Wednesday, May 16, 2007

Federal Taxes And Spending-We are Losing The Class War

Few people in this country have much of a clue about the Federal Government. Where does it get it's money? How does it spend that money? How big is it? How many people work for it? And many other questions.

Readers of this site are smarter than the average bear, for sure. Even so, the subject is pretty dense and maybe all of us are in need of a little refresher. So here are a few questions. If you answer them correctly, you are awarded a gold star. But if not, you might want to read further.

I) In 1962, the Federal civilian Executive Branch workforce contained 1.8 million employees. What was the size of this workforce in 2006? a) 1.1 million, b) 1.8 million, c) 2.5 million, d) 3.4 million. In answering that question remember that the population of the country grew from about 180 million to 300 in that time period. (The Executive Branch does not include the Post Office, Congress or Courts.)

II) In 2006, what percentage of Federal expenditures came from income taxes paid by individuals? a) 39%, b) 45%, c) 68%, d) 81%

The answer to the first question is b) 1.8 million employees. Yes, even though the population has grown by 40% since 1962 the Federal workforce has stayed the same. This number does not include contract employees, whether working individually or for large companies. I hope to get to that later or in another article.

The answer to the second question is a) 39%. Less than two fifths of what we spent last year came from your and my income taxes. The rest came from other sources which are discussed below.

The source materials for this article are the 2008 Budget of the United States from the web site of OMB. This is an invaluable document which you can download or read on line. Ignore all the propaganda about how Bush is making life better and go to the charts and tables in the Analytical Perspectives. The Congressional Budget Office historical tables provide forty-five years of comparative data. The Office of Personnel Management has a treasure trove of employment data. Lastly, the Congressional Budget Office is a great resource that also cuts through some of the bloviating coming from the Administration.

Income

The government gets income from hundreds of sources. They are grouped in seven major categories - Individual Income Taxes; Corporate Income Taxes; Social insurance Taxes, which are largely social security and medicare; Excise taxes, like the gas tax; Estate and Gift taxes; Customs Duties; and Miscellaneous. In addition to knowing how we collect money now it is really interesting to see how the burden of these taxes has changed over the years. This chart tracks changes in those numbers starting in 1962, to the height of the Viet Nam War, the last years of the Carter, Reagan, GHWB, and Clinton administrations, and 2006, which is the last year for which we have data.

Revenues by Major Source, 1962 to 2006 (Billions of dollars)
Sources: Congressional Budget Office; Office of Management and Budget.

Ind. Corp. Soc.Ins. Excise Est. & Gift Customs Misc. Tot. Tot.

1962 45.6 20.5 17.0 12.5 2.0 1.1 0.8 99.7

1970 90.4 32.8 44.4 15.7 3.6 2.4 3.4 192.8

1980 244.1 64.6 157.8 24.3 6.4 7.2 12.7 517.1

1988 401.2 94.5 334.3 35.2 7.6 16.2 20.3 909.3

1992 476.0 100.3 413.7 45.6 11.1 17.4 27.3 1,091.3

2000 1,004.5 207.3 652.9 68.9 29.0 19.9 43.1 2,025.5

2006 1,043.9 353.9 837.8 74.0 27.9 24.8 45.0 2,407.3


Many things jump out of that data, but there are two really noteworthy thing for me. In 1962 corporate income taxes represented 20% of Federal income, by 2006 they had dropped to 14%. Social insurance taxes increased from 17% of income to 34.8% of income in 2006. Keep in mind, those are the taxes paid largely by working people because they only apply to wages below $97,500 this year and don't apply to dividends or capital gains.

Deficits and Debt

This is one of the most confusing parts of the budget. Not only are they two different things but there are two kinds of debt and two types of deficits.

As of the end of 2006 the federal government had accumulated a debt of $8.42 Trillion. That is what is referred to as the National Debt. It is a monster number but also a misleading one because there are two different national debts. The Government owes $4.829 Trillion to the public, which is people who bought government bonds. But it also owes $3.622 Trillion to itself. How can that be one might ask?

