There's been a lot of talk about "taxing the rich" recently. The idea seems to be that taxes from "the rich" can provide more revenue to the government without any negative economic consequences. Usually "the rich" are people making more than $250,000 in income, and the proposal is to increase their marginal rate to at least the old marginal rate of 39.6%.
But who are "the rich", really? Well, there are probably very few single people who make over $250,000 - less than 10% of the returns in the top tax bracket are filed by singles, as opposed to over 40% of all returns - so it's mostly likely a married couple. And most likely it's a married couple who both work - like two doctors or two lawyers - so that their combined income comes in above $250,000, even though neither of their individual incomes does.
So let's take a look at the situation one of these couples is in. The husband, say, is a specialist physician making $180,000 a year after adjustments to income like malpractice insurance. The wife is a general practitioner making $140,000 a year after adjustments. The total is $320,000 a year, which puts the couple well above the $250,000 cutoff proposed for "the rich".
So what's the wife's effective take home income from working? Well, she makes $140,000 per year. $69,460.70 of that is paid in taxes - $44,737.50 federal, $7420.00 Massachusetts state, $17,303.20 self employment. She pays a nanny $20 an hour for the 50 hours per week that she works, plus for her 2 hours a day commute; subtracting a $3000 child care credit, that's $57000. Leasing a BMW is $500 a month - the nanny uses the Cayenne to cart the kids around during the day - so that's another $6000 a year.
After subtracting all those work related expenses, she actually only takes home an extra $7539.30 in disposable income per year - barely more than 5% of her taxable income. No wonder most mothers in the U.S. stay home rather than work! But that's okay, our doctor enjoys her job and enjoys helping people. It's true that she'd rather stay home with the kids, but that's only worth $500 a month - $6000 a year - to her since her work is also rewarding. $7539.30 is enough to keep her working - barely.
Now, let's bump up the tax rate on the half of her income that causes the couple's combined income to come in above $250,000. We'll bump the rate from the present 33% to the former top rate of 39.6%. Her taxes increase by $4620. Her disposable income drops to $2919.30. That 6.6% increase in taxes may not have seemed like a big number, but it cuts our doctor's effective take home income by more than half!
Here's the kicker. Taking home $2919 is no longer enough to keep her working. So she quits, fires the nanny, and stays home to take care of the kids. That means she not only quits paying that extra $4620 in taxes - she also quits paying the original $44,737.50 in federal taxes as well. The government is also out the social security taxes, the state taxes, and the taxes the nanny paid.
Now, not everyone in that situation will quit. Some will go ahead and pay the extra taxes - maybe they feel that a different kind of work during the day will make them be fresher for the kids and appreciate them even more when they're home. But not a lot have to quit to make the supposed revenue benefit of the tax increase disappear, or even become a revenue loss.
Statistics on returns of various types that were in various tax brackets are here: http://www.irs.gov/pub/irs-soi/05in
Nanny rates are $17-$25 per hour: http://www.tandcr.com/candidate/article
Doctors work an average of 51 hours a week: http://www.bloomberg.com/apps/news?p
Estimates for doctors' incomes vary all over the place. The above link suggests that GPs make $173k per year. A comment at this link puts malpractice insurance at $34k per year: http://www.hcplive.com/primary-care/art
My spreadsheet for calculating this stuff: http://www.powderhouse.com/~wdew/articl
I feel like this misses a bunch of subtle points:
1, child care only comes from the wife's income?
2, anyone who is working 51 hours is probably not doing it for the money.
3, paying $20/hr * 50 hours/wk is within the family's control. My point being, there are knobs people control to change their spending habits (e.g., how much you spend on coffee, or child care, or restaurants, or new cars, or fruity drinks at the bar, etc) as times get better or worse (pay raises, tax increases, economy takes off or crashes).
I believe your argument is, "if taxes go up enough, then one person in a two-earner family will quit, because the net return isn't worth it". I think your argument has some validity to it -- clearly, there's not a single point where, all of a sudden, everyone quits, whereas if it were 1% less than that, everyone would stay. But I'm not sure your analysis captures your point correctly.
