Combined Tax Rates and Creating a 21st Century Social Welfare Budget

In testimony yesterday before a joint hearing of two House subcommittees, I urged Congress to modernize the nation’s social welfare programs to focus on early childhood, quality teachers, more effective work subsidies, and improved neighborhoods. One way lawmakers can shift their gaze is by considering the effects of combined marginal tax rates that often rise steeply as people increase their income and lose their eligibility for benefits.

While some talk about how we live  in an age of austerity, we are in fact  in a period of extraordinary opportunity. On a per-household basis, our income is higher than before the Great Recession and 60 percent higher than when Ronald Reagan was elected President in 1980.

A forward-looking social welfare budget should not   be defined by the needs of a society from decades past.  Two examples of how our priorities have shifted:   Republicans and Democrats didn’t always agree on the merits of Aid to Families with Dependent Children (AFDC) or the Earned Income Tax Credit, yet they agreed on the need to shift from welfare to wage subsidies.  Ditto for moving from public housing toward housing vouchers.

I sense that both the American public and its elected representatives are united in wanting to create a 21st century social welfare budget.  That budget, I believe, should and will place greater focus on opportunity, mobility, work, and investment in human, real, and financial capital.

However, for the most part, our focus has been elsewhere.  As I show in my recent book Dead Men Ruling, we live at a time when our elected officials are trapped by the promises of their predecessors.  New agendas mean reneging on past promises.  Even modest economic growth provides new opportunities, but the nation operates on  a budget constrained by choices made by dead and retired elected officials who continue to rule.

For instance, the  Congressional Budget Office and others project  government will  increase spending and tax subsidies by more than  $1 trillion annually by 2025, yet they already absorb more than all future additional revenues—the traditional source of flexibility in budget making.

I am concerned about the potential negative effects of these programs on work, wealth accumulation, and marriage of combined marginal tax rate imposed mainly on lower-income households.  To see how multiple programs combine to reduce the reward to work and marriage, look at this graph.


For households with children, combined marginal tax rates from direct taxes and the phasing out of benefits from universally available programs like EITC, SNAP, and government-subsidized health insurance average about 60 percent as they move from about $15,000 to $55,000 of income.  This is what happens when a head of household moves toward full-time work, takes a second job, or marries another worker.

Beneficiaries of additional housing and welfare support face marginal rates that average closer to 75 percent. Add out of pocket costs for transportation, consumption taxes, and child care, and the gains from work fall even more. Sometimes there are no gains at all.

While there is widespread disagreement on the size of these disincentive effects on work and marriage, there is little doubt that they exist. One solution: Focus future resources on increasing opportunity for young households. Make combined tax rates more explicit and make work a stronger requirement for receiving some benefits.

This post originally appeared on TaxVox.

How to Pay Zero Taxes on Income of Millions of Dollars

Remember when people complained that hedge fund managers and private equity firm owners paid a lower tax rate than many workers? Or when Warren Buffett said he shouldn’t pay a lower rate than his secretary?  In those cases, investors were benefiting from low capital gains rates, but at least they paid some tax.

Now, thanks to Roth accounts, a special form of retirement savings, investors and even their children pay close to zero tax on huge sums of income. While this scheme can create significant future government budget shortfalls, my attention here is on how our tax code favors those who understand how to play this Roth-account game.

You got a hint of what might be possible when Governor Romney disclosed that he had over $100 million in his individual retirement account. However, this money was in a traditional IRA, taxable upon distribution, not a Roth IRA, where once a modest tax is paid up front, then all future income from the account escapes tax. Thus, Romney missed out on some of the tax benefits available to Roth holders.

The Taxpayer Relief Act of 1997 first made such accounts possible. At about that time, I warned in Tax Notes Magazine about how some investors could use Roths to avoid almost all tax on significant amounts of income. But I didn’t have a smoking gun, since I was anticipating future accruals on this then-new option. Tax professionals who put high-return hedge fund or private equity return assets into a Roth for wealthy clients have no incentive to disclose the details of these deals.

