Saturday, December 8, 2012

The Fiscal Cliff and the Missing Family Structure Fix: Construction or Reconstruction?

Introduction.

In this blog post, I'll discuss the current fiscal cliff, the likely reform being proposed, and how there is a missing fix based upon recognizing family structure (including singles), that is needed to prevent this reform failing and more fiscal problems emerging.  At the end of the blog post, I present some conclusions (If you're someone who is already well versed in these issues and their mechanics, you may just want to skip to the end. :)


The Fiscal Cliff.  The negotiations over the fiscal cliff appear to have progressed far enough along that we know the likely resolution.   There will likely be a return to the Clinton era tax rate schedule for families with taxable incomes over $250,000.  Families below that income level will be taxed under the Bush Tax Cuts model, generally speaking.  The only Social Security and Medicare reform proposals widely discussed involve (a) assessing more tax on higher earners (such as by removing the cap on income subject to Social Security tax) (the Democrats' preferred method) and (b) raising eligibility ages (the Democrats' preferred method) or reducing COLA increases or benefits to a voucher in Medicare (the GoP's preferred method).

Peer Marrieds, Singles Not In The Picture; Reconstruction Failed, Why Do It Again?   While these fixes may all have merits, so far there has been no discussion of how this affects a Peer Married family, however.  When their situation is examined, another aspect to resolving the problem emerges. In fact, if their situation is ignored, the current fixes to the fiscal cliff are likely to fail and ultimately reproduce the problems which led to the fiscal cliff.

To provide some historical context, the current political environment has been described as an environment similar to Reconstruction, where the United States had been divided for many years over economic and social justice matters, and an attempt was made to restructure dysfunctional laws and programs, an effort which many see as ultimately failing and leaving portions of the United States population and economy stagnated for decades.  http://inamerica.blogs.cnn.com/2012/11/01/parallels-to-countrys-racist-past-haunt-age-of-obama/.

One big difference between Reconstruction and today, however, is that our marriage laws and child welfare laws at the state level have changed dramatically.  Coverture and head-and-master laws have been repealed (the last head-and-master marriage law was repealed in the 1970s).  The default rule is that income and property is no longer required by law to be held by the man alone, but that marital income and property is joint property (although couples may make other arrangements by contract as well in many jurisdictions.)  Barriers to single or married women holding employment have been repealed or struck down as unconstitutional.  Most child welfare laws now use a "best interests of the child" standard, a child-centric approach which differs from paternal control and financial provision and maternal work standard of some earlier common laws and statutes.    Alimony is no longer required in many circumstances, and is required for shorter periods when it is.   In a reversal from the situation when the US was founded and even during Reconstruction, medical advances have meant that women now survive childbirth and live 5 years longer than men on average (although there is some evidence that this difference in longevity is reduced in peer parenting populations, interestingly).

Nonetheless, these changes which mostly occurred at the state and local level have not been reflected in our national policies, including in the policies being advocated as a fixes to the "fiscal cliff".   (Our Constitution, interestingly, always seemed to contemplate this change in family structure in the way it uses the term "Person" rather than "Man"; when the Constitution was written in 1787, and during Reconstruction when the 14th Amendment was adopted in 1868, marriage laws in most localities looked very different than they did today, however, single women have always had rights to property and earning, if not always anti-discrimination protections to ensure voting and employment rights; in some early locales, such as New Jersey, women could vote if they met the property requirement, until a discriminatory law was passed a few decades into statehood). 

Even though this current fiscal cliff fix is happening against a backdrop of very different state level marriage and child welfare laws, we are not seeing these effects reflected in the fix.  So, we risk doing a "Reconstruction" again rather than a "Construction".  How could we do a "Construction" instead? I'll provide more detail on this below.

Build-Up to The Fiscal Cliff.  

First, here are a few background elements of relatively recent history:

1.  The Missing Half of "Optimal Tax Theory".  In the 1980s, the Reagan Administration and Congress engaged in tax reform that reduced marginal rates.  They also raised the payroll tax rates, the amounts charged for Social Security and Medicare.  Whether this created a flat tax system or a regressive tax system is disputed; part of the answer lies in the fact that property and sales taxes at the state level are regressive, so without a progressive federal system, we necessarily have an overall regressive tax code, which inevitably leads to significant income inequality and instability, such as the recent Great Recession.

