Income gap, tax policy closely linked

People are becoming increasingly aware of the income gap – the growing spread between incomes at the top and the bottom.

Proposed solutions range from levying a higher income tax on the wealthy to raising the minimum wage to doing nothing in the belief the market take care of the problem.

The gap would be even wider without the effect of the tax system, according to a new study by Federal Reserve economists.  It focuses on the federal and state income tax and levies on consumer purchases.

Income taxes are usually designed to impose higher rates on upper income people, those with the ability to  contribute to government revenues, and lower rates on people with modest incomes, whose ability to contribute is limited.

The study finds that federal taxes cushion the impact of the growing income gap while state taxes on average make the gap even greater.  But the performance varies from one state to another.

Without a sales tax, much of the effect of federal taxes on households comes from work-related taxes.  Lower income people may pay little or no income tax, though they are likely to pay payroll and gasoline taxes.  The Earned Income Tax Credit, which can be paid to lower wage workers, also cuts the gap.

At the state level, both income and sales taxes affect the gap, as does the gasoline tax.  Some states, including Maine, have their own EITC.

State tax systems provide greatly varying results.  At one end is Minnesota, which increases by more than 18 percent the federal tax effect in compressing the income gap, and at the other is Tennessee, which counteracts the federal gap-narrowing effect by 33 percent.

Maine adds 3.5 percent to the federal gap reduction effect.  One positive aspect of the Maine system, 

according to the study, is that food is not subject to the sales tax.  Exempting clothing would also reduce the gap as it does in some states.

Perhaps the most significant tax falling more heavily on lower income people than the wealthy is the gasoline tax.  Like food, gasoline can be a necessity of life.

Interestingly, the increase in upper end incomes has some influence on reducing the gap.  As more people move into the top federal tax bracket thanks to their gains, they pay a higher percentage of their income in taxes.

The tax system could have an even more significant effect on reducing the income gap.  At the federal level, the income tax on the wealthiest could be increased.  French economist Thomas Piketty, one of the most well-known experts on the gap, advocates a drastic levy at the top. 

Investor Warren Buffett, one of the wealthiest people in the world, favors increasing the EITC, which would bring up the bottom and, because it is paid to workers, would encourage people to seek employment.  He opposes merely increasing the minimum wage, which he says would cut employment.

Some current proposals to modify the income tax would have the effect of increasing the gap   between lower income people and those at the top.  Abolishing the income tax, as proposed by Maine Gov. Paul LePage, would clearly increase the income gap.  State taxes do that in all nine states that have no general income tax. 

While eliminating the income tax may have little effect on those at the bottom end of the income scale, who pay little even now, it would allow incomes of those at the top to increase.

Even the seemingly more modest proposal to impose a so-called “flat” tax, under which the same rate applies to all, would have a similar effect.

Are there possible changes to federal and state taxation, even without increasing the rates, that could have a more impact on reducing the income gap?

At the federal level, a tough reform of loopholes, so-called tax expenditures, could have a major effect.  The more they are eliminated, the more the wealthy pay, but it might even be possible to lower everybody’s income tax rates.  

That’s less drastic than Piketty’s proposal, but would have a somewhat similar effect.  But reform discussions now seem to focus more on rates than on the loopholes protected by well-funded lobbyists.

Right now, none of the states without an income tax offers workers an EITC.  Without imposing a new income tax, they could cut the gap by adding such help for lower income workers.

Sales tax exemptions for non-essential items could be eliminated in many states.  And states tagging onto the federal system could close some of its loopholes.  Both could be done in Maine.

Should Democrats be running scared?

The Democrats may be their own worst problem.

The party has considerable advantages according to recent national polls, but, at best, it comes across with a somewhat blurred image and, at worst, as pursing a version of liberalism that has limited appeal.

Yet surveys show that most Americans agree with what is usually considered Democratic policy.

Take campaign finance.  Four-fifths of people say they favor new controls over campaign spending.  Opposition to limits comes from Republicans who say bankrolling political campaigns is a form of free speech.  Democrats have not made this an issue, and may themselves also go for the big money.

Or immigration.  Almost 60 percent say that today’s illegal or undocumented aliens should have a path toward citizenship.  Republicans are divided on this, but many of them say the borders must first be secured, though they know that is not a practical possibility.

Or same-sex marriage.  This is a so-called “wedge” issue, a social issue leading voters to support the GOP’s candidates without much regard to their positions on other issues.  But a strong majority of voters nationally support it, though some conservative states strongly oppose.

It seems clear that the GOP hopes to benefit from such wedge issues including abortion and gun control.  And their adulation of Israeli Prime Minister Benjamin Netanyahu suggests they are trying to make support for Israel also a wedge issue.

