Economic Policy Recommendation 20120916

Economic Policy Recommendation

Mike Debiak

September 16, 2012


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Abstract

“Today, the Census Bureau released its annual poverty report, which declared that a record 46.2

million (roughly one in seven) Americans were poor in 2010. The numbers were up sharply from

the previous year’s total of 43.6 million.” (Rector & Sheffeild, 2011) This said, a disconnect

remains between this data and some of the reality of what poverty is in the United States. The

growing issue is whether the government is connected enough with the needs and concerns of the

working public given the widening gap between wealth and poverty. This paper presents a

recommendation for change in economic policy that helps alleviate the growing disparity in the

socioeconomic levels within the United States.


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“As America is the wealthiest and most bountiful nation in the world, it is no surprise that many

Americans think of hunger and poverty occurring only in developing countries” (Results, 2012).

Poverty is the condition of people who lack adequate income and wealth. Absolute poverty is

when people are absolutely impoverished if the minimum amounts of food, clothing and shelter

necessary for survival absorb all of their income, and they live a razor’s edge existence.

Relative poverty is when people are relatively impoverished if the customary (average) standard

of living in their society requires more spending than the income they have available. This

standard changes as a society becomes more prosperous. For example, the standard of living

average Americans experienced in 1900 was below the poverty threshold (guideline) estimated

by the US Department of Health and Human services in 2000 (Byrns, 2011).

There is a growing disparity between those with the least, impoverished, and those with the most,

wealthy, in the United States. There are a number of reasons that can be cited as the cause of this

widening gap, but they all point to one combined root cause – earned income, income and

savings. It seems obvious though that there is a correlation between how much you make and

how much you keep that effects your relationship with, or distance from, the poverty level.

Imagine.

Now, to explain how a few other terms will be used and that are relevant here – earned income,

income and savings. Earned income should be easy for the vast majority to understand, these are

wages like what is seen in a paycheck. Earned refers to work. So all that have a 9-5 or 7-6, or

whatever variation can be thought of that is a job, have earned income. Whether satisfied with

that earned income for the effort put in or not or whether enough is left over to pay the bills, well

that is for further discussion. Income is a collective term that means any source other than earned

as from employment. This includes investment income, retirement income (e.g. pension, IRA


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distribution, Social Security, etc.) and income from business that is not considered wages. Saving

here is used to mean all cash or cash equivalents (money, savings accounts and bonds, etc.),

stocks, real property (homes, boats, cars, property, etc.), business investments, IRA deposits,

401(k) accounts, etc. that make up what are considered financial assets. The combination of

these things and accounting for any monies owed (bills and other regular expenses, loans, rent or

mortgage, credit card debt, etc.) produces what is known as net worth. “The 47-to-1 wealth gap

between old and young is believed by demographers to be the highest ever, even predating

government records.” And “On Wednesday, Forbes magazine released its annual tally of the 400

richest Americans, whose combined net worth has soared to $1.53 trillion, up 12 percent since

last year. To even make the list, it was necessary to have a fortune of at least $1.05 billion, more

than ten thousand times the median net worth of an American household” (Kishore, 2011). Net

worth then seems to drive the measure and define the gap between wealth and poverty. As stated

earlier - it’s not what you make, it’s what you keep.

Since the publication of the first official U.S. poverty estimates in

1964, there has been a continuing debate about the best approach to

measuring income and poverty in the United States (DeNavas-Walt,

Proctor, & Smith, 2012). Income inequality between 2010 and 2011

increased as measured by changes in the shares of aggregate household

income (Rector & Sheffeild, 2011). So, the problem then is simply

stated as – How is the gap between wealth and absolute poverty closed,

in a meaningful way. This is no small task. In a market economy as in

the U.S. there is a natural tendency to allow economic conditions,

either business or personal, to at least initially to resolve themselves, albeit that there is no loss of

The 2011 Poverty Thresholds for the

U.S. Census

Persons in family

Income Threshold

1 $11,702

2 $15,063

3 $17,595

4 $23,201

5 $27,979

6 $32,181

7 $37,029

8 $41,414

9 $49,818


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attention that such things receive once it is decided that taking action is for the common good.

What then has prevented an appropriate level of attention from being placed on the issue of the

gap between wealth and poverty? Suffice to say that those at the top try to stay at the top.