But a recent article by Richard Rubin and Margaret Collins for Bloomberg  describes a redesigned retirement plan of Renaissance Technologies that allows employees to put retirement monies into Medallion, a hedge fund that historically has produced extraordinary high returns. My colleague, Steven Rosenthal, examines the tax implications and questions the future role of the Labor and Treasury Departments in these developments.

But you don’t need to work for a private equity firm or hedge fund to benefit.  Let’s start with the tax sheltering opportunity available to almost anyone willing to invest far into the future and who earns no more than the normal long-term rate of return on stocks.

Suppose a 25 year-old taxpayer puts $10,000 in Roth accounts, perhaps helped out by parents. Once he pays a small upfront tax on the contributions, the tax on these accounts is now totally prepaid. He will never owe another dime. If stocks provide a traditional historic return of, say, 9 percent per year, the portfolio would grow to $483,000 by age 70, the age at which people must withdraw from traditional retirement accounts but not Roths.  Make a few such deposits, and soon millions of dollars of income can escape tax.

But 9 percent represents an average return, chicken feed compared to the successful private equity investor, inventor, entrepreneur, or small business person. If they are insiders or somehow know, they might well know that they are likely to generate 15 percent per year over time. Others might also generate this higher return because of invention, luck, or simply leveraging up their returns. If the investment returns 15 percent annually, a $10,000 deposit held for 45 years grows to $5.4 million by age 70.

Perhaps you think the example of a 25-year old depositing money until age 70 is exaggerated. But it understates the more extreme cases. A Roth IRA can be held much longer than 45 years, e.g., a 35 year old living to 90 can leave the money to his kids who must withdraw the money only gradually after the parent’s death, so in this case complete tax exemption would last 55 years, and partial exemption would extend outward toward a century.

Think what this does for the fairness of a tax system. People who turn out to make millions of dollars of income on their investments will often pay no more tax (up front or down the road) than people who make little or nothing on their saving. To be clear, I’m saying dollars of tax, not rate of tax, would often be the same. The unsuccessful will be taxed the same as the successful, violating the whole notion of proportionality, much less progressivity, in taxation. I can think of almost no other tax provision, whether in an income or consumption tax, that goes so far in violating the notion that those who either make more money or consume more can afford to pay more tax.

This post originally appeared on TaxVox.

Empowering the Next President—and the Next Congress

This is a trade-promotion authority not just for President Obama but for the next president as well.”

That is how Senate Majority Leader Mitch McConnell explains his support for granting the president expedited authority to negotiate trade deals and fast-track through Congress a vote those deals. The authority would apply not only to an agreement negotiated by President Obama with several Pacific partners, but to agreements made through mid-2018 and potentially through mid-2021.

McConnell recognizes, at least in this case, that a president must have enough room to perform his executive duties. The Constitution provides the president with particular powers, including the negotiation of treaties. It makes no more sense for 535 members of Congress to negotiate treaties than it does for them to micromanage other tasks that should be left to the country’s chief executive.

I would like to extend McConnell’s thought beyond treaty making. Now is the ideal time to empower both the president and Congress to better perform their assigned functions: the president to execute and Congress to legislate.

Why? First—and obviously to even the casual observer—both branches of government have been weakened extraordinarily over recent decades by the politicization of every action and the growing influence of interest groups. Many impasses in both legislation and administration arise when one party thinks that it can diminish the other by imposing roadblocks. This thought is neither new nor unique to government; when an organization’s decisionmaking boundaries are ill defined and its members cross those boundaries to seek additional power, the organization often becomes dysfunctional.

Second, less than two years away from a presidential election with an uncertain outcome, elected officials more likely recognize, as Senator McConnell does, that maintaining roadblocks deters one’s own party’s likelihood of future success as much as that of one’s opponents.

