Tax policy is like prescribing prescription drugs: Identify the problem, choose the remedy, decide the dosage, and remember to end the treatment. Neither are cut & dry sciences. Both claim to be.
Tax loopholes are targeted tax cuts aim at specific problems in the economy. These are intended to change business, investor, or consumer behavior.
For example, when technological advances significantly change the employment requirements for a job type or an industry, the government creates a tax loophole that encourage employers to train current and new employees in the new technologies.
For example, when an industry is becoming increasingly dependent on a material which is mainly sourced from dangerous locations, then the government creates tax loopholes that divert the market towards more attractive alternative materials.
For example, because so many other key manufacturing, industrial, and service industries are impacted by new home building and the renovations associated with existing home resales, the US government created and continues a mortgage interest deduction to encourage widespread home ownership. (There might be other good reasons as well for creating and maintaining this loophole.)
Generally, voters and politicians tend to refer to loopholes well liked, such as the home mortgage deduction, as tax breaks and those not well liked, such as for rewarding outsourcing, as loopholes.
Just like prescription drugs: Some work as intended; some don''t work as intended; some have unacceptable side effects; and sometimes the doctor just forgets to get you off a drug after it's done the job intended. (A few drugs are long-term or life treatments, but few are and they usually treat large population groups.)
These 3 failed tax loopholes didn't work as intended, have unacceptable side-effects, and should have been closed long ago.
Social Security, Medicare, and Unemployment Insurances suffer nasty side-effects from these 3 loopholes: (1) Social Security Insurance Tax income ceiling; (2) Federal Unemployment Insurance Tax income ceiling; (3) Capital Gains income exemption from payroll taxes; and (4) Capital Gains rate for consistent annual high gainers.
(1) Social Security Tax's "income ceiling": Having a total personal income above which no Social Security and no Federal Unemployment Taxes are paid. It has been about $110,000 over the past 20 years and this year goes up to $113,700. Perhaps even more ridiculous, only your first $7,000 in annual income is subject to Federal Unemployment Insurance tax and, therefore the FUCA rate is unnecessarily high at 6.0%.
(2) Federal Unemployment Insurance Tax's "income ceiling": Although only employers pay the Federal Unemployment Insurance Tax (called FUTA for Federal Unemployment Tax Act), they only pay it on the first $7,000 of annual income. That means employers pay FUCA tax of $420 annually per employee.
To collect the same total FUCA insurance premiums annually nationwide, we could eliminate the income ceiling and drop the rate down from (FUTA rate 2013) 6.0% to an estimated .38% (based on estimated number of U.S. households, total U.S. personal income annually, and total estimated federal unemployment insurance taxes collected).
At the U.S. median household income of approximately $60,000, employers would pay Federal Unemployment Insurance Tax of $266 per employee annually instead of paying FUCA of $420 per employee annually, which saves employers an estimated $154 per employee annually. For every 390 employees, an employer saves the median income of 1 full employee (or can hire one more employee at median income).
What employer, especially large businesses, should oppose median saving $266 per employee per year?
(3) Capital Gains income's complete exemption from paying any payroll taxes until 2013 when it becomes subject to Medicare tax of 3.8% but still not Social Security payroll tax of 12.4% and Federal Unemployment Tax (FUTA) of 6.0%.
Since its inception during the 1930's depression, the Social Security system was funded sufficiently because it's tied to income, which has increased over the decades, plus a small rate increase every 5 years to account for increased lifespans. Typically, the rate increased by 1% to reflect longer average lifespans.
Then in 1981 government confronted the facts that (a) that people are living, hence collecting benefits, a lot longer from major scientific advances and (b) baby-boomers would be reaching the age of 65 in 2010 creating a 20-year hump in benefit payments.
In response, Republican President Reagan and a Democratic Congress made 2 major changes: They raised the Social Security benefits eligibility age to 67 and raised the Social Security tax rate.
The rate was increased by more than it had been since the beginning of the program because it had to deal with both problems, each having a bigger than normal impact.
The simultaneous Social Security tax rate and benefits eligibility age increases, without corresponding benefits increase, had the effect of a sustained period of significantly increasing our balance in the Social Security Trust Fund between 1983 and 2010. They started saving upfront in order to ease the burden in 2010.
The Social Security Trust Fund has been around for a long time, contrary to common belief.
All Social Security tax receipts are deposited daily into the SSTF and all Social Security benefit payments are paid out from the SSTF. You can see the actual monthly and annual transactions through the Social Security website www.ssa.gov.