The complexity stems from the fact that the government collects general revenues, such as income taxes, which can be spent on anything. But it also collects money that can only be used for specified purposes. The most familiar of those sources are Social Security and Medicare taxes, but they also include gas taxes and airport taxes. Those revenues go into "trust funds" and must be used for designated purposes. Every year that less money is spent on Social Security benefits than is collected in taxes, the surplus amount is added to the fund. That has been the case with Social Security for all but a handful of years, which has accumulated $2 Trillion.

A problem arises, though, when the Government doesn't collect enough general revue in a given year to cover it's general expenses. At that point it needs to borrow the difference. It has two choices - issue bonds to the public or borrow from it's own trust funds. It does both. It borrows from the trust funds first, giving them notes with a specified interest rate, and then borrows from the public for the rest. It makes sense for the government to do this, otherwise it would have to increase public borrowing which would drive up rates. But because this is not well understood, the public does not get a clear picture each year of our revenue shortfalls.

That gets us to the deficit. The deficit is the difference between what the Government takes in each year from all sources and what it spends in that year. But in reality, here are two deficits. There is the one the public sees each year and then the real deficit. In 2006 we were told that the deficit was $284 Billion But in truth, it was $434 Billion The difference was $185 Billion that was borrowed from excess Social Security taxes. It is important to remember those taxes came only from wage earners making less than $97 thousand. They did not come from people earning millions of dollars or whose income is from dividends and capital gains.

This also means that every time we cut income taxes for the wealthy or eliminate the estate tax, we are shifting that tax burden onto the shoulders of wage earners who pay Social Security taxes.

Federal Spending

The Federal Budget is comprised of thousands of programs. For an overview those expenditures are aggregated into the following "functions', as described by the Center on Budget And Policy Priorities. Here is the percentage of the total 2006 budget that was spent on each of these categories.

Defense and security - 21%: The largest component of the “defense and security” category is the national defense function. This category also includes expenditures for activities that OMB has designated as homeland security activities but that fall outside of the defense function.[4] In addition, this category includes the international security assistance subfunction of the international affairs function.

Social Security - 21%: This category consists of all expenditures in the Social Security function.

Medicare, Medicaid, and SCHIP - 19%: This category consists of the Medicare function, as well as the “Grants to States for Medicaid” account and the “State children’s health insurance fund” account.

Safety net programs - 9% : This category of programs includes all programs in the income security function except those that fall in the following two subfunctions: the federal employee retirement and disability subfunction; and the general retirement and disability insurance subfunction. The latter contains the Pension Benefit Guarantee Corporation and also covers programs that provide pension and disability benefits to certain small groups of private sector workers.

Interest on the national debt - 9%: This category contains the net interest function.

Everything else - 21%: This category includes all federal expenditures not included in one of the five categories defined above. The subcomponents of this category that are displayed in Figure 2 are defined as follows:

Benefits for civilian retirees and veterans - 5%: This subcategory combines the veterans benefits and services function and the federal employee retirement and disability subfunction (which is part of the income security function).

Education - 4%: The education subcategory combines three subfunctions of the education, training, employment, and social services function: elementary, secondary, and vocational education; higher education; and research and general educational aids.

Scientific and medical research - 3%: This subcategory consists of the general science, space, and technology function and the health research and training subfunction of the health function.

Transportation - 2%: The transportation subcategory consists of the entirety of the transportation function.

Non-security international - 1%: This subcategory consists of the international affairs function with the international security assistance subfunction removed.

All other -5%: This subcategory consists of all expenditures that fall in the “everything else” category and are not included in one of the five subcategories described above.


This "all other" category, which spends only 5% of the budget is much of what most people think of as the Government. It includes the Federal Courts and prosecutors; FBI and ATF; USDA, which includes the Forest Service, farm programs, rural development programs like the Rural Utility Service which used to be the REA, and meat inspectors; Department of interior, which includes the National Park and BLM; all the regulatory agencies like the Consumer Product Safety Commission, Food and Drug Administration, FDIC, and Federal Reserve Board; the Congress whose largest expenditures are for the Library of Congress, Government Accountability Office and other research arms, and the list goes on and on.

