warren Buffett’s claim, “Never did anyone mention taxes as a reason to forgo an investment opportunity that I offered,” may or may not be true to his personal experience but it is dead wrong for the economy in general. Asness points out, too, that Buffett himself has carefully orchestrated his own income and estate to minimize taxes. It is very much Buffett’s freedom to pay as little tax as he legally can yet the fact he bothers shows taxes do matter. Smart, rich people do structure their economic lives to minimize tax. The higher the tax on investments, the lower the net return. As tax rates go up, some investments become unfeasible. Asness says:

Consider how every business-school student, investment banker and investment analyst on Earth has been taught to choose whether to invest in a specific project or company. You make a spreadsheet (a napkin will do sometimes). You put in your best guess of the future cash flows, and you discount those cash flows back to the present at some required rate of return you believe reflects the risk entailed. Of course, opinions about the future cash flows and the proper discount rate can vary widely, but the essential methodology is ubiquitous.

Now here’s the kicker: Nobody who pays taxes and has ever done this exercise has failed (while sober) to use after-tax cash flows in this calculation. Somewhere in the spreadsheet there is a number, say 20%, or 28%, or a Gallic 75%, representing the taxes you’ll pay on the assumed cash flow—and you only count the amount you’ll get after paying this tax. If you turn the tax rate up high enough, projects or companies that looked like good investments become much less attractive and vice versa. Mr. Buffett is undoubtedly right that rich people will continue to invest some amount in something regardless of the tax rate (except for a 100% rate!). He’s also undoubtedly right that an investment that easily clears all hurdles will likely still be attractive after a small tax increase. But life, and the investment decision, occurs at the margin. Fewer and smaller investments will be made if the after-tax prospects are worse. It’s just math and logic, unassailable and commonly accepted regardless of one’s political persuasion.

I’m a Manager of Financial Planing & Analysis.  Taxes absolutely are part of the investment equation. If taxes are higher, the marginal projects – the ones where you’re on the fence about whether or not to invest – become less attractive and eventually, don’t make sense. Perhaps you invest in Brazil or Turkey, instead.

My insight is rich people have a choice what to do with their money.  If you earned a half million and received a special $50,000 year-end bonus, what do you do?  Do you spend it on a luxury imported car?  Do you take a long, expensive trip to Asia?  Or do you invest in new but somewhat risky business venture of an acquaintance?

Savings means forgoing current enjoyment. People, naturally, like to spend money on themselves and their loved ones right now. In order to ask them to defer that spending pleasure, they want an economic return, especially if their investment is a risky one where they might end up with a total loss. Every percent increase in taxes on investments tunrs that save versus spend decision a little more heavily toward spend now. This is especially true of those who are well-to-do, earning several hundred thousand dollars but not Buffett rich (Warren being one of the world’s richest men).

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[1] http://online.wsj.com/article/SB10001424127887324640104578161791213136954.html
[2] http://www.marketwatch.com/story/fiscal-cliff-accelerating-dividend-payments-2012-12-04
[3] http:en.wikipedia.org/wiki/Municipal_bonds, retrieved 12/17/2012.
[4] http://www.nytimes.com/2012/11/26/opinion/buffett-a-minimum-tax-for-the-wealthy.html?_r=0/
[5] http://www.huffingtonpost.com/2012/12/13/warren-buffett-buyback_n_2293794.html

Picture from Wikipedia Commons.

If Bush Tax Cuts Failed, Why Not Enjoy Riding Over the Fiscal Cliff?

In Income Tax Rates, Obama Administration on December 14, 2012 at 1:25 am

An open question to my liberal friends:

Why do most of the “Bush Tax Cuts” need to be extended?

Almost as perplexing as the hubbub about the 2012 end of the Mayan calendar is the sudden concern of left-leaning folks about the “fiscal cliff”.

For a decade, we’ve been told the broad-based tax cuts enacted in the Bush Presidency “didn’t work”. That economic sage Nancy Pelosi even said the 2008 financial crisis was caused by the full package of Bush-era tax cuts, leading to a “near depression” [1] To think some thought too many subprime mortgages and ultra-low interest rates led to the financial meltdown.

Treasury Secretary Geithner said Bush tax cuts didn’t work. [4] Loony writers like Annie Lowrey of Salon, wrote, “The cuts were a colossal failure.” [5] Some actually argue raising taxes, at least on wealthy, is somehow good for the economy. Call it anti-Keynesianism. If they believe that, they should applaud the fiscal cliff: end those pesky tax cuts once and for all!

But wait, the nonpartisan Congressional Budget Office predicts a return to a recession. [3] Everyone from Obama down to the lowliest Lefty blogger says the Bush tax cuts, at least most of them, better get extended or the world will end. Which is odd, if those same tax cuts were a “colossal failure.”

The Lefties try to parse the cuts, they were great, it turns out, no colossal failure at all, for the bulk of the people earning less than $200,000.