Third, the last years of a presidency seldom focus on the changes that new power brings a political party. Yet it need not be a lame-duck period. It offers the opportunity to turn to those process reforms usually neglected when the political debate centers on bigger or smaller, rather than more effective, government. President, cabinet secretary, congressional leader, and committee chair alike should be examining their power and reorganizing both internally and across jurisdictions—or, quite bluntly, they are not doing their jobs.

Behind closed doors, almost every elected official will admit that many government systems are broken. Examples abound: Medicare continually out of balance, infrastructure and highways unfunded while bridges fall apart and trains crash, the inability to pass budgets or appropriations bills, a sequester requirement that must be overridden, and much more. These are process failures, not policy failures.

How might strengthening the hands of both the president and Congress improve the likelihood of solving such problems?

Medicare provides a good example. In the last presidential election, the candidates attacked each other for trying to constrain cost growth in what both knew was an unsustainable system. Governor Romney castigated the president for cutbacks that helped expand health insurance for the nonelderly, and the president attacked the governor for favoring a voucher-like approach put forward by then–House Budget Chair Paul Ryan.

In truth, all answers to the Medicare problem involve payment constraints. The program simply has to operate within a budget. Congress won’t create a budget for Medicare, but it won’t allow the president to use his executive power to do it either. Instead Congress passes the power of appropriating money onto our doctors and us as beneficiaries.

The fix is simpler than it seems. If the Democrats favor price controls for Medicare and the Republicans favor voucher-like approaches, then set up the general rules but let whoever attains executive power use it whenever spending starts to exceed a congressionally approved limit.

This method can work well in other arenas too. Congress can set guidelines for what it wants accomplished—certainly within a budget—but then it should allow the executive branch to fulfill those guidelines. If Congress over-constrains any particular function by demanding that more be done than allowed by the budget it sets, then the executive should be empowered to make changes necessary to restore balance. This is not rocket science, it is basic management theory.

In his acclaimed book The Rule of Nobody, Philip K. Howard similarly argues that the president must have executive powers restored, to be able to avoid wasteful duplication and unnecessary bureaucracy, to expedite important public works, to refuse to spend allocated funds when circumstances change and the expenditure becomes wasteful, and to reorganize executive agencies.

When Congress limits the president on executive matters, no matter how small, it isn’t empowering itself. Instead, it entangles itself in complex and contradictory legislation, attempting to appease every interest (no matter how small), while weakening itself as it spends less and less time tackling the big issues that it is elected to address.

All this does not let recent presidents off the hook. The constant expansion in political appointees and the centralization of power in the White House over several decades has led to even more roadblocks to progress. When every decision must go through several political layers, almost no good idea can filter through to the president. When so many public statements and decisions on millions of government actions must be fed through the White House, civil servants and even top political appointees can’t function well, and they often retreat to doing nothing risky and seldom attacking limitations or failures in their own programs. Among the further consequences, many excellent government officials retreat to the private sector. Who wants to work where you are not allowed to do your job?

Whether one agrees with the examples presented here matters less than recognizing the ripeness of this time for procedural reform. Senator McConnell is right. Let’s empower the next president—and the next Congress as well.

Progress for Every Child

The ultimate goal of educational policy must be progress for every child.  Not standards.  Not attainment of grade level proficiency.   Not college readiness.  But progress toward developing each young person’s potential to the fullest extent possible every year.  Not only is this the right educational goal, but it is the only one that pulls parents, teachers, and administrators together politically in a shared vision of helping every child, disadvantaged and advantaged alike, to grow into smarter and more capable citizens.  With rare exception, each student’s progress, no matter how high or low the base level of attainment, eventually benefits others in society.

While most teachers and parents adhere to that goal, they also care deeply about their own children and protégés, and many top-down requirements ignore that legitimate and natural impulse.   When my children were in school, governments and school boards devoted additional resources to the “gifted and talented.” Others felt left out. Later, the focus shifted: the schools needed to do more for “special education” students, then those for whom English was a second language (ESL).  Next efforts were made to pull more students into advanced placement AP courses, then to mainstream a larger share of students with different abilities. Later, standards became the focus du jour, culminating partly in 2001 in the No Child Left Behind (NCLB) law, and more recently in new fights over the “common core” level of achievement agreed to by state officials.

