The High Cost of Low Taxes
One issue in health reform that’s gotten very little attention outside of Greg Mankiw’s blog is that the phase-out of the subsidies for low income people is going to have an impact on their incentives that’s similar to a high marginal tax rate:
According to CBO, a family of four making $54,000 would pay $4,800 for health insurance. The rest of the premium would come from government subsidies. If the family’s income rises to $66,000, the subsidy falls, and the cost of health insurance rises to $7,600. In other words, earning an additional $12,000 requires the family to pay an additional $2,800.
I think the best way to think about this (I sort of doubt Mankiw agrees) is as an illustration of the economic cost borne by U.S. political culture’s extreme aversion to taxation. Americans “know” that high taxes are bad for the economy, but this belief doesn’t really lead them to reject the idea of public responsibility to ensure the provision of certain kinds of services. Instead it often leads politicians to embrace ways of doing things that are much less economically efficient than high taxes would be.
In a socialist dystopia like Sweden, when the decision is made that everyone should have access to a certain level of health care services what happens is that the government pays for everyone to get those services. Compared to a complicated mix of mandates and subsidies, this leads to higher taxes. But it can lead to much less in the way of tax-related economic distortions. What’s more, it makes the tax situation much more transparent to policymakers and analysts. I’m pretty sure that nobody on the Finance Committee intends to create the particular set of weird implicit marginal tax rates that are now going to exist for the near-poor. But a number of the members probably don’t quite see what they’re doing. If they were just straightforwardly sitting down to write a tax law, by contrast, everyone could see what was happening.
46 Responses to “The High Cost of Low Taxes”
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October 16th, 2009 at 1:51 pm
Or, to put it better, when there are phase-outs of subsidies, there will probably be ranges of income where there are high marginal effective tax rates, *if* one counts the subsidy phase-out as a tax. I’ve run into this before, in discussions of welface and WIC payments. I’m not sure how to get around it.
October 16th, 2009 at 2:12 pm
In sweden, the poor pay income taxes at a rate similar to the middle classes here. And, the progressive tax structure adds the same “loss of incentive” to increase their pay. I doubt the near poor in this country would prefer this method, but maybe.
October 16th, 2009 at 2:18 pm
Americans: they love their country but they won’t pay for it.
Even more apparent when viewed from outside the country, where, for instance, in Canada school textbooks present the American Revolution as partly inspired by a desire of the colonists to avoid paying their fair share for their own defense (and to steal the land that had been given to the French in Quebec and the native peoples).
October 16th, 2009 at 2:18 pm
We have way too many ‘taxes’ that are not efficient.
Health Care is an obvious one in the news now.
We have phase outs of deductions and exemptions that raise the effective tax rate.
If you have kids in college then it is very easy to have an effective tax rate of well over 75%
October 16th, 2009 at 2:20 pm
Mack,
From what I can find:
n 2002, personal income tax rates, the combination of state and local rates, were 31% on the first increment of taxable income up to 232,600 Krona (about $173,065); 51% on the next increment up to 374,000 Krona (about $278,000); and 56% on increments of income above 374,000 Krona. Personal deductions vary between 8,600 and 18,100 Krona ($6,364 and $13, 400).
I’d be interested to see more about Swedish tax policy and how it impacts the working and lower middle class in Sweden vs. similar groups in the US.
October 16th, 2009 at 2:25 pm
“…is as an illustration of the economic cost borne by U.S. political culture’s extreme aversion to taxation.”
No, it’s an aversion to taxation by a government that doesn’t serve the average taxpayer.
October 16th, 2009 at 2:26 pm
Exactly so. Anti-tax orthodoxy results in policies that are so bent into pretzels to avoid higher taxes that they end up hurting the economy and citizenry more than higher taxes would.
October 16th, 2009 at 2:30 pm
Kafka,
In order to get buy in, Sweden seems to offer a lot of middle class entitlements. In the US, the left seems to primarily push programs that will help the disadvantaged. But, in so doing, they weaken support from the middle class. In they instead set up systems similar to Social Security with programs that helped the poor as well as the middle class, I think they would get a lot more support.
October 16th, 2009 at 2:33 pm
I generally agree with Matt on this point, if only because high taxes would make the costs of these policies more transparent, which is always a plus in a democracy (or any other system of governance, for that matter).
That all is really a theoretical question for changing American political culture later, though.