Now that the problem has been enumerated it’s time to dig into the data, and there is a wealth

(excuse the pun) of data. The data is largely various researchers, economists, universities,

authors, columnists, etc., including reports published by the various departments and agencies of

the government, that performed some form of analysis on the whole or part of one primary

source. That is the U.S. Census. The Census Bureau serves as the leading source of quality data

about the nation's people and economy (United States Census Bureau, 2012). There is however a

plethora of other anecdotal sources that rein the realm of information that influences readers.

What will be focused on here are the more reliable sources.

To start, begin at the bottom. A study was conducted by Dr. Paul Piff and his colleagues at the

University of California, Berkeley, which reported in the Journal of Personality and Social

Psychology, that it is the poor, not the rich, who are inclined to charity. Dr Piff himself suggests

that the increased compassion which seems to exist among the poor increases generosity and

helpfulness, and promotes a level of trust and co-operation that can prove essential for survival

during hard times. (The Economist Newspaper Limited, 2010). This will become more useful

later in the paper as discussion of the recommendation is presented. Suffice to say however, that

this type of reaction to the socioeconomic condition of poverty is in part why the problem exists.

Another is the fact that compared to other nations the impoverished in the United States are in

general better off having, as a whole, better overall living conditions. “Liberals use the declining

relative prices of many amenities to argue that it is no big deal that poor households have air

conditioning, computers, cable TV, and wide-screen TV. They contend, polemically, that even


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though most poor families may have a house full of modern conveniences, the average poor

family still suffers from substantial deprivation in basic needs, such as food and housing. In

reality, this is just not true” (Rector & Sheffeild, 2011). Then compare that hard line to, “The

face of a poor person in the United States is a single parent who works full time, but still can’t

afford to pay for food, rent, child care, medical bills, and the costs of transportation to work”

(Results, 2012). Problems become increasingly more difficult when not even the pundits can

agree on the terms and conditions of the issue, no less what the data reflects. Each seeming to

spin the information into whatever message works to further their cause.

Given the

information put forth

here it could be

concluded however

that there is still an

issue of poverty in

the United States, and

the gap between the

wealthiest and

poorest is still growing. So, is this actually a bad thing? Or, is it that as the wealthy get wealthier

the poor are getting poorer. And therein lays the rub.

Taking this all by the numbers can get taxing; this is not to be flip about what many see as one of

the root causes of the expanding wealth gap issue. There is a lot of data to digest. Fortunately

there are reliable sources that have mined this data and put together relatively easy to understand

charts, graphs and tables that can deliver the message effectively. Some of the highlights are: in


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2011, the official poverty rate was 15.0 percent. There were 46.2 million people in poverty; in

2011, 7.2 percent of workers aged 18 to 64 were in poverty; the poverty rate for those who

worked full time, year round was 2.8 percent, while the poverty rate for those working less than

full time, year round was 16.3 percent (DeNavas-Walt, Proctor, & Smith, 2012); according to a

new report by Economic Policy Institute the top 1% had 288 times the net worth of the median

household as of 2010 (Hope Yen, 2011).

The means by which to narrow the gap between the wealthiest and poorest Americans has been

debated in many economic and political circles for years. The recommendation here in fact is not

entirely a new idea. One aspect of this idea has been around since the mid-1990’s with its roots

in Baltic countries and was designed by economists at the Hoover Institution, Robert Hall and

Alvin Rabushka. There are several states in the United States that currently use these ideas to

collect sales and income taxes.

The recommendation is to change the American tax system with one that would have a positive

effect on the U.S. Economy. It is to impose a simplified Flat Rate income tax (Flat Tax) and a

national sales tax. The simplified Flat Tax would be paid by all forms of income earning entities

- wage earners, businesses, mutual funds, hedge funds, etc. The only exemption would be wage

earners below the lower income level similar to the currently establish poverty limits. All income

earners would then only pay income tax on the amount above this exempt level (i.e. earning $1

more than the exempt limit would only subject you to pay tax on the $1). This would distribute

the tax burden equitably and equally across all income levels. No long would earning a $1 more

on a certain tier be subject to a higher tax rate which ultimately reduces the effective take-home

pay. This would encourage both individuals and businesses to pursue higher earnings as they are

no longer penalized for enthusiasm or success.