Many of the 1980s changes were done in the name of "supply side economics", an economic scheme that draws in part from "optimal tax theory", an academic theory that shows that behavior tends to change in response to tax policy and thus tax policy can distort choices and behaviors and create economic problems (and solutions if it is soundly designed).  "Optimal tax theory" has some merits and a number of illustrations of it have been proven empirically.  "Supply side economics" only took part of the "optimal tax theory", though.  "Optimal tax theory" would have said that to avoid the tax system distorting family choices, you would need to tax income of married people individually (even if the couple shares income as required by many local laws, each earns the income separately, and sometimes incur expenses separately in earning it, and it is distorting to create a fiction that they are jointly earning and expensing it).  In the joint earning fiction, "secondary earner bias" is a significant problem because it means the lower earner pays the highest marginal tax rate the couple faces and also transfers to the higher earner part or all of certain credits and deductions based on expenses the lower earner is the one personally paying.  When a tax code is made progressive, or more progressive (as it was during the Clinton years), and joint taxation stays in place, "secondary earner bias" is exacerbated.  Because joint taxation of married people stayed in place, and because Social Security and Medicare tax and benefits schemes were not adjusted to reflect family structure choices, this ended up overtaxing and underbenefitting 2-earner/2-parent families and creating financial pressures to set a family up with a sole breadwinner.   

2.  Minor Adjustments Since the 1980s.  Since the 1980s, only a few things have been done to address this missing half of "optimal tax theory".  These include: (a) the Clinton Administration and Congress in the 1990s adding the child care tax credit and (b) the Bush Administration and Congress in the the early 2000s removing marriage penalties for 2-earner families with incomes under $130,000 (including making some inadequate adjustment to the EITC to address the marriage penalty there).  Nothing has been done to address the secondary earner bias problem, though, and nothing has been done to address the overtaxing/underbenefitting of 2-earner families relative to 1-earner families and singles in Social Security and Medicare.


Where We Are and Modeling the Fiscal Cliff and Obama's Proposed Fix.  

A lot has been written and said about the problem of income inequality in the United States and how this has grown since the 1980s/Reagan Administration policies were enacted.  We have the largest income inequality of any developed nation.  http://money.cnn.com/2011/11/08/news/economy/global_income_inequality/index.htm  Also, much has been written and said about the growing debt level of the United States.  Our debt level now roughly matches our GDP.  This is very high historically for the United States, and places us 20th in the world for sovereign debt according to one study.  http://www.cnbc.com/id/30308959/The_World039s_Biggest_Debtor_Nations

It is not difficult to see how both these effects of high income inequality and debt result at least in part from the policies listed above in (1) and (2) together with the Bush Tax Cuts policy of cutting rates on upper income taxpayers, particularly those with passive income, like capital gains and dividends, and borrowing money to fund wars and other government programs.


________________________________________________________________

First, let's look at how the tax system would treat a comparably situated sole breadwinner family, two-earner family, and single people at two levels of income.

1.  (a) A sole breadwinner who earns $52,000 and his wife; (b) a two-earner married couple where each earns $40,000 and (c) two single people, each earning $40,000. 

2.  (A) A sole breadwinner who earns $130,000 and his wife; (b) a two-earner married couple where each earns $100,000 and (c) two single people, each earning $100,000.

I deliberately chose the ratio of 130%, i.e. that the sole breadwinner makes 130% of the sharing parent, based upon a study some economists did that showed that, on average, when a sole breadwinner takes on half the unpaid work of being a parent, his (or her) income drops by 30%.  This frees up the other parent to earn money however, so that is why the 2-earner families'  combined taxable incomes in two sample groups are $80,000 and $200,000, respectively.  Significantly, this example does not include any analysis of earners, whether they are parents or sole breadwinners, who are able to get into passive ownership roles and earn much higher incomes because they are no longer earning by their labor and control significant amounts of assets.  The modeling for that type of income has some similarities, however, to the modeling of earned income in how our current system distorts matters and creates deficits and instability.  It adds too much complexity to address it here, but I will try to do that in a later post.