The real question of the day is: is the Baucus bill worth those really high marginal tax rates on the poor and middle class?
October 16th, 2009 at 2:35 pm
I think that they should have phased the subsidies out slower and then eliminated the employer exclusion. This would get you to universal coverage with less economic distortions. They should also create a public plan which might allow you to have lower subsidies poorer people while giving them the same quality of care.
October 16th, 2009 at 2:38 pm
OK I love Canada but they stole land from Native Americans too.
October 16th, 2009 at 2:41 pm
… and permanently higher levels of unemployment. You write as if it’s free; it’s a trade off. One that some people like, and others dislike.
Being opposed to this does not make you a bad person; it merely puts you in the camp of those who read the tradeoffs differently from you.
October 16th, 2009 at 2:47 pm
The Baucus bill sucks but it is definitely worth the marginal tax rates. Over time the subsidies can be increased to phase out more slowly and a strong public plan can be introduced to lower costs. We can also allow everyone into the exchanges and eliminate the health tax exclusion. The important thing is that it commits us to near universal coverage and forces conservatives to choose between conservative health care policy on one hand and lower taxes on the other.
October 16th, 2009 at 2:48 pm
Craig,
That is an interesting take-one that I’m not sure most families like Matt described above would agree with.
October 16th, 2009 at 2:50 pm
To what extreme could we take this? For example, if we instituted a marginal tax rate of 100% above a nominally comfortable income level (i.e. $30,000) would this be a net positive for transparency and democracy? I doubt it. People will not be spurred to work without compensation purely because the way in which their productivity is being wasted and/or redistributed is more evident.
October 16th, 2009 at 2:58 pm
My favorite outrage: if this bill gets passed, as it stands, around 20,000,000 people still won’t have health insurance.
Insanity or malice?
I’m going with malice.
October 16th, 2009 at 3:00 pm
It’s all about making true levels of taxation so opaque that the vast majority of people who are middle class and poor don’t see that they are being screwed by the system while the rich get richer and big corporations get huge gifts from the taxpayers. Lack of transparency is a feature, not a bug, for those writing these laws.
October 16th, 2009 at 3:04 pm
Greg Mankiw should focus on economic distortions among his friends in the top 1% (or 0.1%) of income earners.
October 16th, 2009 at 3:04 pm
as a technical issue, this is worth thinking about.
as a practical matter, the number of people who will go from $54K one year to $66K the next is very, very small (an actual real-world example would be i’m making $54K this year and i’m making $55.1K next year, but greg mankiw was the chair of the council of economic advisers under bush – he don’t need no stinkin’ real-world examples).
October 16th, 2009 at 3:06 pm
Whenever the issue of taxes and American’s distaste for tax increases, the example of Sweden and Western Europe’s fine health care system is held up as one of the benefits of higher taxes. The reason Americans hate higher taxes, apart from having to pay more, is watching fat ass lazy nepotistic bums in government squander the tax money they get now.
Ever seen a guy ‘fixing’ a pothole with three supervisors watching him? Ever driven by a brand new government building palace on roads that look like Dresden after WWII? Ever run into a drunken idiot while trying to get a permit to build a fence on your own property? Government, be it local, state or federal wastes money on a colossal scale every day. You’d have to be blind not to see it and it pisses people off. That’s the cause of taxpayer revolts – not because Americans are dumber than Europeans.
October 16th, 2009 at 3:10 pm
the number of people who will go from $54K one year to $66K
Pretty much anyone moving from one job to another is going to make a jump like that – unless your moving for a better commute or more convenient hours.
October 16th, 2009 at 3:10 pm
Howard, I’m one of those people who bounces around those numbers in income due to working several extra freelance jobs in addition to my regular fulltime work, while my wife also works two or three different freelance gigs, just like a lot of other middle class folks trying to make ends meet. My income goes up and down rather unpredictably each year and I guess so would my subsidies under this law. One also doesn’t even know when the paycheck will arrive so you can have a sudden unpredicted rise or fall in income right at the end of the year, throwing off your tax projections. It can be very unpleasant at tax time to find out that because I made a tiny bit more I go over some threshold and lose out completely on some tax break or subsidy–I’ve seen that happen more than once in the past.
October 16th, 2009 at 3:11 pm
Actually, since the ‘mandate’ provisions are so weak, it probably means that more of those families will just choose to pay the $1.95 or whatever and not buy coverage.