The Social Security Trust Fund deposits are automatically executed as buying "Special Issue" US Government Bonds that ONLY the Social Security Trust Fund can purchase and which can be redeemed at ANY time by the Social Security Trust Fund from the US Government. The interest rates paid to the Trust Fund are determined, usually based on current market rates, at the end of each month for the bonds of the following month.
For example, in 2011, the $905-billion in Social Security tax receipts deposited into the Trust Fund exceeded the $809-billion in Social Security benefits payments withdrawn from the Trust Fund by approximately $95-billion. So the Social Security Trust Fund balance was increased from $2.430-trillion to $2.525-trillion.
The average monthly interest rate paid on the special issue bonds issued during 2011 was 2.417%. This rate is high, compared to newly issued rated now, because many of these bonds were issued before the interest rate cuts after the 2008 crash.
In this example, the Social Security Administration purchased $905-billion in these special issue Social Security Trust Fund (SSFT) bonds from the US Treasury and sold $809-billion in the bonds back to the US Treasury.
The balance in the Social Security Trust Fund has increased every year since the 1983 "fix" and continues to increase to date.
Much has been joked and derided about the Social Security Trust Fund. Some say that it was repeatedly raided and that caused the shortfall we will face in about 10 years. That might be true.
However the Fund also has encountered the "income ceiling" and capital gains exemptions from paying Social Security tax, meaning that a very disproportionately higher share of income from increased GNP went to those households already earning above the $110,000 income ceiling and/or in the form of capital gains.
Without a healthy increase in Social Security tax revenue increases reflecting at least the cost-of-living increases in Social Security benefit payments, the Social Security Trust Fund savings levels planned for the Baby-Boomer bump were not met.
The Social Security Trust Fund did not save enough funds to handle (a) the continual improvements in health care that continue to extend life and (b) the projected benefits needed during the baby-boomer retirement bubble. (Graph below shows this.)
Actually, two problems got in the way:
First, early retirements by baby-boomers who have been displaced by globalization and the current economic depression.
As well as second, essentially all new income from 1983-2010 GNP growth went only to those already earning above the Social Security "income ceiling" and nearly 50% of that income came from capital gains. (See charts below.)
The Social Security tax "income ceiling" and Social Security tax exemption for Capital Gains income have cost the Social Security Trust Fund an estimated $300 billion annually over the past 20+ years (that's an estimated $6 trillion over the 20+ years).
From 1941-1979, new income from GNP growth was split among income groups by the natural economic forces of balance of economic influence and tax policies.
From 1980-present, the income of the top 1% of household earners rose from approximately $500,000 up to nearly $2 million annually yet all other households' remained flat or dropped. So none of the nations growth in income was taxed for Social Security. It was starved.
The chart below shows that, from post-WWII 1949 until 1976, per capital income growth for those earning below the Social Security tax income ceiling grew at a healthy rate and a rate comparable to those earning above the income ceiling. It also shows that from 1976 income went to those earning above the Social Security tax income ceiling.
So the Social Security "income ceiling" and the capital gains "payroll tax exemption" tax loopholes have starved Social Security, Medicare, Unemployment, and other payroll tax funded insurance pools of tax revenue paid from inception to 1979 and expected to continue in the 1981 changes.
There were "income ceilings" on Social Security taxes from inception. The difference since 1980 has been that all new personal income generated by GNP growth has gone to those already earning above the income ceiling.
This change in distribution of income, since 1980, has worked against the 1984 Social Security tax changes intended to address retirees' longer lives and the baby-boomer retirements.
Tax rates were raised and eligibility age raised, so middle and low income Americans paid more and got less for nothing.
The Social Security "income ceiling" tax loophole now needs to be closed ... or modified to stimulate economic growth by removing the income ceiling and cutting the Social Security payroll tax rate from a total of 12.4 down to 8%. That means a reduction for employers from 6.2% down to 4% and reduction for employees from 6.2% down to 4%.
The differences between having the income ceiling and, instead, having Social Security tax applied to all income levels but at a reduced tax rate is found in the fact that the money multiplier (a.k.a. velocity of money) is lower for upper income households than lower income households (the more money earned the larger the percent of income saved and not spent); the fact that both employers and employees get a tax cut; and the fact that I propose cutting the tax only by 1/3 whereas the additional income taxable now (that above $113,700) represents more than 1/2 of all personal income.