Yet surveys show almost equal division of opinion on abortion and gun control with no information yet on Israel.

On the central issue, whether people have a favorable view of Republicans or Democrats, the GOP trails badly.  And since the Republicans took control of both houses of Congress this year, opinions about that institution have sunk even below their already low levels.

Despite all of this evidence that should give comfort and political strength to the Democrats, they fail to capitalize on their advantages.  In fact, they often give the impression of running scared.

The Republicans say they are the conservative party and most voters are conservative.  If the Democrats accept this view, they are tempted to move to the right and actively avoid being labeled liberals.

It’s possible that a conservative-liberal political split does not provide a true picture.  Pretty clearly, the conservatives have a coherent set of views and policies, and they freely label as liberals those that oppose them.  But are the 57 percent who say they support same-sex marriage all liberals?

We have seen the U.S. Supreme Court being reported by the media as composed of four conservatives, four liberals and one swing voter.  But a close look shows there are four, sometimes five, conservatives and four non-conservatives.  The media designation of them as “liberals” may please the GOP.

But what about Obamacare?  Isn’t the majority disapproval a sign of conservative rejection of a liberal policy?

Perhaps, but it is also a good example of the Democrats’ failure to champion their own causes and allowing themselves to be intimidated into soft-peddling their own policies.

Or the economy?  Unemployment is down, and output is growing.  While individuals should be earning more (and the top one percent is), the Democrats never fail to admit the situation is good but could be improved.  Certainly honest, but not a way to win elections.

The national media has supported the increasingly incorrect notion of a conservative-liberal split, which the right is supposedly winning.  “Red states” and “blue states” supposedly have both a political and an ideological meaning.

It’s possible to disagree with the conservative position, making you a non-conservative but not necessarily a liberal.  As the surveys show, you may be in the mainstream.

In Maine, the split between conservatives and those who have opposing views is playing out differently.  The Democrats may sometimes be drowned out by Gov. LePage, but not to the point of running scared.  And the legislative Republicans remain attached to protecting their prerogatives even from a governor of their own party.

The presidential campaign will sharpen the contrast between the conservative and non-conservative views.  If they can put one of their candidates in the White House, conservatives could then claim political domination.

Recently, the Washington Post reported that Hillary Clinton, the likely Democratic presidential candidate, is adopting positions that just a short while ago would have been deemed too liberal.  She’s not doing that to squelch more liberal challengers, but because her polling shows most voters are increasingly supporting policies formerly considered liberal.

The Democrats have the opportunity to appeal to the majority, but only if they have the courage of their convictions.  

Social Security needs major changes

The good news is Americans are living longer.

The bad news is many Americans cannot afford to live longer.

Many people do not have enough money saved or in Social Security to provide sufficient income in retirement.  Of course, some are wealthy or have good employer provided retirement plans, but they are a minority.

Most people are at least vaguely aware that Social Security will not have enough funds to make its promised payments to retirees.

The main reason for the shortfall is the decreasing number of people working and contributing to the program compared with the increasing number of people eligible for its benefits.  Current payouts have always depended heavily on current payroll contributions; its trust fund alone is inadequate.

To make matters worse, the federal government has borrowed from the Social Security trust fund to meet other expenses.  In fact, it owes Social Security more than it owes the largest foreign holder of public debt, Japan, which just passed China. 

Now comes a new issue.  The forecast of how long people will live may be too short, meaning that with people living longer than expected and receiving longer payouts, Social Security will face even more problems in keeping pace with its commitments to retirees.

The federal government will struggle to find the money to make payments to retirees, and the challenge will become greater as time goes by.

Meanwhile, retirees themselves will struggle.  About 29 percent of them have less that $1,000 in savings, and 58 percent have less than $25,000.  With so little in savings to support them in retirement, they must rely on Social Security. 

Though it was not intended to be the main source of retirement benefits, Social Security provides most older beneficiaries with more than half their retirement income.  And about a quarter of married recipients and half of single beneficiaries depend on the program for at least nine-tenths of their income.

Whatever the original intent, Social Security is becoming the default pension program just when its resources are becoming inadequate. 

It all adds up.  Fewer contributors relative to recipients, tens of millions of new retirees, Social Security itself owed money, and older people increasingly dependent on it.

Political promises to “protect” Social Security are not enough.  A more comprehensive reform is needed, though it would come at a time when there is great pressure to reduce government spending not increase it.

In the end, it is likely that each of the current problems will have to be addressed.

As life expectancy is increasing, the retirement age will be raised.  It is now on course to reach 67, up from 65.  But it may need to be raised even more, especially as the forecasts on the length of life continue to put pressure on the program.