If the cost curve isn’t bent significantly this whole thing is going to blow up in a couple of years with or without more subsidies in the initial bill. Either because no will be able to afford coverage or it’ll bust the budget.
October 16th, 2009 at 3:19 pm
Hm, no, there is lots and lots of income variance year to year out there, at all income levels. I’d hazard more than 20% of 54K households are over 66K next year. You don’t even need to switch jobs, just overtime changes can be 10K easily even for a very working class household.
In general, one of my big pet pieves is Republicans who oppose raising taxes since it distorts economic decision making and then make it necessary to pursue neccessary public policy without taxes in a much more distortionary and costly.
October 16th, 2009 at 3:25 pm
I thought of something yesterday that I’ve not heard anyone bring up, and I hope it’s not cynical on my part. We’ve heard lots about people forced to stay in jobs they might want to leave because a member of their family has a health condition that they couldn’t be covered for outside of that employer’s insurance.
How many spouses are staying in a marriage they might want to leave for the same reason? Yikes!
October 16th, 2009 at 3:33 pm
Yup. People do real work to earn that money. That’s what proponents of high taxes never understand. People don’t like to work, and they especially don’t like to work for free. When it comes to a point where a quarter of the time they spend working is done so that a group of self-appointed elites can pat themselves on the back…well, it pisses them off a little bit.
October 16th, 2009 at 3:39 pm
as a practical matter, the number of people who will go from $54K one year to $66K the next is very, very small
My last raise six months ago was from $52k to $65k. Data is not the plural of anecdote, blah blah. But not everyone works for a company with a defined pay scale that goes up 4% a year or whatever.
October 16th, 2009 at 3:42 pm
People don’t like to work, and they especially don’t like to work for free.
I’m sure they don’t. But they probably like having roads, police, a military, a social safety net, etc. All those things cost money. They’re not working for free, they’re working to pay their share of the benefits a government provides. Most intelligent people understand that. But if they’re not interested in paying for such things, I hear Somalia’s lovely this time of year.
October 16th, 2009 at 3:43 pm
stefan, zyxw, i appreciate that there are individuals whose income might have that kind of bounce to it.
but they nonetheless constitute a very small number of households: they must. aggregate household income numbers don’t move around that much, and it’s impossible to believe that’s because there’s a whole bunch of matched pairs out there (i.e., one year person a makes $54K and person b makes $66K, the next year person a makes $66K and person b makes $54K, so household income looks static as result).
October 16th, 2009 at 3:47 pm
adam, i’ll basically say the same to you i already said: there’s 120M households in america (and let’s keep it with the smaller number of households rather than the larger still number of individuals). you could have 1M people a year with 20% swings in their income and it would still be a trivial percentage of the whole.
and your raise is a classic example of anecdote isn’t data: if what happened to you were happening in substantial numbers, we’d see it in the data.
look, i’ve been a self-employed consultant for years and years: i know that income can swing. but that’s not what mankiw is talking about: he’s talking about the theoretical disincentive impact on the very limited number of people who fit this very precisely defined niche, not a larger group of people whose income flows up and down around a point, because their rates will normalize to their actual incomes.
the number of people getting a 20% raise a year is small, and it’s especially small at that point on the income latter.
October 16th, 2009 at 3:48 pm
Mankiw: According to CBO, a family of four making $54,000 would pay $4,800 for health insurance.
MY: I’m pretty sure that nobody on the Finance Committee intends to create the particular set of weird implicit marginal tax rates that are now going to exist for the near-poor.,
The median household income in the U.S. in 2007 was $50,233. One or both of the following is therefore true:
- Matt is out of touch with regard to how rich most American actually are.
- Half of the country is just barely getting by.
I think both are true, and I don’t especially blame Matt for being out of touch. The entire political class is. Hell, even those not in the political class are out of touch: What’s called the “middle class” is really the 55th-99th percentile of households, so broadcast discourse treats someone at the 77th percentile as the middle of the middle, when really they’re among the richest quarter of Americans.
October 16th, 2009 at 3:53 pm
In the wingnut mind, taking a larger amount of money out of people’s pockets and giving it to insurance companies harms the economy less than taking a smaller amount of money out of their pockets and giving it to the government.