That’s right! The corporate manager who earns $199,000 needs a tax cut, she’s a good human being. A tax cut for her is a positive to the economy. Just don’t give her a pay raise to $201,000; then, she shouldn’t get a tax cut. Crossing the magic $200,000 threshold, she’s become a freeloader now, a bad person not paying her fair share. Increase her taxes and it won’t hurt the economy at all. Understand?

Perhaps the liberals and Obama have, belatedly, figured something out: Eighty-five percent of the cost of extending the Bush tax cut costs in 2010 were for people earning less than $250,000 per year.[2] Meaning many of them have been lying the past decade when they said the Bush tax cuts were “for the rich.”

[1] http://www.cbsnews.com/8301-503544_162-57485549-503544/pelosi-immorality-in-gop-tax-plan/
[2] http://money.cnn.com/2010/12/07/news/economy/tax_cut_deal_obama/index.htm

[3] http://www.stltoday.com/news/opinion/columns/fiscal-cliff-could-erase-the-middle-class/article_b54f2b88-79e4-54d2-9a33-3ffd6a4ff99f.html
[4] http://abcnews.go.com/blogs/headlines/2009/03/geithner-bushs/
[5] http://www.slate.com/articles/business/moneybox/2011/06/happy_10th_birthday_bush_tax_cuts.html

Obama’s Buffett Rule AMT Math Off by Factor of 289, or $1.4 Trillion/Year

In Federal Deficit, Income Tax Rates, Warren Buffett on April 11, 2012 at 5:50 pm

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President Obama claimed the new Alternative Minimum Tax he calls the “Buffett Rule” would eliminate the deficit. [1]  He is off by a factor of 289, or $1.4 Trillion per year.

The Obama AMT (“Buffett Rule”) would raise about $4.7 billion per year [1].

The Obama deficit in the past 365 days was $1,359.1 billion [2].

Just yesterday, White House officials conceded the Buffett Rule would only produce $47 billion over ten years in additional tax revenue for the government. That amounts to just 0.6 percent of the $7 trillion in spending projected for that period. [1]

Whatever the merits of demerits of the proposal, the claim was wildly false.  Personally, I’d recommend cutting spending.  Eliminating Obama Administration give-aways to for-profit businesses under the guise of ‘green’ initiatives would reduce more than the Obama AMT would.

[1] http://www.cbsnews.com/8301-503544_162-57411687-503544/white-house-pushes-buffett-rule-on-taxes/

[2] Using search range of April 11, 2011 ($14,267,760,539,191.80) to April 10, 2012 ($15,626,832,596,694.90) at http://www.treasurydirect.gov/NP/NPGateway

Pictures from Wikipedia Commons.

Warren Buffett’s Secretary Earns Hundreds of Thousands of Dollars

In Buffett Rule, Income Tax Rates, Obama Administration, Warren Buffett on January 25, 2012 at 11:42 pm

As I said last August, it is literally impossible for Warren Buffett’s secretary to be “middle class” and pay a higher income tax rate than Buffett.  She is either married and filing jointly with someone who earns hundreds of thousands of dollars or is earning over $200,000 a year herself.

Forbes picked up on this in a post today: 

“I have nothing against Debbie Bosanke earning a half million or even more. Buffet is a major player in the world economy. His secretary deserves good compensation. At her income, however, she is scarcely the symbol of injustice that Obama wishes her to project.” See http://www.forbes.com/sites/paulroderickgregory/2012/01/25/warren-buffetts-secretary-likely-makes-between-200000-and-500000year/

My original posts on this topic are here:  

https://econscius.wordpress.com/2011/08/29/is-warren-buffetts-924725-employee-super-rich/ 

and see what people actually pay, according to the IRS:  

https://econscius.wordpress.com/2011/10/09/who-pays-what-average-income-tax-rates/

There is No Santa Claus for Illinois Unemployed after 2011 Income Tax Hike

In Illinois, Income Tax Rates, Job Creation, Unemployment on December 2, 2011 at 12:17 am

People told me a Christmas tree dealer’s showroom in nearby North Barrington, Illinois is great for kids because it displays some 200 decorated Christmas trees.  My young sons happen to be connoisseurs of garish Christmas lights.  Thinking that walking the boys through an indoor forest of lit Christmas trees would occupy some free time on a gray, rainy Saturday, I looked up Tree Classics to check hours and address.

I was surprised when the Tree Classics website only showed an address in Wisconsin. [1]  Could I have the wrong name?  I tried an internet search and sure enough, Tree Classics was listed in yelp.com reviews and in business directory Manta.com as located on North Pepper Road in North Barrington, Illinois.  Except that in 2011 Tree Classics moved a bit closer to the North Pole. 