If I'm reading this correctly, the IRS link you provided doesn't compare returns across many years for the highest income earners. I see on pg 15 that the $1M+ returns went from 148,635 returns in 2004 to 192,359 in 2005, but that's only two points. My anecdotal understanding is:
1, that that number has been both increasing and sharply rising, which
2, is an ongoing trend of a shift of wealth to the most rich, and
3, it's a tax on those people that would be the big benefit.
A few caveats I should note that I'm glossing over:
1, I am failing to account for all the variables introduced by the stock market (my weak understanding is that those making over $1M are largely making it via the stock market, rather than in direct salary).
2, the most rich have the resources to find tax loopholes and/or lobby Congress to create them, so there may be no net benefit after all.
3, Anecdote != data. :)
Thanks for doing the research and crunching the numbers. I wish this were much more common. Of course, people will disagree over interpretations (as I am), but I feel it's a great way to enable discussion.
child care only comes from the wife's income?
You only need paid child care if both parents work, therefore when calculating whether the second income is worth it you have to weigh child care costs against the salary of the parent who would otherwise stay home, usually (but not always) the woman. I didn't think this needed explaining.
paying $20/hr * 50 hours/wk is within the family's control
I take it you think this is a lot for child care? If so, I must inform you that you are sadly deluded. I've priced daycare in this area. The one in Davis Square is $450/week per child. The one at my work is $83/day per child. A nanny is a bargain by comparison. (You can get home-based daycare for $300/week per kid, but I am unwilling to use daycare that operated out of someone's home because I know they routinely take more kids than regulations allow.) Someone I know who lives in San Diego pays her nanny $15/hour, BUT the woman is an illegal immigrant; she's tried to find a nanny with a green card but hasn't been able to. I don't think it's a stretch to believe that you can't find a legal nanny for much less than $20/hour. Childcare is expensive.
Yeah, it's still a net win for me to have a job too. (Of course you're technically single which changes the equation.) The worry is that when raising taxes on the two doctor and two lawyer families doesn't bring in the expected revenue that the government will then raise taxes on our bracket, which would put me in the unpleasant position of working at a net loss just so we can get health insurance.
Hopefully greyautumnrain clarifies two of your three "subtle points".
On the remaining one, when I was working 50+ hours a week, I was most certainly in it for the money. Many salaried professionals are routinely expected to work much longer than 40 hour weeks. The 51 hours per week figure is for the average doctor, and I think it's naive to think the average doctor doesn't want to be paid.
With respect to the IRS document, you are looking at the AMT (alternative minimum tax) figures, which are irrelevant to this particular discussion. The relevant figures are on pp. 20-21 of the PDF, numbered 27-28 because the PDF starts on p. 8.
Presumably the negative consequences that you point out here would also apply to raising taxes on people in the middle-class. It seems likely that the negative economic consequences might even be greater in that case. So, if you wanted to raise taxes while minimizing the economic consequences, it seems like raising taxes on the rich is a reasonable plan. There may be other taxes which had even less economic impact such as a value added tax but they tend to be less progressive as well.
Really what I'm pointing out is that "the rich" actually are middle class - most people consider doctors upper middle class, rather than "rich". To put it another way, increasing taxes on tax returns making over $250,000 mostly consists of raising taxes on a select subset of individuals, mostly women, making more than somewhere around $125,000, probably starting around $75,000 or so.
Well, that plus pointing out that raising those tax rates will likely result in a reduction in revenue rather than whatever increase is projected.
It's absolutely a valid point that there will be some negative economic consequences from any tax increase; I'm addressing this particular proposal because it's the only concrete proposal that's currently being floated, as far as I know.
You bring up a good point about value added taxes. I think there are reasons why value added taxes might become more suitable as an economy shifts from an industrial economy to a services based economy, but that's a topic for another post.
Edited at 2010-09-03 01:44 pm (UTC)
It's definitely true that $250,000 is somewhat arbitrary and possibly low if what you're targeting are the "rich", especially given the fact that married couples have their income combined for tax purposes.
And, it's definitely worth considering what the actual revenue effects will be from a given tax increase. I think the math for your example is valid. The real question is how many people will actually fall into that category. Presumably there are also other people who will work harder to earn more money to make up for the additional money lost to taxes. I'm not going to claim that this is a bigger factor: just pointing out that the analysis is more complicated. I could write up a use case about a doctor who is thinking of retiring early but now decides to work an extra couple years to make sure that she has enough savings given the increased taxes.