The reaction?  I think it can be summed up well by the story of the school superintendent who in response to No Child Left Behind essentially told his principals to focus on that group, let’s say 20% of students, with the highest probability of being brought up to the standard.  As for the other 80 percent of students, those above the standard and those more likely to never achieve it, well, they implicitly had to accept relatively fewer resources if relatively more were devoted to the 20%.  A more extreme reaction came to light with the “racketeering” conviction of several Atlanta school teachers and officials for feeding students answers to standardized tests and changing test sheets.

These various reform efforts didn’t necessarily fail.  They responded partly to past areas of neglect.  But one can also see that if each program’s success depends mainly upon shifting attention and resources, and if there are narrowly circumscribed measures of success, then it’s quite possible to come full circle on these efforts, succeed modestly with the targeted population each time, and then at the end of the day advance not at all with any one of them as the targets rotate into and out of view.  To me that partly explains why our school systems have fallen behind those of many other countries.

The literature on performance measures, successful organization, and statistics gives us many lessons that need to be heeded. Among those most relevant here: no organization succeeds unless it engages in a process of continual improvement.  Those who are on the ground must buy into and have ownership of the process.   Tests should occasionally shift to areas that haven’t been checked.  For instance, if success in math comes about because extra time to it came out of fewer recesses, one had better check on whether active students become more out of control and if obesity is increasing.  Finally, it’s all right to teach to a test if we know that the test incorporates much of what we want to succeed.  A great example in the school systems are the advanced placement tests, where teachers often follow a fairly rigorous but also standard way to advance a selected group of students on a subject matter eventually to be tested.

Teaching to the test is bad enough when it discourages educators from teaching necessary skills that those tests neglect. But it is even worse when state governments, school boards, or school superintendents grade a school, or principal, or teacher primarily on the percentage of students reaching some minimum standard. Such judgments ignore both other sources of knowledge and the potential progress of many students above or below the standard.

Though No Child Left Behind may have failed on some fronts, it did help set in motion more rigorous efforts to track students over many years. These tracking systems often provide the types of data by which progress can be measured along several (but, of course, far from all) useful dimensions. The potential of these data for first empowering teachers and parents with multiple measures of each student’s progress, not just attainment, has yet to be realized.

Senators Lamar Alexander and Patty Murray, chair and ranking member of the Senate Committee on Health, Education, Labor, and Pensions, have recently released a bill known as the Every Child Achieves Act. The label at least suggests a focus on every child, rather than NCLB’s focus on a subset of students who are “behind.” Many experts call the bill a step in the right direction because it tries to maintain some accountability even while allowing states much greater flexibility in setting standards.

Still, whether the states advance our still-mediocre educational system—either on their own or with the help of federal incentives—remains to be seen. A crucial telling point will be whether enough schools and jurisdictions start to recognize how to better use measures of progress, not just attainment, and then aim to develop each and every student’s potential regardless of whether they fall well below, near to, or well above any particular attainment standard.

One Avenue to Bipartisan Tax Reform: Simplification and Improved Tax Administration

There are many ways to restructure the tax code. Elected officials often fail to detect opportunity when they adhere in a path-dependent way to one past model of success, such the 1986 tax reform.  An alternative approach where even the acclaimed 1986 effort made at best modest progress would focus on making tax code simpler for taxpayers and improving compliance without adding to IRS costs. This reframing of reform stands a chance of stepping around the partisan wrangling that deters progress on so many other policy fronts.

In recent weeks, IRS Commissioner John Koskinen has been lamenting the Service’s inability to perform its functions well, mostly recently at today’s Tax Policy Center event on the impact of IRS budget cuts. It not only continues to lose staff, but less experienced staff quickly must replace a large fraction of senior employees who are leaving.

