As we head into the last laps of the Presidential election, it seem appropriate to consider how our tax system is structured. The people who argue that the tax system is too complex are correct, but not for the reason that they think. The marginal tax on income is higher than we think because of the large number of other taxes that we pay. Pigouvian taxes, like the taxes on cigarettes and liquor, raise a surprisingly small amount of revenue, yet they are the ones that people feel most strongly (and feel most strongly about ) because they are rapidly passed through to the customer. I like to joke that the truest market basket that we can use for the cost of living is ten gallons of gas, a carton of Marlboros, and a case of Bud or bottle of Jack Daniels.
One tax that I dislike is tax on unemployment compensation. I’ve never qualified for unemployment compensation, but taxing it seems to be mean-spirited at best, and it doesn’t raise that much money. If I buy insurance against nearly any loss, I am not taxed when the insurance company pays me for my car being totalled or my house being damaged. At the same time, I also believe that the amount that is charged for unemployment insurance should be much higher, and that people should be able to opt out. It should be self-funding, not something that is largely dependent on federal funding. Unfortunately, this means that unemployment insurance rates would either have to go up or people would need to work longer to qualify for it, and the amount of time that they would receive benefits would be reduced.
Another hidden tax is the increasing reliance that towns have on various fees, like the $150 ticket for that red-light camera. What most people don’t know is that the revenue is split between the camera operator and the town, and that’s a lot of the reason that the ticket is so expensive. If you have a good volume of traffic, as Washington DC does, the ticket is fairly cheap because most people won’t fight it and a lot of people will run the light or speed.
Another interesting tax is the ability to buy a deferred verdict for your first misdemeanor or traffic violation conviction in some jurisdictions. One pleads guilty, pays the fees and fine, and if you keep a clean record for six months, the guilty verdict is not entered and it is effectively suspended until then, unless you get picked up on another charge. The people who would benefit most from this are the least able to pay the fines, and if you need a payment plan, it costs you $35 extra. There are opportunities to work off one’s fines at $10 an hour, but that doesn’t do you any good unless you have a day or days off during the week. Work crews do not go out on weekends. If you are booked into the county jail, it costs you $30 to be booked, though that fee is refunded if you are found not guilty on the charge. A lot of arrests in my town are actually just the issuance of a summons. The county jail has about three times the number of inmates that it was built to accommodate.
I don’t expect the reduction in FICA taxes from 6.2% of income up to $106,500 to 4.2% will survive into 2013, and we’ve already seen a reduction in the maximum contribution to health savings accounts from $5000 to $2500 to health savings accounts effective in 2013. I believe that 2010 saw the removal of over-the-counter drugs from the list of items that you could use the account to reimburse your costs.
I liked the “Making Work Pay” tax credit that was available in 2009 and 2010 more than the FICA tax holiday because it was a lot cheaper and the greatest amount of the tax cut went to people who made $60K or less if you were single. It phased out above that level. You needed to make something like half-time minimum wage to get the maximum amount, which I think was $800, and everyone would get $800 ($1600 for married filing jointly) until they hit the phase-out amount for their filing status. I had the pleasant surprise of the IRS telling me that I qualified for a couple of hundred dollars for the “Making Work Pay” tax credit with my 2009 return. I had figured that I wouldn’t be eligible for it, so I didn’t bother to research it.
One thing that people often don’t understand is that tax deductions aren’t worth what they think that they are. Suppose that I have $10K in itemized deductions. I’d get $5950 for the standard deduction in any case, so I save only about a thousand dollars on my federal taxes compared to not having the deductions.
The coming thing will be to broaden the tax base. Rates won’t change, but taxes will increase.