Posted by: Jeff | April 19, 2010

Disentangling Taxes from Welfare

Last Friday I linked to a few things on the hubbub over reports that 47 percent of Americans will be paying nothing in income taxes this year. A few caveats apply right off the bat: First, this applies to income taxes only. Not to state taxes, payroll taxes, etc. (A point outlets like Fox News have tried particularly hard to paper over.) Second, one reason the percent is so large is that we’re currently in a recession. When incomes drop, income taxes drop by definition as well. Under more normal economic conditions, Americans with no cumulative income tax could conceivably be under 40 percent. That said, let’s move on to this:

I think the real problem with the current setup is the political economy of it.  A very large percentage of our electorate has nothing at stake when they vote for new spending.  Since that spending imposes real costs on other people, and the economy at large, this is a problem.  We don’t want to end up in a situation where 65% of the population is systematically voting to take the stuff possessed by the other 35%.

That’s Megan McArdle, and I would think this would be a fair point so far as it goes. Human nature being what it is, such a political economy would be dangerously unstable. But I don’t think that’s quite what’s going on.

Technically, no one, no matter how poor they are, has no income tax liability. There is no income bracket for which the tax is zero. What happens is myriad collections of tax credits and exemptions come into play that wipe out the tax liability of those 47 percent. (This is a separate matter from the myriad loopholes built into our tax system to benefit corporations and the wealthy, which is a whole can of worms unto itself.) A decent explanation of how tax credits, deductions and refunds work can be found here.

This gets at one of the odd things about American government. An enormous amount of our welfare spending actually comes in the form of a “shadow” welfare state comprised of tax carve-outs for the poor and for people in various kinds of economic misfortune. We don’t think of tax deductions and credits as welfare spending, but that’s really what they are. If we were to take the money represented by those deductions/credits, and simply give it to people as a check separate from their taxes, the net result would be the same both for them and for the government.

The difference is that the true tax burden for those people would become readily visible, as opposed to being hidden by our complex patchwork of tax carve-outs. So I don’t think it’s right to say a large percentage of the American electorate has nothing at stake when it comes to government spending. Rather, what’s going on is that our system is sufficiently mercurial and fractured that it’s really hard for the electorate to tell who has a stake in government taxation/spending and who doesn’t. And that leads to the resentment you see amongst the electorate over statistics like this – resentment which establishments like Fox News feed off of and encourage.

If we were to disentangle tax payments from welfare benefits, I think it would make it more apparent that, contra McArdle’s description, the vast majority of that 47 percent actually do have “skin in the game.” And since the shadow welfare state operates through the tax code, disentanglement would also make that code a good deal less complicated.

A comparison to other developed western countries is instructive: Not only are their welfare states larger, more generous and more broad-based than ours, but they’re simpler as well. That also makes their tax codes simpler, which reduces the stress for their citizens of paying taxes. Most importantly for our purposes, it keeps the question of who pays into the system, and who gets benefits out of it, much more “above board,” as it were. Which probably helps with that question of political economy, and general feelings of solidarity and fairness amongst the populace.

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