At the same time, congressional Republicans have been finding fault with much of what the IRS does, from its inability to regulate the activities of social welfare 501(c)(4) organizations to its implementation of the Affordable Care Act. Democrats say the solution is a bigger IRS budget. Republicans say it is a smaller one. But there is an alternative choice.

Focus tax reform on an objective almost never before given priority: developing a system that is less costly for taxpayers to comply with, mostly through simplification of existing laws. Simultaneously modify laws where IRS enforcement is difficult or impossible or too costly ever to do well. Such an effort would not necessarily require base broadening, though that often would be consistent. For instance, rather than engaging in a non-productive debate over whether to  eliminate or expand  refundable tax credits for low-income households, Congress  could simply replace the existing credits with versions that are easier for taxpayers to understand and for the IRS to administer.

Put everything on the table, ranging from business deductions to multiple capital gains tax rates to complexity of retirement plan options to refundable credits that go mainly to the poor. Include many of the small items like mileage deductions that can be vastly simplified.

The first step in such an effort would be for the IRS to better understand known error rates for each preference and “program” based partly upon the audit data it keeps. Believe it or not, the agency has never done any good comprehensive study on this, though on occasion it has tried to measure the extent of noncompliance in rough terms.

And the IRS has never conducted this type of research to inform policy, as opposed to allocating internal audit functions. IRS should study taxpayer time costs, error rates, causes of error, costs of auditing, and administrative aspects of every program put into the tax code. For instance, although relatively easy to do, it has never really distinguished in its studies what it can’t know or can’t enforce well from the error rates that it can find under some audit technique.

The second step would be for the IRS and its colleagues at the Treasury’s Office of Tax Policy to be prepared, at least in a tax reform setting, to acknowledge what provisions it cannot monitor at a reasonable cost. For instance, it can estimate compliance with wages reported to the IRS on W-2 forms, but it seems fairly certain that it has little idea of how much charitable contributions of clothing are overvalued. Even if it did, it has no way to efficiently allocate resources to monitor such deductions.

I recognize that a balancing act is required, since IRS doesn’t want to encourage even more noncompliance. But an agency can’t engage in continuous improvement if it doesn’t study and acknowledge its problems in the first place. Indeed, some of IRS’s recent public conflicts, such as over the tax-exempt status of Tea Party and other social welfare organizations, stemmed from what every tax policy analyst has always known: that limited resources devoted to vague or hard-to-enforce law eventually can lead to disaster.

With attention to individual simplification, along with the improved compliance that comes from removal of laws that can’t be enforced, both parties could claim a victory. A simpler and more efficient tax system conforms to both progressive and conservative principles.

Unlike more money for audit, moreover, making the system more administrable and simpler modestly increases national well-being.

In a fairly comprehensive study I undertook for the American Bar Association and the American Institute of Certified Accountants many years ago, I  found that expanding IRS audit resources was likely to raise more than was spent, ranging from $2 to $7, depending upon type of return, for every dollar spent. I doubt the conclusion has changed greatly since then. But while more auditors would help redistribute the tax burden in favor of compliant taxpayers, there’s no gain and a likely loss in output by taking workers away from more productive activities.

Administrative reform and simplification, on the other hand, can reduce noncompliance while increasing the time that taxpayers can devote to more productive pursuits. Of course, to achieve this goal, leaders of both parties have to cooperate to make changes that benefit the public, even when it gives them no partisan advantage.

This column originally appeared on TaxVox.

Assessing “Wrongs,” Mainly on the Young, to Pay for “Rights”

What happens when the claim to some financial right from the government creates some financial “wrong” somewhere else?

That is, when the government’s balance sheets don’t balance, and there aren’t enough assets to pay for claims on them, someone must get short-changed. If that “someone” must accept unequal treatment under the law, has the right been matched by a “wrong?”  These issues have now arisen for underfunded state pension plans, but they continue to apply in other arenas, such as the unequal assessment of property taxes in states like California. In these and other cases, the young often end up paying the piper.

