The Progressive Freedom Vision: Federal Tax Policy for Individuals
As progressives we share common values and a vision of a just and equitable world articulated as the progressive freedom vision. The “essential freedoms” that flow from our shared values require advocating relentlessly for specific policies, and advocating for candidates who support and champion these policies. This post focuses on federal tax policy for individuals. We suggest several levels of policy change, labeled progress, ambitious, and full.
Federal tax policies exacerbate the large and growing disparities in wealth in our country and play an important role in determining whether people have the Life & Human Dignity and Economic Opportunity essential freedoms.
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Progress: Eliminate the Social Security wage base cap
Social Security aims to provide basic economic security for our senior citizens and disabled citizens of any age. It is funded by a 12.4% (2019) tax on wages, split equally between employer and employee (self-employed workers pay the entire tax). Only wages up to the wage base cap of $132,900 (2019, inflation adjusted annually) are taxed.
Social Security is unsustainable and will become more so as the baby boomer generation fully retires. Payments have been reduced repeatedly and further reductions are being threatened. The alternative is an increase in tax revenues. Eliminating the wage base cap would increase tax revenue by about 13%, while impacting only the 5% highest earners.
Progress: Effective tax enforcement
Tax evasion is big1. In a 2016 report2, the IRS estimated the gross tax gap — “the amount of true (Federal) tax liability that is not paid voluntarily and timely” — to be around 18%. This doesn’t sound like much, but the lost tax revenue is nearly three quarters of the size of the annual Federal budget deficit (before the Trump tax cuts).
Ambitious: Eliminate preferential treatment of investment income
When an asset like stock or a house is purchased, held for more than a year, and then sold for a profit, the profit is taxed at a lower rate than wages or interest. Most stock dividends are also taxed at a lower rate.
These breaks cost more than $200B annually (2013 data)3. Moreover, preferential tax treatment of investment income is an important cause of income and wealth inequality in the US.
Ambitious: Subject all personal income to Social Security tax
Wages are less than half of all earnings; the rest comes from investments, including interest, dividends, and capital gains. If Social Security taxes applied to all income, Social Security would instantly be sustainable with no need to reduce benefits, and the overall Social Security tax rate could be lowered substantially. This would help lower-income and many middle-income workers, and would reduce the large preferential treatment our tax system gives to investment income.
Ambitious: Subsidize housing fairly
The tax code subsidizes home ownership through tax breaks. These subsidies only help people wealthy enough to be able to purchase a home. One can debate whether or not to subsidize housing, but if we do, we should subsidize it in a way that applies to everyone, not just to people who earn enough to own their own homes.
Full: Fundamental tax reform focused on major simplification and fairness
Our tax code is enormously complicated. It might seem that this is just a full-employment program for accountants and tax attorneys, but many tax breaks for the wealthy are hidden from the public’s understanding through this complexity. The whole tax code needs to be replaced with something much simpler, with fewer opportunities for tax breaks and tax evasion.
Eliminate Social Security Base Wage Cap
The wage base cap makes Social Security a regressive tax: Workers earning more than the base wage cap pay at a lower rate than everyone else. For example, a full-time minimum-wage worker in North Carolina earns $15,080 annually and pays 12.4% (including the employer’s portion). In contrast, a worker earning $1M per year is only taxed 12.4% of the $132,900 base wage cap, which is only 1.6% of the worker’s earnings. Eliminating the base wage cap would make the Social Security payroll tax a fairer flat tax instead of an unfair regressive tax.
Doing so would also improve the system’s solvency. Let’s look at a back-of-the-envelope calculation to get an idea of what eliminating the base wage cap would do. In 2017, the Social Security Trust Fund collected $873.6B from the payroll tax4 and there were 165.4M workers earning wages5. Approximately 95% of workers earn less than the base wage cap. Eliminating the base wage cap would affect only the 5% highest-earning wage earners and would raise the revenue from the payroll tax to about $990B, an approximately 13% increase. This change would improve Social Security’s long-range sustainability, but would not, alone, eliminate the long-term shortfall.
Increasing revenue from the payroll tax is one approach to improving sustainability. The other approach is reducing benefits. Over the years, benefit reductions have been implemented by partially subjecting Social Security payments to income taxes, by increases in the “full retirement age,” and by changes in the way that cost-of-living adjustments are computed.