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The national sales tax would be 1% ($0.01) and imposed on all non-food goods and services,

regardless of whether it was a raw material or a finished product. This would distribute the tax

burden throughout the manufacturing and distribution chain and not place all the taxes on the end

consumer. Now, this is not to say that the end consumer would not be paying for the incremental

taxes throughout the process. It would however redistribute the tax to include exports, and it

would collect tax on products as they are manufactured and distributed thereby improving the

timing of revenues to the government as products are placed into inventory rather than waiting

for the sales to the end consumer. The recommendation would extend to states for their sales and

income tax systems.

The use of a combination of taxing facilities would reduce the income portion of the tax

collection need and distribute the burden to higher volume and value consumers, which are

primarily higher income/wealthier individuals. Lower income families that purchase fewer and

less expensive goods would pay the least. Noting that the current state imposed sales tax is

equivalent to a consumption tax. “…the current U.S. tax system is not a pure income tax; it is a

hybrid between a consumption tax and an income tax. About half of private savings already

receive consumption tax treatment. Funds placed in pensions, 401(k) plans, Keogh plans, and

most individual retirement accounts (IRAs) are not taxed until they are withdrawn…. The flat tax

would eliminate corporate income taxes, put all businesses on an equal tax footing, reduce the

statutory tax rate applied to business income, and make investment write-offs more generous”

(Gale, 1999).

A true flat rate tax on income has two characteristics: first, the tax base is a comprehensive

measure of income with no preferential treatment given to specific sources or uses of income,

and second, a single tax rate is applied to that base. In short, a flat rate tax is a proportional tax


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on total income (Browning & Browning, 1985). The flat tax is a VAT, not so different from the

taxes popular around the world. Under one variant of VAT, called a subtraction-method VAT,

businesses deduct the cost of inputs from gross receipts and pay tax on the difference—the value

added. It is basically a sales tax where the tax is collected in stages from each producer on the

supply chain rather than all at once from retailers (as in the retail sales taxes that are common in

the US). A flat tax adds one more wrinkle: businesses are allowed a deduction for wages paid,

but the employees pay the “flat tax” on their wages directly. If that’s all that happened, the tax

burden would be identical to the VAT (assuming the same level of compliance), but the flat tax

also allows an exemption for every worker. Wages are only taxed above that exemption level,

typically set at around the poverty level, so that wages up to the poverty threshold are exempt

from tax. (Burman, 2011)

Turning to the Armey-Shelby flat tax proposal, notwithstanding what has been argued so far,

there are some benefits to its enactment. First, it would reduce Congress's ability to grant one

group of Americans special tax privileges that are denied to another group of Americans. The

House Ways and Means Committee and the Senate Finance Committee are two of the most

powerful committees in Congress. Their members have the largest political war chest, and the

reason is that they are the focus of Washington's lobbying groups, who pay handsomely and

work diligently to have favors bestowed upon them. The Armey-Shelby flat tax plan would go a

long way toward eliminating privilege-granting by the United States Congress, and that may

explain some of the political resistance to having a flat tax. (Williams, Blackwell, Fund, &

Forbes, 1996)

A Flat Tax is an effect means of helping to reduce, or at least reduce the growth of, the gap

between wealth and poverty in the United States. In examining the effects of a flat rate tax, we


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assume that a flat rate tax is substituted for the present federal individual income tax and that the

single tax rate is set so that government revenues remain unchanged. In this framework, it is

reasonable to suppose that government expenditure policies do not change, so we can

concentrate on the consequences brought about by the change in tax policy alone.

As will become clear, most of the advantages expected from this change in tax policy are really

the alleviation of the disadvantages of the current income tax. One of the most important

advantages of the flat rate tax is that it will improve incentives to produce by reducing the

marginal tax rates of most or all taxpayers. It is important to recognize that the marginal tax rate

that applies to the earnings of productive resources is what produces adverse effects on resource

supplies. If the marginal tax rate is 40 percent, for instance, a person who has an opportunity

to earn an extra $100 will decide whether it is worth the effort based on the $60 in after-tax

income that he gets to keep. The higher the marginal tax rate, the lower is the net rate of

remuneration received and the more adversely resource supply is likely to be affected.

Currently, marginal tax rates under the federal income tax range from 11 percent to 50 percent.

In 1979,35 percent of taxpayers filing joint returns faced marginal rate brackets of 28 percent or

higher, and 13 percent were in marginal rate brackets of 37 percent or higher.