Protecting rights has long been crucial to maintaining a democratic order. The United States has a long history of protecting citizens’ rights, embedded from the beginning of the nation in the Bill of Rights and, since then, in many legal and constitutional clauses. These aim largely to establish liberty and require equal treatment under the law. When it comes more narrowly to most disputes over private property and assets, there are no “unfunded” government promises; contestants simply dispute over who gets the private funds. The court effectively fills out the balance sheet when it resolves those private disputes. A higher inheritance to one party out of a known amount of estate assets, for example, means a lower amount for another. There’s no third party or unidentified taxpayer who must to contribute or add to the estate so all potential inheritors can walk away happy.

When it comes to financial “rights” established by law, the issue becomes more complicated. The latest cases getting much attention revolve around the rights of state and local public employees to the benefits promised by their pension plans, even when those plans do not have the assets to cover the claims. Some courts have determined that the promised benefits are inviolable under state constitutions, regardless of available assets; other courts have recently interpreted state laws differently, led by the bankruptcy and financial distress of state pension plans.

As another example, some states give longer-term homeowners rights to lower taxation rates than newer homeowners. Proposition 13 of the California Constitution requires that property taxes cannot be increased by more than a certain rate, effectively granting existing homeowners lower tax rates than new homeowners receiving the same services for their tax dollars.

So where does the money come from?  Saying that it can be the future taxpayer still dodges the issue of whether the allocation of benefits and costs meets a standard of equal justice.

Thus, when people lay claim to nonexistent government assets, “rights” can’t be totally separated from the “accounting” system under which they are assessed. I’m not a lawyer, but I believe courts and legislators do not do their job completely if they don’t admit to and address the following questions in any disputes on such matters:

  • How can we judge anyone’s right to some financial compensation, pension benefit, or lower tax rate without at least knowing where and how the balance sheet is or might be filled out?
  • How does the claim to a right by one set of citizens affect the rights of other citizens?

Even when courts determine that any resulting injustice is constitutional or the prerogative of the legislature, they still should do their balance-sheet homework.

In some arenas, the courts have made clear that the lack of underlying funds limits the rights of people to some promised benefit. The United States Supreme Court has stated, for instance, that Social Security benefits can be changed regardless of past legislative promises. This system is largely pay-as-you-go: benefits for the elderly come almost entirely from the taxes of the nonelderly. Because promised cash benefits now increasingly exceed taxes scheduled to be collected, even the pay-as-you-go balance sheet has not been filled out: some past Congress promised that benefits would grow over time without figuring out who would pay for that growth. Legislators can rebalance those sheets constitutionally without violating the rights of a current or future beneficiary. Whether they do so fairly is another matter.

When the courts have leaned toward treating as unalterable the rights of some citizens to unfunded promises made in the past, however, they have directly or indirectly required some unequal treatment under the law, with the young often paying the piper.

Our Urban Institute study of pension reforms in many states reveals that efforts to protect existing but not new state pensions almost always requires the young to receive significantly lower rates of total compensation than older workers doing the same work. Worse yet, we have determined that to cover unfunded liabilities from the past, some states are adopting pension plans that grant NEGATIVE employer pension or retirement plan benefits to new workers, essentially by requiring them to contribute more to the plan than most can expect to get back in future benefits.

In the case of California’s limited property tax increases, new, younger homeowners are required to pay much higher taxes than wealthier, older, and longer-term homeowners.

In these cases, it seems fairly clear that the “rights” of existing state workers or homeowners leads to an assessment of “wrongs”—unequal taxation of unequal pay for equal work—on others, mainly the young, to fill out the balance sheets.

As I say, I’m not a lawyer, but I do know that 2 + 2 does not equal 3. When the courts say that you are entitled to $2 and I’m entitled to $2, they can eventually defy the laws of mathematics if only $3 is available. It’s not that the declining availability of pension benefits to many workers and rapidly rising taxes are problems to be ignored. It’s just that assessing wrongs or liabilities on unrelated parties to a dispute is unlikely to represent equal justice under the law or an efficient way to resolve public finance issues.