The idea of the 130% ratio is to establish each family as relatively self-contained and self-supporting.  The Sole Breadwinners have one parent doing unpaid work of family life full-time.  The Peer Marrieds each work at paid employment less than Mr. Sole Breadwinner and split the unpaid work of family life between them.  In both families the money gets earned and the unpaid work gets done. This is a very crude way to measure this, however, as there are a number of intangible issues that arise in comparing these families that are very relevant and that I'll discuss in a later post.  Although these intangibles ultimately bear on fiscal costs in many ways, to keep things simple in this illustration of the missing family structure fix in the current fiscal cliff compromise, I'm just focusing on the accounting of money.

I have also chosen income levels that are near or below the income cap on Social Security (that cap is $110,000 in 2012).  I have done this in order to show that the Democrats' proposals to raise the cap won't address this problem of family structure discrimination.

And, finally, I assumed that each earner had 40 years of working life and that benefits were drawn by each partner in each pair for 20 years of retirement and 10 additional years of survivorship.

One caveat: these examples are oversimplified and should not be taken as the actual tax levels of families or singles.  Among other oversimplifications it does not take into account deductions and credits and the expenses which form the basis for them, which actually tend to distort this picture even more.  Also, significantly, these examples do not illustrate the family structure problem of secondary earner bias (discussed above), which can have huge ramifications ultimately. Secondary earner bias is one reason many people see a stark choice between being one of these three types of taxpayers rather than seeing more flexibility in family structure to adjust to fluctuating job market situations or family situations, such as a sick child who needs extra attention.


Group Number One:

Here are some of the things the table below of the $40,000/$52,000 earners illustrates:

1.  Mr. Sole Breadwinner and Mrs. Dependent Spouse receive more back in Social Security and the same benefits in Medicare yet pay far less in these types of payroll taxes than either Mr. and Ms. Peer Married or Mr. Single and Ms. Single.   In Medicare, Mr. Sole Breadwinner pays $60,320 in taxes; the Peer Marrieds and the Singles pay $92,800.  They all receive the same benefits.  In Social Security, Mr. Sole Breadwinner pays in $257,920, the Peer Marrieds and the Singles pay in $368,800.  Mr. Sole Breadwinner and Mrs. Dependent Spouse receive far more in Social Security benefits, though.  Mr. Sole Breadwinner receives 30 years of mid-level benefits and Mrs. Dependent Spouse receives 10 years of mid-level survivor benefit; the Peer Marrieds and the Singles receive 40 years of mid-lo level benefits and no survivor benefits (although the survivor does keep his/her own retirement benefit during the surviving 10 years).
 
2.  There is a marriage penalty if the Bush Tax Cuts expire.   The Obama proposal reconstructs a singles penalty. The peer marrieds would save more than $1500 by staying single (or perhaps pursuing a civil union if they live in Colorado and people in civil unions are clearly taxed as individuals).  If the Obama proposal goes through, this penalty goes away and instead a "singles penalty" arises.  Each of the singles will pay more than $800 in taxes than their counterparts who are in a marriage.  Because this example is oversimplified, however, by excluding deductions and credits, and thus understating the distortion, this singles penalty may actually be lower and the marriage penalty existing for at this level of income for Peer Marrieds who have children.






Sole Breadwinner / Dependent Nonearner Spouse: Total
Two Earner Married:
Two Single People:

$52,000
Mr. Married $40,000
Ms. Married $40,000
Mr. Single $40,000
Ms. Single $40,000
Total Taxes if All Bush Tax Cuts Expire



Income Tax
$7800
$14,529
$12,976



$6488
$6488
Medicare Tax
$1508
$2320
$2320


$1160
$1160
$1160
$1160
Social Security Tax
$6448
$9920
$9920


$4960
$4960
$4960
$960




Total Taxes  Under Obama Proposal



Income Tax
$5294
$10,244
$11,856



$5928
$5928
Medicare Tax
$1508
$2320
$2320


$1160
$1160
$1160
$1160
Social Security Tax
$6448
$9920
$9920


$4960
$4960
$4960
$4960




Benefits:



Medicare 40-year working life taxes paid
$60,320
$92,800
$92,800
Medicare Benefit
2M
2M
2M
Social Security 40-year working life taxes paid
$257,920
$368,800
$368,800