It would be interesting to see figures on what proportion of taxes are paid on income over $500,000 or $1,000,000.
That said, I think dcltdw is correct that the really rich are more affected by various loopholes rather than by tax rates. For example, they can use the charitable donation of appreciated assets rules to double the tax benefits of charitable donations - which essentially means they can donate half their income and take the other half tax free. Closing loopholes like that would be much more effective in getting the truly rich to pay taxes.
You are making one of the classic mistakes in assuming that all tax burden is born by the consumer. In this case, the correct thing to do is for to go to her employer and say she needs a raise to cover the increased tax cost. A rational employer when faced with losing an employee in a field where there is a shortage of workers to a compensation issue raises the compensation. (GPs are majority woman since it is one of the lower pay ranges of doctors. There is already an ongoing shortage of GP's. If this example were true for most female GPs than the vast shortage would add a significant premium and increase the wages paid.)
You are missing a social aspect: if she has gone through all the years of med school, it is exceptionally unlikely she wants to be a stay at home mom. She would almost certainly prefer to be working as a doctor. Total compensation also includes intangibles. If she had wanted to be a stay at home mother she would have already been one.
You are also making the assumption that they would not adjust there consumption in response to this. Swapping from the $70k SUV (avg midrange cayenne cost) for the nanny to a less extravagant volvo would probably tip your balance back in the other direction. Or even just stopping having 3 cars -- many of the doctors in the boston area use public transit and the only time you need 3 cars is during the work day.
Basically, you argument only works if she is exceptionally rigid in spending choices, has an employer who does not react to market conditions, and she values her job enjoyment not at all. In the real world, none of those are true.
Most general practitioners are in partnerships or are principals in small businesses. To increase their income, they have to raise the rates on the customer. Even for those employed by HMOs, the HMO has to raise the rate on the customer if they are to keep the employee - and they may choose instead to accept the loss in the doctor at the cost of, say, increased wait times for the customer.
The final customer here is relevant. The largest one is medicare, because older people have many more medical problems requiring doctor visits; medicare rates are set by law rather than directly by the market, and it's unlikely they'll see an increase beyond inflation in the current economic climate. The remaining ones are almost all insurers, who set their own reimbursement rates and don't like to be paying much more than medicare rates, so again it's more difficult than in a fully free market for the supplier to raise rates. Indeed, submarket medicare rates are likely a primary cause for the shortage of general practitioners.
I agree that many doctors who are mothers have likely already left the job market; I'm sure that for many, even the current $7539 in the above example would be insufficient to keep them working. Preferring to be working as a doctor doesn't necessarily translate to preferring to work for close to free - or for less than free, as would be the case if the doctor felt guilty enough about the children to hire a top of the line nanny at $25 an hour instead of a slightly below average one at $20 an hour.
Carting the kids around in a Volvo or Odyssey instead of a Cayenne doesn't change the above analysis at all; I said "Cayenne" instead of "minivan" just for flavor. Switching entirely to public transit likely involves a move to a more expensive house in most cases, to be within walking distance of a station.
I do agree that not all mothers in double income families will choose to stop working in similar situations - indeed, it's likely a minority. I think it's a substantial minority, though, even in cases where compensating factors such as you suggest reduce the effect on take home pay. It will still be a pay cut, even if it's a 30% cut rather than a 60% cut. Remember that it only takes one in ten of these mothers choosing to quit for the impact on tax revenue to become negative instead of positive.
A rational employer when faced with losing an employee in a field where there is a shortage of workers to a compensation issue raises the compensation. (GPs are majority woman since it is one of the lower pay ranges of doctors. There is already an ongoing shortage of GP's.
Well, if that's all true either medical employers aren't rational or market forces don't apply to medicine, yes?
The whole stickiness argument has some validity, but that just means this will happen long-term, not short-term. The real question is whether non-taxation-related extra costs to working shift seemingly reasonable tax rates onto the wrong side of the Laffer curve. This is even more obviously a problem, ironically, for the single mom making $20K than it is for the $250K couple due to aid eligibility...
Basically you can consider the man's income to be a taxable income and the bottom line numbers don't change. That would bring the man's gross income up closer to the real average specialist's income; the woman's income is already where the average GP is. The only reason I didn't explicitly specify that was because I'd have to add calculations on medicare taxes, and there was too much arithmetic already.