A Better Alternative to Taxing Those Without Health Insurance

Although the public debate on health insurance coverage centers on a thumbs-up, thumbs-down fight over the Accountable Care Act (ACA, also called Obamacare), our national system needs a lot of smaller fixes. Many items on this long list of fixes make sense under either a Republican alternative to Obamacare (like the one recently but only partially laid out by Representative Paul Ryan) or Democratic amendments to the existing plan. One example: rethinking the tax penalty on people who do not buy insurance, an issue receiving increased attention as the IRS assesses its first penalties. We can achieve the same end much more effectively by requiring households to purchase health insurance if they want to receive the other government benefits to which they are entitled. No separate tax is required.

The history of the tax penalty

A system of near-universal insurance—where most people of the same age, regardless of their health conditions, can buy insurance at approximately the same price—needs a backup. This need became clear when health reform proposals were first introduced in 2009. Without a backup, individuals have a strong incentive to avoid buying insurance until they are sick, thus effectively getting someone else to pay for their health care. This incentive exists regardless of income level: even a wealthy person who buys health insurance only after becoming sick could hoist his bills on those with lesser incomes who pay for insurance year-round and every year.

The ACA’s partial response to this incentive is to tax those who fail to buy health insurance. The tax for failure in 2014 was either 1 percent of income or $95 per person; it rises to 2.5 percent of income or $695 (adjusted for inflation) after 2015. At the beginning of 2015, millions of people discovered that they owed this tax as they started filing their federal tax returns for 2014.

Practical considerations have always led toward some individual requirement to buy insurance, simply because there are limits on how much government can spend on subsidizing everyone. Our very expensive health care system now entails average health costs per household of about $24,000. The federal government would have to spend just about all its revenues trying to cover all those costs. A mandate to purchase insurance is a partial alternative to ever-more subsidies—as Governor Romney knew when he implemented a related mandate in Massachusetts. At one point, the mandate idea was favored by conservatives even more than liberals as a way to avoid an even more expensive government-controlled system, such as Medicare for all.

What might work better

The problem with the Obamacare tax penalty isn’t the idea; it’s the design. This problem, in various forms, occupied the federal courts needlessly. The central dilemma that pre-occupied an earlier Supreme Court decision was whether government could mandate that we had to buy some particular product (maybe not, it said, but, at least in Chief Justice Roberts’ opinion, it could impose a tax).

Another type of requirement avoids many past and current issues surrounding the Obamacare tax penalty. Simply deny to taxpayers other government benefits if they do not obtain insurance for themselves and their families. There has been no debate over whether government can—indeed,  at some level administratively must—set conditions for determining who receives benefits.

This type of requirement could be implemented in various ways. The personal exemption or the child credit or home mortgage subsidies could be limited; some portion of low interest rates for student loans could be denied. This approach entails no new “tax” for not buying insurance; it simply adds to the conditions for receipt of other government benefits.

Designed well, the denial of any tax benefit could easily be reflected in withholding, so there are fewer end-of-year surprises. Employers, for instance, could adjust withholding for months in which employees did not declare insurance for themselves. As for the many poor receiving benefits like SNAP, most tend to be eligible for Medicaid, so the requirement than they sign up could be handled better by the related administrative offices that deal with them than by the IRS imposing some surprise penalty at the end of the year.

For both administrative and political reasons, this type of requirement can also be made stricter than the current extra tax. The IRS has always had trouble collecting money at the end of the year, and people react more negatively to an additional tax than to a requirement that they shouldn’t shift health costs onto others if they want to receive some other government benefit.

The road ahead

I doubt that any future government, Democratic or Republican, is going to deny people the ability to buy health insurance at a common community rate, even if they are sick or have failed to purchase health insurance previously. The world has already changed too much. Insurance companies have adapted, and so have hospitals. Before health reform, uninsured people could generate partial benefits or coverage by receiving treatment in emergency rooms (where such care is often required by law), and then not paying their bills. With some major exceptions, that practice has declined since the ACA was implemented. No one wants to go back to the old ways.