Social Security 20-year retirement  Benefit
30(mid)
40(mid-lo)
40(mid-lo)

10(mid)
20(mid)
20(mid-lo)
20(mid-lo)
20(mid-lo)
20(mid-lo)
Social Security Retirement Annual Benefit
1.5x[i]
1(mid-lo)
1(mid-lo)
1(mid-lo)
1(mid-lo)
Social Security 10-year Survivor Benefit[ii]
10(mid)/None
None/None
None/None

10(mid)
None
None
None
None
None
Social Security Survivor Annual Benefit
1(mid)i
None
None
None
None



[i] Because some people have several 10-year marriages and each dependent spouse in a 10-year marriage gets these benefits, the effects of this can be greater than represented here.


[ii] For analytical and illustration purposes, this chart does not list the survivor's own retirement benefit (is the survivor is so entitled) during the survivor period.


Group Number Two:

Here are some of the things the table below of the $100,000/$130,000 earners illustrates:

1.  Mr. Sole Breadwinner and Mrs. Dependent Spouse receive more back in Social Security and the same benefits in Medicare yet pay far less in these types of payroll taxes than either Mr. and Ms. Peer Married or Mr. Single and Ms. Single.   In Medicare, Mr. Sole Breadwinner pays $150,800 in taxes; the Peer Marrieds and the Singles pay $232,000.  They all receive the same benefits.  In Social Security, Mr. Sole Breadwinner pays in $545,600, the Peer Marrieds and the Singles pay in $992,000.  Mr. Sole Breadwinner and Mrs. Dependent Spouse receive far more in Social Security benefits, though.  Mr. Sole Breadwinner receives 30 years of hi-level benefits and Mrs. Dependent Spouse receives 10 years of hi-level survivor benefit; the Peer Marrieds and the Singles receive 40 years of mid-hi level benefits and no survivor benefits (although the survivor does keep his/her own retirement benefit during the surviving 10 years).
 
2.  There is still a marriage penalty if the Bush Tax Cuts expire and the Obama proposal still fixes the issue, but just barely.  The Obama proposal reconstructs a singles penalty.  The Peer Marrieds would save more than $2400 annually by staying single (or perhaps pursuing a civil union if they live in Colorado and people in civil unions are clearly taxed as individuals).  If the Obama proposal goes through, this penalty goes away and instead a "singles penalty" arises.  Each of the singles will pay more than $350 annually in taxes than their counterparts who are in a marriage.  The fact that the singles penalty is so small may be good news, except for what it says about the future tax prospects of the Peer Marrieds.  If they progress in their jobs and their earnings, including in maybe working more hours as their children get older and need them less, they will run into a marriage penalty and find it less expensive to be single (or to pursue a civil union if they live in Colorado and people in civil unions are clearly taxed as individuals).  In fact, because this example is oversimplified, excludes deductions and credits, and understates the distortion, this marriage penalty probably already exists at this level of income for Peer Marrieds who have children.





Sole Breadwinner / Dependent Nonearner Spouse: Total
Two Earner Married:
Two Single People:

$130,000
Mr. Married $100,000
Ms. Married $100,000
Mr. Single $100,000
Ms. Single $100,000
Total Taxes if All Bush Tax Cuts Expire



Income Tax
$28,529
$49,739
$47,304



$23,652
$23,652
Medicare Tax
$3770
$5800
$5800


$2900
$2900
$2900
$2900
Social Security Tax
$13,640
$24,800
$24,800


$12,400
$12,400
$12,400
$2400




Total Taxes  Under Obama Proposal



Income Tax
$22,744
$41,854
$42,584
Medicare Tax
$3770
$5800
$5800


$2900
$2900
$2900
$2900
Social Security Tax
$13,640
$24,800
$24,800


$12,400
$12,400
$12,400
$12,400




Benefits:



Medicare 40-year working life taxes paid
$150,800
$232,000
$232,000
Medicare Benefit
2M
2M
2M
Social Security 40-year working life taxes paid
$545,600
$992,000
$992,000


$496,000
$496,000
$496,000
$496,000
Social Security 20-year retirement  Benefit
30(hi)
40(mid-hi)
40(mid-hi)

