Tuesday, February 26, 2019

Going In Way Over My Head

OK here goes. 

Let's say you have a society of 1,000 households that has $1,000,000 to go around to pay for everything and that society is currently structured like the US.  This is a crude breakdown of how the money would be distributed.

1 Household:  $500,000
10 Households:  $19,000
89 Households:  $2,134.83
400 Households:  $175.00
500 Households:  $100.00

So for the society to survive we need to build roads, have a government, have utilities, have businesses, etc.  This requires an infrastructure and so we decide as a society we will have tax rates that match those of the US.  Here is how that would breakdown. 

First we have two categories.  If you work for the money you will pay at a higher rate than if you earn money from investment.  This is a very important distinction.  Normally the people at the top of the money, the 11 households in our example society that control such a large chunk of the wealth will be investing their money.  So they will be paying at a lower rate than those say in the middle.  For example the 400 households making $175.00 will pay at around 24% or $42.00 in taxes.  The top household would pay a maximum of 20% on their capital gains.  Let's say for instance they invested their $500,000 and earned $10,000 in the year.  That is a modest gain of 2%.  They would then pay $2,000 in taxes.

It is important here to note that only earning at 2% and making $10,000 in one year meant they earned more in 1 year than more than half the value of one of the next 10 families total worth.  It should also be noted that the 24% those 400 households paid was 24% of their total worth.  The $2,000 paid by the 1 household was only .4% of their total worth.

So let's look closer at one of those middle income houses.  They earned $175.00 and paid $42.00 in taxes.  That left them with $133.00.  They put 10% toward retirement.   Now they are down to $115.5.  Now we pay for insurance and are down to $106.75.  There is home payments, groceries, kids activities, vacations, etc.  So let's say at the end of the year this house is able to save $35.00.  That is 20% of their gross income.  

OK we had a good year.  Made good money, have a home, and saved $35.00.  Luckily nothing big happened to affect our income.  Inflation in the US runs at around 2.5% so we'll hope next year to make another $4 or $5 to help cover the increase in inflation.  Saving $35.00 a year will be very good, but at $35.00 a year it will take us 61 years to match the wealth of the lowest of the top 10%.  The truth is the average American saves less than 5% a year.  So closer to $9.00 in our case.

Then the 900 people decide hey you know we think that top 1% should really pay a higher tax.  Let's say everything they earn in a year above $2,000 will get hit with a 70% tax.  OK let's look at the effect this has.

So let's say you are one of the 89 households earning $2,134.83 and you have no capital gains so you are paying at the highest possible tax rate. On the first $2,000 you would pay $720, then on the next $134.83, you would pay $94.38.  A Total bill of $814.38.  OK that reduces their net income to $1,320.45.  That is still 10x what our middle income houses net income was at $133.00.  So assuming the cost of living was the same for both families while the middle income family saved $35.00.  The higher income family saved $1,230.45.  That is 35 times the amount saved by our middle income family. 

Well the government in our society is made up of members from the top 10% setting all the rules and they decide that they want to cut funding for the college in our society and argue that it is these ever increasing higher education costs that required the 70% tax.  So that is eliminated.  The college still has the same costs as before but now they have less funding, so they decide to do two things.  They'll ask for donations from the wealthy members of our society who can write that off on their taxes and they increase tuition.  Not at 2.5% a year but closer to 5% a year since the college is facing a 20% to 30% decrease in funding over a 10 year period.

Before this decision it was much easier for those middle class families to afford college, but with this kind of increase the amount they have to save for college has increased quite a bit.  Now very often those families will have to borrow money in order to send their child to college.  Of course the people with the money are the wealthiest 1% so the lower income families will have to borrow from them in order to afford college.  For the wealthy this was a win win.  Not only did they eliminate the 70% tax but now they have created another source for capital gains income. 

We could play this cycle out over and over and what you'll see is that the wealthiest gain great benefit by whatever decisions are made.  Investing in infrastructure.  Sure sounds great who controls all the money to borrow to do the work.  Who owns all the companies with all the heavy equipment to do the work.  Really no matter what those decisions are the wealthiest are going to be fine.  The only time the lower 900 households are getting any help at all is when something is done in the society to help take some of the financial burden off of their shoulders. 

I write all this for two reasons.  The notion that is raised by the wealthy that increasing their taxes will somehow overburden them is complete nonsense.  It may reduce some of the luxury spending they could do, but its impact on their income would be minimal.  The second reason is to point out that the primary help the middle class needs in order to grow and be strong in our society is a reduction of the financial burden being placed on their shoulders.  Those burdens are real and not going anywhere.  Infrastructure, government, military, police, education, etc.  These are real things with real costs and the more the system works to slide that burden onto the middle class the more strain it puts on their shoulders.  What we have is a society where 10% enjoy the benefits of the work being done by the remaining 90%. 

I understand this is a very simple and crude look at how these things work, but the basic ideas hold true.  There is a reason why the wealthiest .01% have increased their wealth at a rate 4 times that of GDP growth while the middle and lower incomes groups have gained their wealth at a slower pace than GDP. 



  1. Thank you for taking the time to write this. I've read it now three or four times, and it's interesting to think about.

    Why is the flat tax not a good idea? What would happen if we had a nation where X percent of all earnings--off work or interest--are deducted to the till to pay for all of the shared resources like police, fire, schools, etc., and there is no writing off anything, no annual filing, etc.?

  2. The biggest knock on the flat tax has been that it puts a heavier burden on those with less. Let's say you set the number at 25%. Well 25% for a family making $50,000 a year is a much heavier burden than 25% for a family making $500,000 a year. Yes the family making $500,000 pays $125,000 in taxes, but they still net $375,000 for the year. The other family only pays $12,500, but they only net $37,500.

    Most countries have a scale and then an additional hit above a certain amount earned. So for instance if you are making $50,000 you may pay 18% and the family earning $500,000 would pay 37%. Another family earning $12,000,000 would pay 37% on the first $10,000,000 then maybe 50% on the remaining $2,000,000. Then another family making $125,000,000 would pay 37% on the first $10,000,000, then 50% on the next $90,000,000, then 70% on the last $25,000,000. Something along those lines.

    The big controversial ones are capital gains and inheritance.

  3. I thought I remember that being the biggest knock, and I think I would be willing to give it a try for 10 years or so and see then where we are.