In a partisan world, of course, a fix of almost any type becomes difficult. Republicans are afraid to fix almost any aspect of Obamacare for fear it would involve a buy-in to the plan’s success; Democrats dread amending Obamacare because it might hint at some degree of failure. Watching the current Supreme Court battle, you sense that many enjoy the fight more than anything else. Still, this simple fix should be added to the list of reforms for consideration when and if we decide we want something better.

Addressing income inequality first requires knowing what we’re measuring

Politicians, researchers, and the media have given a good deal of attention recently to widening income inequality. Yet very few have paid attention to how—and how well—we measure income. Different measures of income show very different results on whether and how much inequality has risen. Without clarity, even honest and non-ideological public and private efforts to address inequality will fall short of their mark—and, in some cases, exacerbate inequality further.

How we typically measure income

Income measures tell different stories about opportunity and can be useful for different purposes. Some studies on income inequality measure income before government transfers and taxes—for instance, studies that compare workers’ earnings over time. Studies of the distribution of wealth or capital income, too, typically exclude any entitlement to government benefits. These “market” measures capture how much individuals have gained or lost in their returns from work and saving.

More comprehensive measures examine income after transfers and taxes. Transfers include Social Security, SNAP (formerly food stamps), cash welfare, and the earned income tax credit. Taxes include income and Social Security taxes. These measures best capture individuals’ net income and what living standards they can maintain, but not their financial independence or how much they are sharing directly in the rewards of the market.

Within both sets of measures (pre-tax, pre-transfer and post-tax, post-transfer), most studies still exclude a great deal. Health care often fails to be counted, even though increases in real health costs and benefits now take up about one-third of all per-capita income growth. Most of these health benefits come from government health plans (like Medicare and Medicaid) or employer-provided health insurance. Households pay directly for only a minor share of health costs, so they often don’t think about improved health care as a source of income growth.

How improving our definition of income—and using alternative measures—sharpens our view of income inequality

Starting with a more comprehensive measure of income, and then breaking out components, can improve our understanding of income inequality and its sources. As an example, let’s use some recent Congressional Budget Office (CBO) estimates, which provide perhaps the most comprehensive measure of household market incomes (consisting of labor, business, capital, and retirement income), then add the value of government transfers and subtract the value of federal taxes.

Between 1979 and 2011, the average market incomes—that is, incomes before taxes and transfers—of the richest 20 percent of the population (or the top income quintile) grew from 20 times to 30 times the incomes of the poorest 20 percent (the bottom income quintile).


When examining income after taxes and transfers, however, the relationship between the top and bottom income quintiles is more stable. It starts at a ratio of about 5.5:1 in 1979 and increases very slightly to 6:1 by 2011.


We find somewhat similar trends when comparing the fourth quintile with the second quintile. After taxes and transfers, income ratios don’t change much over this period, though the market-based measures of income show increased inequality. Of course, the very top 1 percent still has gained significantly; in 2011 it had nearly 33 times the income of the bottom 20 percent, compared with about 19 times in 1979.

What’s still missing

Even the CBO measures, however, are far from comprehensive. They exclude many benefits that are harder to measure or distribute, such as the returns from homeownership and the value of public goods like highways, parks, and fire protection. As Steve Rose points out, even more elusive are the broadly shared gains in living standards brought by improved technology and new inventions.

Why getting it right matters

Though defining income may seem like merely a technical exercise, it has huge consequences. Inequality has always been a political football: all sides tend to quote statistics that support their policy stances while ignoring the statistics refuting them. Yet if we want good policy, we’ve got to be open to how well any particular policy might improve income equality by one measure or make it worse by another, often at the same time. This is not a new story: bad or misleading information almost inevitably leads to bad policy.

This column first appeared on MetroTrends.