The reasoning for this is that insurance companies, being profit-driven, are the good guys, while civil servants, being public-welfare-driven, are the bad guys. You can tell they’re the bad guys, because they’ve eschewed higher-paying jobs in order to promote the public good.
Insert soft-focus rape fantasy and 90-page monologue here.
October 16th, 2009 at 4:03 pm
Income variability from year to year for individuals is actually rather large according to the CBO. Here’s a short summary:
# A substantial fraction of workers ages 25 to 55 experience large changes in earnings from one year to the next. For example, about 40 percent of workers experienced a change in earnings of 25 percent or more between 2002 and 2003. More than a quarter of those workers experiencing large changes in earnings move into or out of employment covered by Social Security.
# Women, younger workers, and workers with lower earnings experience large changes in earnings more frequently than their counterparts.
October 16th, 2009 at 4:06 pm
This is absolutely true, and it’s also why most people have no problem paying a fair amount of taxes. But at a certain point you’re not paying for roads, police, a military, and a social safety net. People understand this. It’s the other things that they end up paying for that they have a problem with.
And aside from the fanatical among us, sober people understand that this isn’t the choice they’re being offered.
Right, which is why the DC area is among the poorest metropolitan areas in America…
October 16th, 2009 at 4:13 pm
Skepticism if not outright hostility to the government is justified and healthy. Joe From Lowell calls these people ‘public servants’ who are ‘eschewed higher-paying jobs in order to promote the public good’. No way. They’re just people picking up a check. Most government people I’ve ever run into couldn’t earn more pay in the private sector – even the sober ones. Like the general population, there’s some great people, some good ones, some bad ones, some evil ones and the vast majority are mediocre.
The jackass on a Segway handing out parking tickets isn’t Ghandi. A little perspective here, please.
October 16th, 2009 at 4:24 pm
@31: Most households aren’t families of four. Which actually makes it kind of annoying that families of four keep getting trotted out to illustrate absolutely everything, but anyway, the median household income for families of four (most of which I hope are two income) could well be above the median income for households in general (which includes a bunch of young singles, old singles/widows/divorcees, retired couples whose children are out of the home, etc.).
In other words, earning an additional $12,000 requires the family to pay an additional $2,800.
OK, so what? They’re still up $9200. I’d call that a good year for them. Obviously they managed to survive the previous year, so assuming we’re not having hyperinflation not reflected in these figures or something, they’re better off than they were in the previous year. Good for them!
Where’s the bad part? Richer people pay more? That’s kind of the point. Or maybe Mankiw thinks there are some families of four that would decide $9200 isn’t worth working for? You know what, maybe there are. I bet not many, but so what? We have massive unemployment and if they don’t want to take on that extra work, someone else will be hired to do it. (This is true even if they’re self-employed: they’re still crowding out the business of a competitor in the same industry.) That someone else might be in a lower income bracket, which is bad news for the government’s bottom line (because the government doesn’t get that $2800), but it’s good news for society to have two working households rather than one overworked and one on the dole.
October 16th, 2009 at 4:24 pm
The median household income in the U.S. in 2007 was $50,233. One or both of the following is therefore true:
- Matt is out of touch with regard to how rich most American actually are.
- Half of the country is just barely getting by.
There is probably some truth to both, but it is also true that not all households are equal. A single adult making $50,000/year in a small midwestern town is quite well off. A family of four earning $50,000/year in the suburbs of New York or Washington is barely getting by.
October 16th, 2009 at 6:22 pm
The marginally poor are much less likely to be turned off by higher wages at the loss of subsidies than extremely wealthy people are likely to be by huge marginal tax rates (support large rate increases, I’m just sayin). Anyone arguing differently is being disingenuous. Additionally, the cost to society for poor people not working is minimal.
Is it terribly wrong to feel that maybe, as a middle class household who is unmarried, I already pay my fair share? Why wouldn’t I be skeptical? The govt never works for us, so of course “new tax” sounds bad. Even the healthcare bill is the same. Only really and marginally poor will benefit, and the middle class is likely to suffer some reduction of service and some additional costs.
October 16th, 2009 at 9:12 pm
The marginally poor are much less likely to be turned off by higher wages at the loss of subsidies than extremely wealthy people are likely to be by huge marginal tax rates
I think you have it backwards. One of the reasons people are poor is that they put a very low value on additional earnings. You’d be very surprised how many low income people are unwilling to take on more overtime, increased job responsibilities, etc. even if it will dramatically increase their earnings.