These days, it seems most anything not bolted down is leaving Illinois for Wisconsin, Indiana, or some other state.  Motorola, Caterpillar, Sears, Navistar, Chicago Board Options Exchange and the Chicago Mercantile Exchange are some of the big Illinois employers demanding tax concessions to keep them in the state. [2] [3]  “We’re not real happy with the tax rates and we’ve made our feelings known on the subject,” said Irene Rosenfeld, CEO of Illinois-based Kraft Foods. [4]

I could not find any articles about why Tree Classics left Illinois.  It might be about taxes.  Chicago is a much larger market than Milwaukee which makes the move questionable, but perhaps they have their reasons.  Maybe something else dragged Tree Classics out of Illinois.

As we saw in my post https://econscius.wordpress.com/2011/08/03/stimulus-recipient-among-illinois-mass-layoff-notices-indiana-welcomes-another-illinois-company/, smaller companies are leaving Illinois.  Smaller companies do not have the pull to extract tax breaks from the state legislature.  The departure of a company with 50 or 75 employees may not even get a notice in the newspaper, but the state’s job market shows the toll. 

The Department of Labor graph below clearly demonstrates how the Illinois income tax grinched the Illinois job market:

Pertinent facts: 

1. From January 2010 to December 2010, Illinois employment grew by 173,795 jobs.  The Illinois unemployment rate declined from 11.2% to 9.2%, converging with the national average.

2. In January 2011, Illinois passed a 66% increase to the personal and corporate income tax rate, made retroactive to January 1, 2011. [4]

3. After Illinois companies had a few months to react to the tax increase and explore their options, the state unemployment rate surged from 8.8% in March to 10.1% by October.

4. After the December 2010 peak of 6,052,731 jobs, Illinois lost 93,787 jobs through October.

5. The US unemployment rate has been steady in 2011, being at 9.0% in both January and October. [5]

Why did 2010’s job growth in Illinois abruptly end in 2011, then reverse into job losses and a 10.1% unemployment rate even as the US national unemployment rate held flat at 9.0% in 2011?  Might income tax rates have something to do with it?  Job losses continue:  we have breaking news literally today that Unilever is eliminating all 800 office and manufacturing jobs at the Melrose Park, Illinois headquarters of its Alberto-Culver unit. [6] 

There is no Santa Claus for Illinois workers in 2011 and my sons need another interest to replace seeing groves of articifical Christmas trees.  Perhaps they could count moving vans on the interstates leading out of Illinois?

  How the Grinch Stole Christmas cover.png

[1] http://www.treeclassics.com/Contact-Us-Information-s/63.htm

[2] http://www.chicagotribune.com/business/breaking/chi-caterpillar-tax-vote-sign-of-illinois-dysfunction-20111201,0,3403745.story

[3] http://www.chicagotribune.com/business/breaking/chi-motorola-mobility-could-lay-off-790-and-keep-state-tax-break-20110619,0,2021941.story

[4] http://www.chicagotribune.com/business/columnists/ct-biz-1106-phil–20111106,0,2792639.column

[5] http://money.cnn.com/2011/01/13/news/economy/illinois_corporate_tax_hike/index.htm

[6] 2010 and 2011 employment and unemployment data and graph retrieved 12/1/11 from http://data.bls.gov/timeseries/LASST17000003 (US) and http://data.bls.gov/timeseries/LNS14000000 (Illinois).

[7] http://www.suntimes.com/9185920-417/unilever-closing-alberto-culvers-melrose-park-plant-offices.html

Grinch pictures from Wikipedia Commons; Christmas tree picture from www.treeclassics.com.

Prisoners’ Dilemma: CFOs Want Simple Tax Code But Get Complicated Mess

In Corporate Taxes, Flat Tax, Income Tax Rates, Lobbying, Prisoner's Dilemma, Tax Breaks on November 6, 2011 at 1:01 am

A new Duke University/CFO Magazine survey found the vast majority of CFOs would be willing to give up all tax breaks in exchange for a flatter, simpler tax code at a lower rate.  

“Showing their frustration with the complexity of the tax code and the time and money they spend to comply, 71% of CFOs say they’d be willing to give up all existing exemptions and credits in return for a reduction in the overall corporate rate — even though they might not come out ahead on their tax bill. Another 17% say they’d forgo exemptions for a lower rate because they believe their companies would end up paying less in taxes than they do today.”  Forty-eight percent agreed the corporate tax system in the U.S. is “seriously flawed and needs a complete overhaul.” [1]

If the majority of CFOs want a flat tax, why do we have the world’s most convoluted tax code?  Why does the tax code increase in complexity each year? 

(1) One reason is politicians offering up new tax breaks for every conceivable problem.  Many of today’s tax breaks reflect societal goals such as increasing energy efficiency, encouraging R&D spending, helping American farmers, assisting exporters, operating businesses in economically depressed areas and employing more Americans.  Some of the goals are noble, but each attempt at changing corporate behavior through the tax code adds to the complexity and means some clever companies (e.g. GE) will use so many of these tax loopholes they pay little, if any, tax.

(2) The Prisoners’ Dilemma (“PD”) may help us understand why companies lobby for tax code loopholes even when they know a flat system would be better. 

