Issues from our nation’s taxation and budgeting processes are fundamental challenges we face. Congress will bicker and bloviate about them for weeks and then probably kick the dented can a few feet further down the road.
Meanwhile, pundits may go on vacation.
Better public understanding of these issues could be a small but useful step. So here is a primer on some economic aspects of taxes, the nuances that have changed what they mean and how they are applied. These include a tax’s “base,” “rate, “incidence” and “burden.” All points are involved in measures before Congress.
First, a tax is “compulsory contribution to state revenue, levied by the government.”
A tax’s “base” is whatever thing that is taxed and how broadly — think wages, other income, property or goods in the store. The “rate” is the percentage of value of the base paid as tax per unit of the base.
Bases may seem self-evident: Sales taxes apply to values of goods or services sold; a property tax is on the assessed value of property; a wealth tax depends on the net worth of a taxpayer or on the value or percentage of their equity in a specific asset, and is quite distinct from a property tax.
Income taxes are levied on the incomes of individuals or the profits of businesses. Some Republicans, especially Georgia Rep. Buddy Carter, now call for a consumption tax on money spent, rather than on income earned. Such a tax is different in subtle but important ways from a traditional sales tax, yet the business and political media now universally present Carter’s FairTax proposal as a “national sales tax.”
Most other countries have what’s called value-added taxes. These are levied at each stage of the production process based on the increase in value of the output compared with the costs of inputs used, right up to the point of sale. Trotting this out as a “national sales tax” increases our confusion rather than reduces it.
“Incidence,” another term from above, refers to who actually bears the ultimate cost of the tax — it’s who it hits, just as in the “angle of incidence” of a light beam in a junior high science class. For example, consider who actually “pays” gasoline taxes, as in remitting them directly to the government, motorists? gas station operators? oil companies?
The “burden” of a tax refers to the total cost to society of a tax — not just the money remitted from taxpayers to the government, but any extra bookkeeping needed and the time and expense of filing returns. It also includes the waste of economic resources motivated by a desire to not pay tax. Consider how farmers once held female hogs from slaughter until after they had one litter of pigs, even if slaughter would generate more income in the short run.
To avoid taxes, people hold onto farms, businesses and shares of stock until they die, even if these assets would be more productive if sold. But because of “step-up basis,” holding until death can save enormous sums on income taxes — the tax on capital gains, or the amount of money made on an asset from the time one bought it. When the “basis,” or the amount paid for, say, a share of stock, “steps-up” to the amount it now is worth, the capital gain, and the taxes owed, are reduced to zero. Your estate keeps all the money.
The “excess burden” of a tax is the total burden minus the revenue raised. An excess burden is a deadweight loss to society — people are worse off and no one is better off. Years ago, Minnesota’s personal property tax cost a lot to tabulate each year and brought in little.
So, these are the basic terms one would learn in an intro public finance course. How do they apply to current issues?
Start with base and rate. The one on personal income is by far the most important federal tax, bringing in nearly half of all revenue. The FICA and FUTA you see on your pay stub for Social Security, Medicare, plus the federal portion of unemployment compensation is next. For fiscal year 2023, these were forecast to bring in $3.8 trillion out of $4.8 trillion in revenue.
The income tax, in intent at least, is on all income. But FICA only applies to “earned income:” wages, salaries and profits from self-employment. Interest gained, stock dividends, capital gains and the like are not deemed “earned.” And FICA for Social Security only applies to earned income up to an annually specified ceiling.
All this has roots in logic or political power at some point in the past. But there are consequences. Nearly 40 years ago, when the Greenspan Commission was tasked with preparing a boom in Social Security claims for coming baby boom-generation retirements, there was an increase in FICA rates. These were predicated on an assumption that 85% of future increases in national income would be in “earned income.” That was the historic fraction. But just then we were about to enter a historic period of reconcentration of income. Most of the income increases went to high earners in forms not subject to FICA. The base shrank. Incomes from wages, salaries and self-employment stagnated. This is a major factor now for Social Security and Medicare that our leaders in Congress must deal with, but probably won’t.
At all levels, non-earned income from capital gains is taxed at a lower rate than other income. And very-high income hedge fund managers somehow managed to get their bonuses deemed “carried interest,” and eligible for the lower capital gains rate. An obscene injustice, but with the filibuster and few limits on campaign donations, buying the few votes needed to block reform is easy.
“Incidence” is the crux issue of the corporate income tax. From 1950 to 1970, this brought in 20% of all federal revenue. That fell over time and has been below 10% most of the last decade.
But who actually “pays” this tax? Is it plutocrats, stock owners and high level managers? Or does it just get passed along to consumers? Anti-tax zealots will tell you in the same breath that the corporate tax is both a crushing load on businesses and still all gets passed to the consumer — yet logically both concepts can’t be true at the same time. Yet people need to understand that some or much of this tax does get passed on whether they like it or not.
Much more could be said. As you read the news, see what underlying econ you can spot.
St. Paul economist and writer Edward Lotterman can be reached at firstname.lastname@example.org.