Many proposals to “fix” Social Security have been made. Analyzing those proposals is complex because there are many variables to model — payroll tax rate, base wage cap, how benefits are determined, and how benefits are taxed — and many assumptions that must be made and analyzed — worker demographics over many decades, lifespans during retirement, inflation over decades, etc. A brief synopsis of current bills is available here and a conservative but thoughtful analysis of one of the bills, The Social Security 2100 Act, is available here.
Effective tax enforcement
As detailed in ProPublica’s report “How the IRS Was Gutted,” Congressional Republicans have been working for years to defund the IRS, especially the enforcement division6. Even though evasion is highest among high-income households, audits of the top 1% of taxpayers have declined from 8% in 2011 to 2.5% in 2017, while audits of the bottom 36% of taxpayers have declined far less steeply, from 1.2% to .7%.
Lax enforcement exacerbates unfairness in the tax system because it shifts tax burden from people who evade to people who obey the law.
Eliminate preferential treatment of investment income
The key tax breaks for investment income are:
Much lower tax rate on long-term capital gains and qualified dividends than on wage income. These breaks cost $161B annually and 93% of the benefit flows to people in the top 20% of income (68% flows to people in the top 1% of income).
Step-up in basis: An heir of an appreciated asset does not need to pay capital gains tax on the decedent’s long-term capital gain on that asset. This is a powerful way for wealthy investors to pass along untaxed wealth to heirs. This break costs $43B annually and 65% of the benefit flows to people in the top 20% of income.
Tax is only paid when an asset is sold, allowing large gains to accumulate for years without being taxed. This allows an investor to keep more money invested over time, and aids significantly in wealth accumulation for investors compared to wage earners.
Estimates of cost and distribution are from the Congressional Budget Office3.
Subject all personal income to Social Social Security tax
Total 2017 personal income was $16.8T7, more than twice the total wage income. Taxing all personal income for Social Security would therefore more than double funding for the Social Security system. Since such a large funding increase is not necessary, the tax rate could be reduced without affecting benefits.
Additionally, since most investment income is earned by high-income and high-wealth individuals, taxing all income would shift some of the burden of supporting our elderly population to those who currently pay very little of that burden.
Subsidize housing fairly
The tax code subsidizes home ownership in three major ways:
Mortgage interest is tax deductible
Property tax is deductible,
$500K of long-term capital gain on the sale of a married couple’s primary residence is not taxed; this benefit can be used repeatedly, subject to a few benign conditions.
Overall, about 64% of households own their own homes8. Not surprisingly, more higher-income households than lower-income households own homes: Home ownership is over 78% for households with family income at or above the median income and 50% for households with family income less than the median income. So, tax breaks for home ownership disproprotionately help higher-income households.
Moreover, tax breaks delivered as deductions are more valuable the higher one’s marginal tax bracket, further tilting the benefit of these subsidies toward higher earners.
Gale W, Krupkin A. How Big is the Problem of Tax Evasion? The Brookings Institution. https://www.brookings.edu/blog/up-front/2019/04/09/how-big-is-the-problem-of-tax-evasion/. Published April 9, 2019.
Federal Tax Compliance Research: Tax Gap Estimates for Tax Years 2008-2010. IRS Publication 1415; 2016:1-25. https://www.irs.gov/pub/irs-soi/p1415.pdf.
The Distribution of Major Tax Expenditures in the Individual Income Tax System. Congressional Budget Office. https://www.cbo.gov/publication/43768. Published May 29, 2013.
Old-Age, Survivors, and Disability Insurance Trust Funds, 1957-2018. Social Security Administration. https://www.ssa.gov/oact/STATS/table4a3.html.
Wage Statistics for 2017. Social Security Administration. https://www.ssa.gov/cgi-bin/netcomp.cgi?year=2017.
Kiel P, Eisinger J. How the IRS Was Gutted. ProPublica. https://www.propublica.org/article/how-the-irs-was-gutted. Published December 11, 2018.
Duffin E. Personal Income in the United States from 1990 to 2018. Statista. https://www.statista.com/statistics/216756/us-personal-income/. Published April 29, 2019.
Quarterly Residential Vacancies and Homeownership, Second Quarter 2019. US Census Bureau; 2019:Table 8. https://www.census.gov/housing/hvs/files/currenthvspress.pdf. Accessed August 15, 2019.