In the classic PD game [2], two accomplices are arrested, but the police do not possess enough information for a conviction. The police separate the two men and the police offer each prisoner a similar deal:  if one testifies against his partner while his partner remains silent, the betrayer goes free.  The betrayed prisoner then serves a one-year sentence.

If both prisoners remain silent, the police simply have insufficient evidence and each prisoner will only serve one month in jail on a minor charge.   But, if both prisoners independently betray the other, the police then have evidence to convict both, earning each a three-month term. 

  Prisoner B Stays Silent Prisoner B Confesses
Prisoner A Stays Silent Each serves 1 month A goes free, B serves 1 year
Prisoner A Confesses B goes free, A serves 1 year Each serves 3 months

Obviously, the prisoners should each remain silent and receive a one month sentence.  But they end up each serving three months instead.  The reason is the essence of the PD: because the two prisoners cannot communicate, they have to rely on trust.  Confessing is the superior strategy as it leads to either going free (if the other prisoner is quiet) or serving a three-month term.  A prisoner would like to remain silent but that exposes him to the maximum prison sentence.  Remaining silent is the riskiest strategy as it means either going free (if the other prisoner is also quiet) or serving one year.  Unless the prisoners have a high degree of trust in each other, they will both confess. [3]

There is a very similar dynamic in play in corporate taxation.  Let us look at corporate tax breaks in terms of a simple prisoner’s dilemma model.

For simplicity, assume there are just two corporations, Amalgamated & Big Corp.  Each may pursue their own tax break, if they like, which would reduce their tax by $1, with that $1 paid through higher taxes on the other company

But it is not all tax break gravy, there is a cost for tax breaks.  Either company has to pay 25 cents for lobbying if they choose to influence tax policy; I assume lobbying is always successful.  Both companies pay 25 cents each for tax compliance costs (to accountants and tax lawyers) if there are any tax breaks.

What are the possible outcomes?

  Big Corp. Forgoes Tax Break Big Corp. Lobbies For Tax Break
Amalgamated Corp. Forgoes Tax Break Both Win (A $0, B $0) B Wins Tax Break (A -$1.25, B +$0.50)
Amalgamated Corp. Lobbies For Tax Break A Wins Tax Break (A +$0.50, B -$1.25) Both Lose       (A -$0.50,         B -$0.50)

Clearly, the optimal solution for the economy is no tax breaks because it means neither company has to pay lobbyists or tax accountants.  Yet, the equilibrium is always that both companies lose: they will each lobby for their own tax break and end up being out the $0.50 cost of lobbying and tax compliance.  Why?

For each corporation, the optimal strategy is to always lobby.  Amalgamated has no reason to trust Big Corporation will not lobby for Big’s own tax break.  The payoffs are such that lobbying is always successful and the cost of the tax break you win is borne by the other side.  The rational decision in this framework is always to lobby for the tax break, even if you know you will end up with a zero sum game where you are down $0.50 (for lobbying and tax compliance). 

The driver is you will always bear the cost of the other company’s $1 tax break if the other corporation chooses to lobby for its tax break.  The only way to protect Amalgamated from being stuck with Big Corporation’s $1 tax break cost is to exactly offset it with Amalgamated’s own $1 tax break.   The two breaks net to zero (because -$1 +$1 = 0), but unfortunately, each corporation is out the lobbying/tax compliance costs.

This takes us back to the CFO survey at the start of this post: most CFOs would be happy to give up their tax breaks (the “both lose” corner of my PD diagram) in exchange for no tax breaks at all (the “both win” corner of my PD diagram).  As long as we have a complex tax code filled with loopholes (see https://econscius.wordpress.com/2011/10/18/yes-there-are-lots-of-tax-loopholes/), corporate and individual taxpayers keep ending up in the “both lose” corner.

How do we break the mechanics of the Prisoners’ Dilemma where we always end up in the “both lose” corner of high costs of lobbying and tax compliance? 

I think the only plausible answer is to break the game by disallowing tax breaks in the first place.  That replaces the need for “trust” between the players of the tax game.  The way to disallow tax breaks is to have a simple, flat tax at a slightly lower rate.  Ask everyone to give up their favorite tax break in exchange for everyone else giving up their favorite tax break.   The total tax collected in the economy could be kept exactly the same through a lower rate, but we would remove the inefficiencies and noise that go with lobbying and complying with our labyrinth tax code.  Surely, that is better than the current dilemma of myriad tax breaks that cost a lot in lobbying and tax compliance.

[1] http://www.cfo.com/article.cfm/14599917?f=search.

[2] Discussion of Prisoner’s Dilemma can be found at: http://plato.stanford.edu/entries/prisoner-dilemma/.

[3] The PD helps demonstrate a facet of organized crime groups, which enforce “trust” through lethal force.  If the prisoners are members of the mob, the mob may threaten their lives if they confess.  That changes the outcomes (confess means go free or 1 month, now followed by probable death) and helps explain why mobsters almost always remain silent unless they can be completely shielded from harm from their fellow mobsters by participating in a witness protection program.