Personally, I recommend just eliminating the income ceiling loophole completely and letting the additional revenues fully fund the Social Security Trust Fund and increase Social Security benefits paid to more realistically reflect the increased costs of living.
The capital gains "payroll tax exemption" needs to be modified to a $500,000 exemption so that lower and middle income American retirees benefit as intended.
(4) Close the capital gains special lower income tax rate (than earned income) tax loophole.
Last, but not least of the 3 failed loopholes to close ...
A Congressional Research Service study released in December 2012 and then revised and re-released in mid-February 2013, by Thomas L. Hungerford, the Congressional Research Service's public finance expert, directly sought to determine correlations between productivity and economic growth (GNP) ... and ... the maximum income tax and capital gains income tax rates.
Here is a excerpt from the Congressional Research Service study:
"The results of the analysis in this report suggest that changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. The reduction in the top statutory tax rates appears to be uncorrelated with saving,
investment, and productivity growth. The top tax rates appear to have little or no relation to the
size of the economic pie. But as a small proportion of taxpayers are affected by changes in the top
statutory tax rates, this finding is not unexpected.
"However, the top tax rate reductions appear to be correlated with the increasing concentration of income at the top of the income distribution. As measured by IRS data, the share of income
accruing to the top 0.1% of U.S. families increased from 4.2% in 1945 to 12.3% by 2007 before
falling to 9.2% due to the 2007-2009 recession. At the same time, the average tax rate paid by the
top 0.1% fell from over 50% in 1945 to about 25% in 2009. The statistical analysis in this report
suggests that tax policy could be related to how the economic pie is sliced—lower top tax rates
may be associated with greater income disparities."
The Congressional Research Service study demonstrates that lowering top income tax rates and capital gains tax rates have not advanced the government's original intent of spurring additional economic growth (GNP) and productivity and intent of encouraging more savings and investment among the majority of American households.
Instead of encouraging higher productivity and economic growth, the lower capital gains tax rate encouraged:
(a) high-income Americans, who have such an option, to convert most of their income from earned to capital gains;
(b) businesses to focus on shorter-term ROI expectations; and
(c) shorter-term holding of stocks, bonds, and derivatives to just 1+ years.
The intended purpose of lower and middle income American households would have helped the economy. But in reality it has generated these awful side effects. It runs counter to the key economic policy position of nearly every Administration: Encouraging long-term investments.
I'm open to amending the capital gains lower tax rate loophole to exempt income under $500,000 annually or make the lower rate simply a few percent under the earned income tax rate for the particular household. In other words, make it progressive by tying the capital gains rate to each households earned income (regular) income tax rate.
As it stands, the low tax rate for capital gains loophole has not fulfilled its original purpose and appears to be hurting the economy. So close it.
Added importance and urgency for closing these tax loopholes due to share of total government revenue:
Personal income tax revenue has been representing an increasingly larger share of total federal government tax revenues while corporate income tax has been representing an increasingly smaller share.
This As of World War II, personal income and corporate income taxes each represented 40% of total federal government revenue. However, while personal income taxes have ranged 40%-50%, corporate income taxes steadily have declined as a percentage of total federal government revenue. Corporate income taxes now represent only 10%.
Summary:
American budget spending and insured benefits payments are not too high, especially given the current economic conditions.
The 3 income tax loopholes have perverted the system. 2 of the 3 have failed to achieve their stated purposes. All 3 are benefiting fewer and fewer Americans. All 3 are working against the broader interests in a broadly sustained economic growth.
Social Security benefits should not, and do not need to be, cut. It simply has to be funded as originally planned, and as it had been for 50 years. Closing the Social Security income ceiling (even if some of that windfall goes to cutting the tax rate) will go far towards (re)building the Social Security Trust Fund and increasing benefits.
Even our total federal government budget would not be on a sustained deficit course.
If new national income from GNP had continued to be shared somewhat among all American income groups, as it had been from 1942-1979, and if capital gains tax rates not been slashed since 1980, then all Americans would be paying the normal tax rates and the federal budget would not be in such deficit.
On a personal note ... My grandfather worked for a super-successful global pharmaceuticals giant from 1916-1965, never earned more than $20,000 annually, and was proud to pay his full income taxes and payroll taxes. He even avoided some deductions he could have taken. My other grandfather was an entrepreneur who did well and also proudly paid his full taxes.
Restore the American pride. Restore the American middle-class. Restore the American Dream.
By Steven J. Reichenstein
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