October 17th, 2009 at 12:23 am
@32 joe from Lowell: “The reasoning for this is that insurance companies, being profit-driven, are the good guys, while civil servants, being public-welfare-driven, are the bad guys. You can tell they’re the bad guys, because they’ve eschewed higher-paying jobs in order to promote the public good.”
“Insert soft-focus rape fantasy and 90-page monologue here.”
Wins. To paraphrase a soccer analyst, “that was sheer quality!”
October 17th, 2009 at 6:25 am
What’s irritating is that there’s all the revenue we’d need to fund Medicare for All by uncapping the Social Security side of FICA above the $109,000 (that’d raise $200 billion year) and directing the revenue to Medicare, applying FICA taxes to unearned income ($26 billion per point, so the full 15.3% is just shy of $400 billion a year), cashing out to workers the value of their employer’s insurance premiums ($220 billion a year). Haven’t even gotten to the $350-$400 billion in cost savings that the New England Journal of Medicine estimated would be gained from switching to a single payer system or raising rates in the OTHER income tax system the US government operates.
If you really want to be a dick and want to pay for a universal day care, Phelps wage subsidies, middle class tax cuts and, oh, high speed rail for the kids; apply the FICA tax rates to unrealized capital gains over a set threshold ($109k, $250k, whatever) A tax on unrealized capital gains is the federal government equivalent of direct wealth taxes (which would otherwise be unconstitutional). Fascinating paper I read the other day by Georgist economics professor Mason Gaffney puts the revenue potential in the ballpark of half a trillion a year (page 35).
http://economics.ucr.edu/papers/papers08/08-12old.pdf
October 17th, 2009 at 9:20 am
Maybe this is off-topic, but my concern is the incentive to earn under the table income. I’m from Massachusetts – and it’s wonderful that people have access to health care – but keeping access to subsidized health care vs. possibly unaffordable individual rates is a pretty compelling reason to try to keep your income off-the-books…
October 17th, 2009 at 10:37 am
Re: One issue in health reform that’s gotten very little attention outside of Greg Mankiw’s blog is that the phase-out of the subsidies for low income people is going to have an impact on their incentives that’s similar to a high marginal tax rate
How widespread will this effect be? Since the phase-out only happens well into the middle income range it’s in the territory where most people have employer-provided insurance (yes, I know there will be exceptions), and so will not be needing tax subsidies anyway.
October 17th, 2009 at 10:43 am
Re: if this bill gets passed, as it stands, around 20,000,000 people still won’t have health insurance.
Insanity or malice?
I’m going with malice
Neither. It’s just expediency, no malice or insanity about it. And as with the original SCHIP bill, we will be free further down the line to increase the scope of coverage so that eventually we will include everyone (with the probable exception of illegal aliens, which matter will have to wait on some sort of settlement of that troubled situation).
October 17th, 2009 at 10:58 am
Re: People don’t like to work
I don’t agree with this. While there’s probably a non-trivial number of people who really would like to sit around eating bon-bons and watching soap operas all day, most people are not like that. It’s not that people don’t like to work, it’s that they don’t like their specific jobs(and may not want to work quite as much as they do). That’s a big difference. Unemployment, even without serious financial worries, can be really, really boring. I was once in a position where I could have gone an entire summer withot working. The first three weeks were fine. Then I started going stir-crazy and went out and got a part-time job. Even if I somehow struck it rich I would have to find some worthy causes to devote a good fraction of my time to, and I suspect that most people would feel the same way.
October 17th, 2009 at 10:59 pm
While the proposed insurance subsidies would raise marginal tax rates for some groups, they would dramatically lower them for others. The reason is that the subsidies would mitigate the existing “Medicaid notch.”
For example, suppose someone receives Medicaid, and she decides to work more hours so she can earn $500 more per year. She would actually end up worse off if the extra money raises her income above the Medicaid eligibility range. Once her lost medical benefits are taken into account, she would have to work a lot more just to come out even. That’s a huge tax on labor.
Under the proposed system, the extra income may still leave her ineligible for Medicaid, but she would get a large subsidy that would enable her to retain health insurance. That improves her work incentives.
In the end, it’s an empirical question. Which matters more: eliminating the Medicaid notch, or increasing the marginal tax rate?