Dragnet & Basic Instinct pictures from Wikipedia Commons.  Comments are welcome below:

Which State Has The Most Inequality? Texas or New York? Why?

In Gini Ratio, Income Tax Rates, Inequality, Texas on October 21, 2011 at 12:25 am

Econscius looked into economic inequality by state and found some surprising facts.  Which state did you think has the most economic inequality, defined by the government’s Gini ratio?  Did you guess Texas or Alabama?  The Gini ratio measures unequal outcomes in wealth; a ratio of 0.0 would mean everyone had exactly the same and a ratio of 1.0 would mean one person held all the wealth.

The District of Columbia has the highest level of inequality (Gini ratio of 0.532).  New York has the highest state ratio at 0.502, followed by Connecticut, Texas, Louisiana, Alabama, Mississippi, Illinois, Georgia and Massachusetts which rounds up the Top 10 with a score of 0.468.

The state with the lowest Gini ratio is Alaska at 0.402.  Utah is second most equal at 0.414, followed by Wyoming at 0.415.

Econscius ran several regression analyses of the most recent state Gini ratios, looking for correlations that would help identify the cause(s).  First, I compared “Right to Work” states against the tally of state Gini ratios, expecting the comparative absence of unions might be a factor.  “Right To Work” states prohibit closed shops (mandatory unions).  But there is no statistical correlation (RSquared = 0.01), which can be easily seen by the high rate of dispersion in the graph below.  An interesting follow-up may be to see if there is any difference using the unionized proportion of the workforce in place of Right To Work state.

State Gini Ratio vs Right to Work (1 = yes, 0 = no)

The scatterplot below shows a rather loose relationship between average income and Gini ratio.  The trend line shows high income states tend to be slightly more equal than lower-income states.  (R-squared is 0.08).  In statistical terms, income and Gini ratio should be impacted by co-variance (the two variables are not independent of each other), making it a less than ideal measure.

State Gini Ratio Vs. Median State Income

Next, I ran a regression of Gini ratio against Net State Income Tax Rate, as calculated by the National Bureau of Economic Research.  The NBER is best known as the group that officially dates recessions.  As seen in the graph below, the trend line is the opposite of what one might expect.  Higher state income tax rates actually imply slightly higher inequality (R-squared 0.08). 

The scatterplot graph below clearly shows how the highest inequality states of New York and Connecticut have high taxes and several of the states with no income tax have the lowest Gini ratios, e.g. Wyoming and Alaska.  While higher income taxes are not well correlated with equality, an observation is states known for high property taxes (which are regressive) are bundled amongst the most unequal, including New York, Connecticut, New Jersey, Florida and Illinois.

State Gini Ratio vs. Net State Income Tax Rate (NBER 2009 Tax Data)

Lastly, let’s look at state Gini ratio vs. population density (people per square mile) .  This regressed variable has the strongest correlation with Gini ratio (R-squared 0.14). 

Why would sparsely populated states be more equal and densely populated states have a greater gap between the rich and poor.  I hypothesize higher density means more urbanized areas, which means more specialization of skills.  The economic concept of division of labor shows how the greatest economic benefits come from having each person focus on what they are most economically productive at and then trading their output with the output of someone else for all other items.  One way to think of it is to imagine Steve Jobs working in isolation in a rural area.  He would have less time to spend inventing computers and whatnot if he was unable to employ other people to mow his lawn, clean his car and other household chores.  Imagine if he had to do his own legal work, build his own house, cook his own food because there were no restaurants, etc. 

Large cities allow a high degree of division of labor.   Urban areas tend to be centers of economic specialization.  There are centers of specific industry specialization such as entertainment in Los Angeles, energy in Houston, finance and media in New York, insurance in Hartford, government in Washington DC, pharmaceuticals in New Jersey, autos in Detroit and technology in San Jose.  Most cities provide network benefits for commerce.  Corporate headquarters are mostly found in large metropolitan areas as employers can easily find necessary skilled workers in management, marketing, human resources, accounting, law, consulting and finance. 

The concentration of highly paid professionals in these large cities also leads to a concentration of poorly paid service workers because of the high degree of division of labor.  Whereas a small town worker may handle many household chores on their own, the highly compensated professionals around big cities like Los Angeles and New York hire maids, nannies, gardeners and even dog walkers.  They outsource some of their work to dry cleaners and restaurant employees.  They also may do more retail shopping, which means more need for low skill, low wage workers at retailers plus truck drivers and distribution center workers to deliver the goods.  It is no surprise, then, that large cities like Chicago, New York, Detroit and Los Angeles are both very rich and very poor at the same time. 

The wealthy professionals living in Atherton, CA, Huntington Beach, CA, Wilmette, IL, Grosse Point, MI and Irvington, NY trade some of their copious amounts of money for leisure time by sub-contracting low skill work like house painting and pizza delivery to low skill workers.  These low skilled workers are generally paid below average wages, which helps explain why the large cities, and the states they reside in, are both rich and poor.  This helps explain the high Gini ratios in the more densely populated states.