Observations

The Wealthy are Winning the Class War. Income taxes are supposed to be progressive. The principle is that a wealthy person can afford to pay a larger percentage of his income in taxes than a poor person. The system is supposed to require the wealthy to pay a higher tax rate and provide deductions and exemptions to benefit the middle class. In contrast Social Security/Medicare taxes are designed to be regressive. You pay a flat rate up to the income limit, with no exemptions or deductions. As a consequence, most families earning less than $70,000 pay more in Social security/Medicare taxes than income taxes. And they actually pay more than they think. They pay 7.65% from their wages, but their employer also pays 7.65%. Since the employer could have increased the employees salary by that amount, each of us is effectively paying 15.3%.

So how has this played out in the last forty four years? From 1962 to 2006 individual income taxes slipped from 45% to 43% of revenue and social insurance taxes jumped from 17% to 35% of revenue. And as an added benefit to the wealthy, during that same time period Corporate income taxes dropped from 20% to 14% of revenue. While the stocks of those companies has increased in value 140 fold, their contribution the government and citizens that enable them to prosper has dropped by 30%.

Middle Class is Subsidizing the Wealthy. In 2006 22% of the Social Security and Medicare taxes ($185 Billion), which were collected only from poor and middle income wage earners, were used to fund the military and other expenses of the Federal Government. Expenses that should have been payed with corporate and individual income taxes. That robbing of Social security has been going on for virtually every year since the program's inception and really picked up the pace after 1984. In that year the last major "reform" was made to the program that raised contribution rates and delayed retirement dates. As of right now income tax payers and corporations have "borrowed" almost $3.6 Trillion from Social Security and other trust accounts.

There would be nothing wrong with that in principle except that people like Bush threaten to never pay it back. Remember our President saying that all those Government notes in the Social Security Trust Fund were just a bunch of pieces of paper. Whenever you hear someone advocating "Social Security reform," look close at what they are saying. They are not advocating that the wealthy pay more income taxes so that the trust funds can be repaid. Remember Gore and his "lock box.' He wanted to end the raiding of the trust funds. But the Republican right made that into a joke.

Return to the Reagan Era. We just finished watching the Reagan Love Fest, AKA Republican Presidential candidates debate. Remember those glory days of yesteryear when there were four cars in every garage, prime rib in every oven and an economy humming to perfection. I think we should go back to something from that era, which would go a long way towards making our tax structure more progressive and solving our fiscal problem. Today, the top tax rate is 35%, applied to income over $338,000, and the capital gains rate is 15%. In the heyday of Reaganomics, between 1982 and 1986, the top tax rate was 50%, it applied to income over $215,000, and the capital gains rate was 20%. If it worked miracles then imagine what it could do for us now.

5 comments:

  1. John in IL8:32 PM

    Effective federal tax rates are higher now than during the Reagan years for those in the highest income brackets.

    http://www.cbo.gov/ftpdocs/77xx/doc7718/SupplementalTables.xls

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  2. John in IL8:49 PM

    In 2006 22% of the Social Security and Medicare taxes ($185 Billion), which were collected only from poor and middle income wage earners

    High income earners also pay into Social Security and Medicare. Those taxes didn't come only from "poor and middle income earners".

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  3. John in IL8:57 PM

    One last comment. If we are borrowing from the trust fund, shouldn't that make the trust fund smaller?

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  4. Between 1982 and 1986, Reagan's administration, the maximum income tax rate was 50%. But more importantly the percentage of government income coming from personal and corporate income taxes has declined in comparison with income from SS & Medicare taxes.

    Of course some SS and Medicare income comes from the wealthy. But, as pointed out there, the income subject to SS taxes is capped, currently at $98K. And dividends and capital gains are not subject to those taxes.

    As I tried to explain, when funds are borrowed from the trust funds, Treasury deposits an interest bearing note for the amount. The trust funds are those government IOUs. The $2 Billion SS Trust fund is $2 Billion of government issued notes.Money paid in SS and Medicare taxes that is used to pay for general revenues.

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  5. John in IL10:40 PM

    The maximum(marginal) tax rate is different than the effective tax rate.

    I understand the accounting behind government trust funds. Spending excess SS monies increases the size of the trust fund.

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