Its outlays could be cut if benefits to wealthier people were not only taxed, as they are now, but reduced or eliminated at upper retirement income levels.

The payroll tax rate paid by all, especially upper income people, could be increased.  Perhaps the way to attract enough political support for such an increase would be to allocate some of the new funds to optional investments in financial markets.  However, given the increased level of risk, the amounts invested would have to be kept relatively small.

A payroll tax increase would not be sufficient to solve the financing problem.  The debt owed to Social Security must be paid, and that will require an increase in general taxes.  This is a clear example of the problem of pushing today’s federal deficit spending onto later generations.

Payroll tax revenues could be boosted if there were more workers contributing.  Dealing with immigrants already in the country, legally or not, and a return to America’s historic more open immigration policy could produce workers contributing to Social Security as well as new customers for American products.

It also seems obvious that workers should reduce their current spending and save for their own retirements, and they should start while still young.  That would provide security and a cushion for times, like the recent recession, when pensions stagnated thanks to reduced interest rates.  Retirees made a major contribution to economic recovery.

In effect, unless Social Security turns its back on tens of millions of older people in coming decades, it will almost certainly have to become what, for many, it already is – the national retirement plan.

This conclusion and the remedies seem almost incredible.  But the problem of assisting older Americans to survive is growing and potentially catastrophic.

Government consensus crumbling

The American political system isn’t what it used to be.

While change in governing is as inevitable as it is in every other part of life, the transformation of political practices and behavior is radical.

The system is subject to constitutions, federal and state, and to laws made to carry out their intent.  But the United States has always been governed by people who operated by interpreting the laws in an agreed manner.  In short, the political system is based on both laws and common understandings of how the game is to be played.

No constitution or law can deal with every imaginable situation.  While amendments can be adopted to deal with change, more often government operates under a gradually evolving and informal consensus.

In recent years, that consensus has been crumbling – and not gradually.  In Washington and around the country, elected leaders are using their hold on power, however temporary it may turn out to be, to make basic changes in how government operates. 

The filibuster is the most well-known example.  Originally, a rule to halt debate in the U.S. Senate was adopted as a way to prevent endless delay.  It requires a supermajority, now 60 votes, to end debate.

For decades, the Senate had no problem considering bills without a formal vote to end debate.  The filibuster was used only once or twice a year by southern senators intent on blocking civil rights legislation.

Now the threat of filibuster is used for virtually all important bills.  In effect, the simple majority required by the Constitution has been replaced by a supermajority.  That gives great power to whichever party is in the Senate minority no matter who controls the government.

For “originalists,” people who want to apply the Constitution as the Founders wrote it, this should be unacceptable.  Many of those who rely on the new practice continue to insist on their view of the original meaning of the Constitution.

Last week, the head of the Federal Election Commission said that her agency could not make any significant decisions on violations of campaign laws.  That’s because Republicans on the evenly divided six-member Commission say that limiting questionable political financial practices would violate free speech rights.  Is that what the Founders had in mind?

And the Senate, which worries about President Obama making a risky nuclear deal with Iran, wants to force itself into approving an executive agreement.  Until now, all presidents have been able to enter into working agreements falling short of formal treaties without congressional involvement.  This Senate action could set a new historic precedent.

Some senators voted against Obama’s pick for Attorney-General, because she would not promise to operate the Justice Department independent of the White House.  That’s a new standard.  Think of President Kennedy’s brother or President Reagan’s campaign chief of staff, who both served as Attorney General.

In Maine, similar change is taking place, and the driving force is Gov. Paul LePage.

To issue bonds, the Legislature must pass a bill and then send it to the voters.  They decide if the proposed use makes sense enough for the state to take on added public debt.  The campaign debates on debt can be serious and are almost always contested.

After the voters approve a bond issue, the bonds should be issued and the money put to work.  The people are the sovereign, and they have decided and not merely issued an advisory opinion to state government.

But LePage has blocked the issuance of bonds for years until the Legislature gives him something else he wants.  Republican state Sen. Roger Katz, a member of the governor’s own party, has said, “No one, including a governor, ought to have the right to be able to veto what the citizens of Maine do at the ballot box.”

But that’s just what LePage is doing.  In the process, he is changing historical practice, and his action has not been effectively challenged.

Why does LePage believe he can make such a change?  Because he blocked bond issues before he was re-elected, he interprets his election as authorization to change historic practice.  With this attitude, he is in line with members of Congress who see their own elections, not as entrusting them with protecting the generally accepted political system, but as a license to topple it.

A House member of the governor’s party defended his action with words that apply to the recent trend toward change.  “It’s politics,” he said.  Apparently, politics trumps all, including history and the need for consensus.