These four regression analyses do not explain all of the differences in Gini ratios.  While income tax rates have no relationship, it is possible a measure of to marginal tax rates on the rich may be a factor.  We did not look at state and local sales and property taxes.  Other possible explanations may include educational attainment dispersion within each state, the types of industries prevalent in a state, immigration levels, and even cultural differences between states. 

We found New York is actually less equal than Texas, which probably surprises most people but likely reflects the high density of population in metro New York City where many highly compensated, high skilled workers reside as well as many low pay, low skill workers who serve their day-to-day needs.  As we have seen in my posts on Texas, (https://econscius.wordpress.com/2011/09/03/stellar-texas-job-growth-in-above-average-wage-cities/) it is increasingly densely populated and affluent in its large metro areas of Dallas, Austin, San Antonio and especially, Houston.   Metro Houston is the 3rd largest home of Fortune 500 HQs and is now the major home of the energy industry’s professional staffs (senior management finance, legal, accounting, engineering).  Progressive, union-friendly states like Connecticut and Massachusetts are less equal than Right To Work states like Nebraska and Kansas.  It appears one factor is the densely populated concentrations of skilled workers such as hedge fund and insurance workers in Connecticut and biotech and technology in suburban Boston. 

I believe Gini ratio and measures of inequality are overhyped.  If a richer neighbor of mine accidentally drops some of his property, say his iPod, in a river, inequality has been slightly reduced but am I better off?  Nevertheless, the evidence on state Gini coefficients suggests there is no diabolical plot causing high inequality.  Several of the least equal states like New York, Massachusetts and Connecticut are reliably Democratic, high tax and union friendly.  The District of Columbia is the most unequal of all.  The inequality must come from other sources, certainly including the concentration of highly paid, skilled workers in those states. 

 

Notes:

Chart 1: 2009 Gini coefficient data (latest available) from http://en.wikipedia.org/wiki/List_of_U.S._states_by_Gini_coefficient retrieved 10/18/11.   Right-To-Work states from http://en.wikipedia.org/wiki/Right-to-work_law retrieved 10/18/11.

Chart 2: 2006-7 average data (latest available) from http://en.wikipedia.org/wiki/List_of_U.S._states_by_median_income retrieved 10/18/11.

Chart 3: 2009 data (latest available) from http://www.nber.org/~taxsim/state-marginal/avrate.html, retrieved 10/19/11.

Chart 4: Population Density from http://en.wikipedia.org/wiki/List_of_U.S._states_by_population_density retrieved 10/18/11.

Pictures from Wikipedia Commons.

Your comments are welcomed!  What do you think causes inequality?

Yes, There Are Lots of Tax Loopholes!

In Income Tax Rates, Oil, President Obama, Tax Breaks on October 18, 2011 at 1:11 am

Yes, there are lots of tax loopholes!  You can hardly step anywhere in the personal or corporate tax codes without falling into a loophole.  Most every tax break was created in the name of helping a good cause (e.g. electric cars) or encouraging people or corporations to buy of something (e.g. homes or ethanol).  Still, the loopholes reduce tax revenue and add great complexity to the tax code.

 You can see for yourself how ridiculous the tax code is simply by looking at IRS Publication 946 at http://www.irs.gov/pub/irs-pdf/p946.pdf.  Be forewarned: it is large .pdf file.  Do not blame the IRS, they are simply enacting what various Congresses and Presidents have put into law. Econscius thinks these 118 pages, which merely cover tax rules for depreciation, are a microcosm of what is wrong with the tax code.  These 118 pages are a like a few drops of water in the lake of tax complexity, too.  But I assume most readers will be perfectly fine with just one helping of accountant-speak. 

What is Depreciation?  When a company buys an asset like a railroad car, it is not allowed to expense the $100,000 cost right away.  The cost is expensed in little pieces over its theoretical ‘useful life’ of, according to the IRS table, 15 years.  Or seven years if the company is using an accelerated depreciation method. 

What is Accelerated Depreciation?  In order to encourage companies to purchase more assets, e.g. more airplanes, the Tax Code includes the ability to depreciate many assets more quickly than their ‘useful life’.  A 15 year asset may be deducted in seven years.

From a taxpayer’s standpoint, accelerating depreciation is valuable.  Increasing your expenses today means less income and less income means less tax paid.  In theory, the government gets all the tax money in the long run but the fact that the deductions are sped up is valuable because of what we call ‘the time value of money’: because of inflation, a dollar today is worth more than dollar five years from now.

I challenge anyone, Left or Right, to skim through the 118 pages and tell me the tax code is not unnecessarily complex.  There are loopholes aplenty, lying right before your eyes. 