Under a flat rate tax using a comprehensive definition of income, the single marginal rate used

could be as low as 10 to 12 percent. Thus most or all taxpayers would confront a substantially

lower marginal tax rate, and this in turn means the after-tax reward for earning more income

would be increased. Although the magnitude of response to the higher after-tax returns is

disputable, recent empirical research, as well as, common sense suggests that people will choose

to make greater efforts to earn income when the returns are higher. These efforts could take the


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form of increased labor supply or increased saving and investment (or both). (Browning &

Browning, 1985)

Two further advantages can be expected from the use of a comprehensive measure of income

coupled with a low marginal rate. Currently, taxable income is only about half of total personal

income - which accounts in part for the high marginal rates that must be used today. When high

marginal tax rates are applied to an emasculated definition of income, taxpayers are encouraged

to channel part of their incomes into untaxed forms. This change in the composition or use of

income reflects a loss in economic productivity as taxpayers devote resources to lower-valued

uses simply because they are untaxed.

Another benefit from the use of a more comprehensive tax base is that it would produce a fairer

distribution of taxes among those with equal real incomes. Currently, taxpayers who are able to

shift large portions of their incomes into untaxed forms pay less in taxes than those with equal

incomes who are unable or unwilling to make as much use of tax preferences. The result is a

wide dispersion in tax burdens among those who are equally well off.

Our tax code is one of the most complicated in the world. Over two dozen countries have already

adopted a single-rate flat tax system. Nearly all of these nations have tax rates below 20 percent.

Nearly all of these nations have experienced economic growth and lower unemployment rates

after implementing a flat tax. (Kibbe, 2011)

The salutary effects of tax reduction on the economy have been demonstrated. Starting with the

Harding-Coolidge tax cuts in the 1920s and the Kennedy tax cuts in the early 1960s, we have

seen how lower tax rates produce prosperity. In the late 1970s, the Kemp-Roth tax cut proposal

for an across-the-board 30 percent tax cut was adopted by Ronald Reagan when he became

president and launched what became the then-longest economic boom in American history.


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Reference

Browning, E., & Browning, J. (1985). Why not a true Flat Rate Tax. Cato Journal, Vol. 5, No. 2 (Fall 1985), 629-656.

Burman, L. (2011, October 24). What is a Flat Tax? (Surprise! It is a VAT). Retrieved September 16, 2012, from Forbes: http://www.forbes.com

Byrns, R. (2011). Poverty: Absolute and Relative. Retrieved September 16, 2012, from Economics Interactive: http://www.unc.edu

DeNavas-Walt, C., Proctor, B., & Smith, J. (2012). Income, Poverty, and Health Insurance Coverage in the United States. Current Population Reports, 60-243.

Domhoff, G. W. (2006). 15 Mind-Blowing Facts About Wealth And Inequity In America. Retrieved September 16, 2012, from Wealth and Inequity in America: http;//www.businessinsider.com

Edelman, P. (2012, July 28). Poverty in America: Why can't we end it? New York Times. Gale, W. G. (1999). Flat Tax. The Encyclopedia of Taxation and Tax Ploicy, 155-158. Hope Yen, A. P. (2011, November 8). U.S. wealth gap between young and old is widest ever.

USA Today. Kibbe, M. (2011, April 18). Tax Day 2011 - We need a flat tax more than ever. Retrieved

September 16, 2012, from FowNews.com: http://www.foxnews.com Kishore, J. (2011, September 22). Wealth and poverty in America. Retrieved September 16,

2012, from World Socialist WebSite: http://www.wsws.org Luhby, T. (2012, September 11). The wealthy are 288 times richer than you. Retrieved

Septembet 16, 2012, from CNN Money: http://www.money.cnn.com Rector, R., & Sheffeild, R. (2011). Understanding Poverty in the United States: Suprising Facts

About America's Poor. Washington, D.C.: The Heritage Foundation. Results. (2012). Poverty in the United States. Washington, D.C.: Results. The Economist Newspaper Limited. (2010, July 29). The rish are different from you and me. The

Economist. United States Census Bureau. (2012). The National Data book. Washington, D.C.: U.S.

Department of Commerce. Williams, W., Blackwell, J., Fund, J., & Forbes, S. (1996, April 8). The Flat Tax: Revitalizing

the American Dream. Retrieved September 16, 2012, from The Heritage Foundation: http://www.heritage.org

Economic Policy Recommendation 20120916

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