Thursday, November 18, 2004

Bush Economic Team to Upper-Middle Class: Drop Dead (but thanks for the votes)

by Tom Bozzo

Update 1 (11/20): Via Brad DeLong, the Wall Street Journal reports that tax "reform" is not due until 2006 -- Social Security "reform" is apparently going to be first. Will keep the pitchfork and torches ready.

Update 2: Alan Greenspan gave the markets a good scare yesterday by reminding everone that Stein's Law (1) applies to the U.S. trade and budget deficits.

Update 3: Fafnir on tax reform (do read the whole article):

...only recently [...] a few brave Robin Hoods in the Republican Party decided to take things back from these lower-class fat cats an give it back to salt-a-the-earth robber barons [footnotes omitted].


Max Sawicky has saved me quite a bit of typing with this excellent post on the Bush administration's income tax trial balloon. See also Matthew Yglesias here at Tapped.

The plans being kicked around involve greatly reducing or eliminating taxes on interest, dividends, and capital gains, the revenue losses from which may be offset by, according to the Post:

...eliminating the deduction of state and local taxes on federal income tax returns and scrapping the business tax deduction for employer-provided health insurance...

The focus of the other bloggers has been the incidence of these changes on solidly Democratic northeastern states and California -- the "blue state tax" as Max Sawicky memorably calls it -- and (particularly via the change in tax incentives for employer provision of health insurance) the "middle class."

I'll just offer a couple of addenda.

The effects would hardly be limited to solid-blue states. To fare poorly in an elimination of the state and local tax deduction, a homeowning taxpayer without significant offsetting investment income really only needs two (or more) of high property taxes, high state income taxes, and/or a mortgage with balances exceeding $170,000 or so. The last roughly clears the joint filer's standard deduction hurdle for states without income taxes at prevailing interest rates; the threshold for single filers would be half that.

Under these criteria, quite a bit of the working population of the upper Midwest, which narrowly went Democratic (on balance -- I haven't forgotten about Iowa) but was contestable in the election, would be in line for a tax increase. Homeowners in Madison and higher-priced pockets of southeast Wisconsin would tend to be particularly screwed. Evidently, we're no longer thought to be needed to assemble 270 Republican electoral votes. But also consider that property tax rates in parts of Texas are higher than they are here in the People's Republic of Madison.

Moreover, taxpayers meeting the criteria for a taking a hit will tend to be upper-income, but not quite rich, wage earners. Consider this segment of the upper-middle class -- the bottom four quintiles of the top income quartile, whose AGIs range from $56,401 to $126,525 in 2002 (the most recent available year). Collectively, this group deducts about $25-$30 billion a year more in state and local taxes than they earn in taxable interest, dividends, and capital gains, says the IRS. There are about 26 million returns in this group, so there would be a modest but broad tax increase from the change averaging about $300 annually.

Younger members of the group, who would would tend to have the local taxes but not to have had time to build up much in the way of taxable investments, would fare considerably worse. I'd get my pocket picked to the tune of about $300 a month.

To the extent this group can be swung -- and one narrative of the Republican disaster in the Minnesota legislative elections would suggest it gets annoyed by "stealth" tax increases -- Republican strategists might fail to get their economists in line at their own peril.


(1) "If something can't go on forever, it will stop."
Others who would get utterly screwed: older professional people with decent-ish incomes and employer-based health insurance, who have zero savings or investments because they have channeled every last penny into putting their kids through college. I would say that we would be chocking up about $300 more a week!
The plans for health insurance are scary, one way or another, and I didn't even try to quantify the effect.

Here's my guess at the dynamics. Employers probably would initially pass the cost of the lost tax deduction onto their employees, rather than terminate their programs altogether. The impact would be greatest for the most generous employers, where the pass-through would be something like $300/month in the case of an employer picking up the full tab for a decent plan (I have the price of our Unity family plan in mind)-- with a little offset if the shifted premium is paid out of pretax earnings.

Then the vicious cycle begins. The higher price of insurance causes the poor (low ability to pay) and healthy (low willingness to pay) to drop out of the plans. Premiums increase as the insured base gets sicker on average. Repeat.

The end state probably does pretty much eliminate employer-sponsored health insurance, assuming there isn't some revolt en route that leads to a sensible socialized medicine system.

A big variable is the strength of the labor market. Part of the mindset behind this sort of social engineering is the idea that employers would have to replace lost benefits with some other form of compensation to keep overall pay packages level and thus retain their workforces. So forgetting about risk-shifting issues, employees should be left no worse off on balance. I'd be inclined to agree if conditions resembled the late-'90s, though there would be still be distributional issues the center-to-left wouldn't ignore.

Of course, economics-of-uncertainty 101 would say that the risk-shifting in these "reform" plans makes little or no sense.
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