On pages 25-28, we find the Gulf Opportunity Zone break, enacted after Hurricane Katrina.  There’s the Qualified Cellulosic Biofuel PLant Property benefit on page 28.  There are extremely generous accelerated depreciation rules on electric cars on page 66.  There are special depreciation rules for Indian Reservations on pages 38-39.  Fruit and nut trees and vines are covered on page 42.

Table B-1, which runs from page 103 to page 112 is a fine print example of tax loopholes.  You will notice there are different columns as there are different depreciation methods.  We can skip the mind-numbing complexity of GDS (MACRS) vs. ADS depreciation to make a few simple points:

(1.) Whenever the GDS and ADS depreciation recovery periods are different, we are really talking about a tax break.  The different method means a potential tax break because companies can depreciate more quickly than the true ‘useful life’ of the asset.  When you look through the IRS Publication 946, you see how most classes of assets do, in fact, have some sort of accelerated depreciation option.

(2.) Are so many classifications really necessary?  There are special depreciation rules for Cable TV-Microwave Systems, Railroad Track, Railroad Wharves and Docks, Manufacture of Foundry Equipment, manufacture of Leather and Leather Products, Sawing of dimensional Stock from Logs, Manufacture of Textile Yarns, and the ever-important Cotton Ginning Assets.

 

My personal favorite depreciation category is found on page 105: “Any Horse That Is More Than 12 Years Old At The Time It Is Placed In Service And That Is Neither A Race Horse Nor A Horse Described In Class 0.1222.” Got that?

There are special tax breaks for the oil and gas industry.  Surely you have heard of them before.   One of the breaks was enacted in 2004 to encourage companies to manufacture in the U.S.  That break lets most companies deduct 9% of profits from domestic manufacturing.   Oil and gas companies were classified as manufacturers, but their deduction was capped at 6%.  [1]  President Obama’s 2009 Stimulus package included an accelerated depreciation tax break for corporate jets on the theory it would encourage corporations to buy more jets, employing more Americans . [2]  President Obama often talks as if the accelerated depreciation for aviation and oil & gas drilling were the only tax breaks in the tax code. 

The oil and gas industry breaks are surely there, but ethanol, solar and wind actually enjoy far more favorable tax treatment.  Anyone looking at this IRS Publication 946 will see how disingenuous it is for politicians to focus on oil when almost every industry seems to have its hand in the till, even highly profitable areas like computers. 

Without question, an awful lot of time goes into interpreting and complying with the tax code.  Corporations and interest groups lobby for their narrow interests within the tax code. 

How do we fix this?  A flatter, simpler tax code with universal rules and few, if any, special deductions would be a place to start.  Ask everyone to give up their favorite tax breaks and we will all be better off; call it mutual tax break disarmament.  The US corporate tax rate in the highest amongst developed nations; why would we not want to lower the rates, drop the loopholes and end up with the same amount of revenue but with a lot less work? While there are some issues with Herman Cain’s proposed “9-9-9 plan”, it is a bold attempt to throw out the old tax code and start afresh.  Ideas like that would help get rid of monstrosities like IRS Publication 946.

[1] http://www.usatoday.com/money/industries/energy/2011-05-12-oil-industry-tax-breaks_n.htm

[2] http://www.foxnews.com/politics/2009/02/18/stimulus-includes-tax-break-promote-private-jet-sales/

Pictures from Wikipedia Commons.  IRS html from IRS link above.

As always comments are welcome.  Love the Tax Code?  Hate it?  Feel free to share below.

Occupy Chicago Is Completely Wrong on CME Tax & Job Claims

In Illinois, Income Tax Rates, Job Creation, Occupy Wall Street Protests, Political Rhetoric on October 15, 2011 at 12:51 am

Occupy Chicago protesters rally Thursday in the Loop, echoing their Occupy Wall Street counterparts in New York. But how about a march on Main Street by the wealthy? That may be just the catharsis America needs.

I heard a theatre teacher from Occupy Chicago talk on the radio about the movement’s demands.  The various Occupy movements have been criticised in many corners for a lack of specific proposals, but Occupy Chicago has a specific demand.  A quick analysis shows the math does not work behind an Occupy Chicago idea and the concept is completely divorced from reality.

Occupy group Stand Up Chicago is demanding the City of Chicago place a 25 cent per trade tax on all contracts traded at the Chicago exchanges, of which the CME is the largest.   Occupy Chicago says this would earn $1.4 billion of fresh tax revenue, which it claims could be used to create 40,000 new City of Chicago jobs. [1] [2]

One sign of a complete lack of perspective and knowledge is how Stand Up Chicago’s statement demanding the tax calls the Chicago exchanges “giant casinos” it claims brought on the financial crisis.  Considering the financial crisis was caused by subprime mortgages going bad, it is quite curious to blame Chicago’s options and futures markets.  The CME and Chicago Board Options Exchange did not make loans nor did they bundle mortgages for securitization.   CME is the parent of the legendary Chicago Mercantile Exchange and iconic Board of Trade.  Clearly, Stand Up Chicago does not understand.