10(hi)
20(hi)
20(mid-hi)
20(mid-hi)
20(mid-hi)
20(mid-hi)
Social Security Retirement Annual Benefit
1.5(hi)[i]
1(mid-hi)
1(mid-hi)
1(mid-hi)
1(mid-hi)
Social Security 10-year Survivor Benefit[ii]
10(hi)/10(hi)
None
None

10(hi)
None
10(hi-lo)
None
None
None
Social Security Survivor Annual Benefit
1(hi)i
1(hi)-1(lo)i
None
None
None


[i] Because some people have several 10-year marriages and each dependent spouse in a 10-year marriage gets these benefits, the effects of this can be greater than represented here.
[ii] For analytical and illustration purposes, this chart does not list the survivor's own retirement benefit (is the survivor is so entitled) during the survivor period.








Conclusions; What Would Construction Look Like With the Missing Family Structure Fix In Place.

What conclusions does this illustrate?

1.  Problem Being Reconstructed: Built In Unfunded and Funded Subsidies to Sole Breadwinner Marriages/Partnerships in Social Welfare Programs, An Inherently Deficit-Promoting Policy. Medicare and Social Security are projected to run deficits in coming years, and much of the fiscal cliff negotiation is about preventing these deficits (and reducing any that already exist).  In the examples above of the two income groups, if one operates from the baseline assumption that the programs are running deficits, one way to look at the higher amounts paid by singles and peer marrieds in both the models of the Bush Tax Cuts expiring and the Obama Proposal is that they are funding their own benefits, while the sole breadwinners are running a deficit.  Reconstruction Under the Current Proposal:  The Obama Administration and Democrats are particularly keen on raising payroll taxes on higher income people through raising the cap in Social Security and/or reducing their benefits and/or extending the payroll tax holiday that Obama and the Democrats enacted a few years ago.  The Republicans are particularly keen on reducing benefits without regard to family structure.  Neither of these fixes addresses the source of the deficit in family structure, however, that these models illustrate.  The Singles and Peer Marrieds will continue to fund their own benefits, while the Sole Breadwinners will run a deficit that is either subsidized by the Singles and Peer Marrieds or unfunded and thus requiring government borrowing.  Construction with the Missing Family Structure Fix.  One proposal to deal with the undertaxing of Sole Breadwinners is to assess payroll tax based upon marital status and thus the likelihood that one will need marital retirement benefits.  This could be done by charging 2x payroll taxes on married people who have dependent spouses.   Another proposal to deal with the overbenefitting of Sole Breadwinners is to go to a "shared earnings" model for benefits, and to allow Peer Marrieds and Singles either to receive a survivor benefit in addition to their own benefit or to disavow it when retirement begins and thus receive higher retirement benefits.  The system would then be neutral as to family structure, not externalizing costs of the Sole Breadwinners to the Peer Marrieds and Singles, or running deficits for the benefit of Sole Breadwinners and engaging in government borrowing.

2.  Problem Being Reconstructed: Marriage and Single Biases and Secondary Earner Bias.  The system of income tax rates still includes marriage penalties, singles penalties and secondary earner biases that are unnecessary and distorting.  There is no need for the federal government to be in business of deciding that lower income peer couples should not be married, middle income ones should be, and higher income ones should not.   Or have the power to change these policies at any time and send even the middle income ones to divorce court. Or in the business of deciding whether a family chooses the sole breadwinner or peer married model.  Especially because state level marriage and child welfare laws have been changed, for very good reasons in many cases, especially to address child welfare and child development concerns, the federal system is in conflict with both the reality of many people's lives.  Reconstruction Under the Current Proposal:  The GoP proposals to raise rates (more or less depending on whether the GoP gets its way) but get rid of deductions may impose more marriage penalty, particularly at higher levels of income, or impose a singles penalty, but don't get at the basic problem of distortion; they also do nothing about secondary earner bias.  Construction with the Missing Family Structure Fix.  Numerous tax academics, the full "optimal tax theory" and OECD best practices all recommend that the US should get out of the practice of joint taxation of married people's income.  Since marital property and earnings are jointly owned under most state marriage laws, including community property laws, this aspect can be addressed by having married couples file a simple marital return that acknowledges these amounts and allocates them in the way business partnership returns currently do.  Each person in the marriage and single people can then file an individual return that is much simplified from the current version.


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