It just so happens the CME was already negotiating with Florida and Texas about relocating its operations.   Illinois raised its state income tax in January, becoming the 3rd highest in the nation.  [3] The CME then announced its attention to look at alternatives.  Illinois was desperately trying to keep the CME from leaving before Occupy Chicago’s idea of a fresh $1.4 billion tax came along.  Such a tax certainly is not going to stop the CME from leaving.

The idea of taxing the Chicago exchanges will not work.  Surely, the CME will leave and Chicago will end up with fewer taxpayers and thus fewer taxpayers as a result.  CME employs 2,000 in the Chicago area, but it has a large multiplier effect because of the numerous trading firms that reside in Chicago to be near the CME’s trading floors.  Banks and other financial institutions employ many who service the CME and trading firms.  Large private firms maintain traders and support staff, for example, meteorologists who predict weather patterns on behalf of agricultural companies’ hedging activities.  “Some estimates place the job count from the trading industry here, which includes the Chicago Board Options Exchange, at more than 60,000.” [3]

But Occupy Chicago’s ideas are even more outlandish than they seem at first blush.  Let us look at the math.  First, the CME had 2010 revenue of $3 billion, on which it earned a profit of $951 million. [3]    A $1.4 billion tax on a local industry where the primary firm, the CME, earned less than $1.0 billion is a very significant tax, indeed. 

Even if the CME were to stay in Chicago despite the special tax, there is nothing stopping aspiring exchanges in Singapore, London, Dubai, Mumbai, Hong Kong, Shanghai or Tokyo from working to steal away the CME’s business.  Since they are not in Chicago and thus not subject to a special tax, these international competitors would gain a significant opportunity.

Would $1.4 billion create 40,000 new jobs for the City of Chicago? 

No.

A quick check of the City of Chicago budget shows the City employs 32,922 employees at a cost of $3.3 billion.  [4]The average city worker earns about $75,000. [5]  The average worker costs about $100,000, including benefits.  That means a $1.4 billion tax, even if enacted and collected, would employ one-third of the claimed 40,000 but rather 14,000.  Adding 40,000 employees would more than double the entire City of Chicago workforce. 

Adding the 40,000 workers would require a tax of $4.0 billion, or more than 4X the entire profit of the CME.  As a reference for the relative size of a hypothetical $4.0 billion Occupy Chicago tax, consider that the entire city budget, serving 2.7 million residents and long known as one of the least efficient and most corrupt of municipal governments, is $6.2 billion. [6]

The cost of an employee is more than just payroll and benefits.  The 40,000 hypothetical workers will require new leases of office space, and expenses for business cards, computers, telephone connections, pens, staplers, and many other things, all costing money.  Any tax will hire fewer City workers because of these other overhead costs.

The Occupy Chicago tax idea and related job claims may make for good populist press, but they are so divorced from reality they must be dismissed out of hand.  Chicago’s financial industry is already at serious risk of leaving the city over the tax burden already in effect.  A $1.4 billion tax increase would certainly drive it out altogether, putting as many as 60,000 private sector jobs at risk.  The Occupy Chicago claims of 40,000 new City of Chicago jobs are triple what a $1.4 billion tax could realistically pay for.  [7] The Chicago exchanges are not in the mortgage business and did not cause the financial crisis.   Just as protesting capitalism will not create any jobs, excepting the occasional protester paid by a union to attend, a huge tax on financial transactions will cause Chicago to lose jobs, not gain them.

 

 

[1] http://articles.chicagotribune.com/2011-10-11/news/ct-met-take-back-chicago-20111011_1_protesters-demonstration-cboe-holdings

[2] http://www.chicagonow.com/chicago-muckrakers/2011/10/40000-jobs-for-25-cents-a-new-plan-for-job-growth-in-chicago/

[3] http://www.suntimes.com/business/5854347-417/cme-group-leaders-cite-illinois-taxes-in-threat-to-leave-chicago.html

[4] pg. 5 of http://civicfed.org/sites/default/files/ChicagoFY11BudgetAnalysis.pdf 

[5]  http://anthonytrendl.blogspot.com/2011/06/chicago-city-worker-salaries.html

[6] pg. 3 of http://civicfed.org/sites/default/files/ChicagoFY11BudgetAnalysis.pdf

[7] I take the $1.4 billion tax revenue claim at face value though it seems a bit rich.  The CBOE had 1.124 billion contracts trade in 2010 ( http://ir.cboe.com/releasedetail.cfm?releaseid=549018) and the CME approximately 3.0 billion contracts (based on daily avg. 12.2 million contracts (http://cmegroup.mediaroom.com/index.php?s=43&item=3088) multiplied by 250 trading days a year).  Apply 25 cents to 4.124 billion contracts and we only get $1.0 billion in tax.  There are a few other small, inconsequential exchanges.

Pictures from Wikipdia Commons, except Chicago protest from Chicago Tribune (credits embedded in picture).