Taxes - Part I

“In this world nothing can be said to be certain, except death and taxes.”

– Benjamin Franklin.

Tax day is upon us, so it seems like a good time to begin what will likely be a multiple part series about various tax issues. There are quite a few angles to cover, and I try to keep each post reasonably short. As you may have gathered I am a huge advocate of having a solid understanding of the facts around an issue before developing your opinion. When congress returns from their recess it is expected they will try to pass tax legislature, so it is an especially good time to become familiar with how taxes work.

Just about everyone pays taxes. Back in 2012, presidential candidate Mitt Romney made a statement claiming that 47% of Americans pay no federal income tax. To be fair, depending on what year you are looking at, that is accurate. The implication, however, is that these people are not paying taxes at all, and that is just not true. There are several different types of taxes paid by Americans, even those with low incomes. In addition to federal income tax there are taxes such as property, sales, FICA, state and local, and disability to name a few. This post is going to focus on the federal taxes that are withheld from employee’s paychecks.

The first tax I am going to get into is the social security tax. Somewhat off topic, I’d like to point out that the social security program has always been almost completely funded by its own special tax. It has relatively recently begun dipping into its reserves, but budget estimates predict that the program remains solvent for the next few decades. That means when politicians talk about cutting social security in order to shore up budget deficits or to fund general tax cuts, they are talking about taking money from a tax explicitly put in place to fund a particular program. It doesn’t get any closer to stealing than that.

The social security tax is a shared tax on both employee and employer. It is also a regressive tax. That means that the percentage is reduced as the taxable wage base increases. There are simply two tiers to this regressive tax. The full rate is collected up to the limit and, after that, the reduction is zero. Since 1990 the tax rate has been 6.2% for each. The only exception was 2011 and 2012 when President Obama reduced the employee portion by 2% to help stimulate the economy. In 2017 the limit is $127,200, up from $118,500 in 2016.

In practical application, the shared 6.2% tax results in a 12.4% tax on earned income. There is broad agreement among economists that payroll taxes put downward pressure on wages. Your employer agrees too. They likely account for these expenses like your wages rather than their taxes. And for those of you who are self-employed, you simply pay both portions straight-up. Additionally, this tax does not benefit at all from joint incomes. If you file your taxes jointly with your spouse and you are both working, you both are still paying the full tax. This tax falls disproportionately heavy on the average worker since only exceptionally high earners are exceeding the limit.

The second tax of the FICA taxes is used to fund Medicare. And to be fair, unlike Social Security, the Medicare program takes a significant portion of its funding from the general fund, so we can at least have a conversation about the Medicare budget without being thieves. Like Social Security, this tax is also a shared tax on employees and employers with the same ramifications on the employee’s income. Historically, the Medicare tax was also regressive with just two tiers; the full rate and zero. The rate has been 1.45% each since 1986. In 1994 the tax changed from being regressive to being flat with the removal of the taxable limit. That means 1.45% for both employee and employer for all income. In 2013, a provision in the Affordable Care Act kicked in making the tax progressive. Individuals earning over $200,000 single or $250,000 jointly would pay an additional 0.9% tax. What we end up with is a slightly progressive tax on earned income with two tiers. 2.9% up to $200,000 single or $250,000 joint and 3.8% forever after.  

The third tax withheld from your paycheck is the federal income tax and the one most people are more familiar with. In 2017 this is a progressive tax with 8 brackets ranging from 0% to 39.6%. It’s important to remember that you pay tax at each bracket using the rate for that bracket. For example, you are paying 10% on your income earned in the 10% bracket, and when you begin earning in the 15% bracket you pay 15% of that income. Your overall tax rate is called your “effective” tax rate and ends up being a combination of all the brackets that you earned through. When your employer or payroll provider withholds federal income tax from your paycheck they estimate your effective tax rate and withhold at that rate in order to smooth out your per paycheck deductions.

Someone once told me that they got a raise for working hard, and because of tax brackets they ended up taking home less money than before. I can’t think of a situation where that is mathematically possible. That person was either simply confused, confused and their employer used terrible payroll software, or they were lying to try to prove a point. Earning more money will always net you more money, but you could end up paying a larger portion of the new money in taxes.

There are 2 tables used to calculate federal income tax depending on your filing status: single or married. The rates are consistent on both tables, but the brackets are extended for married filers. For simplicity, I’ll be referencing the single table for 2017. At $2,300 tax rates kick in at 10%. They progress pretty quickly up to 25% at $40,250. They progress slower after that reaching their maximum rate of 39.6% at $420,700. There are two things I’d like to point out about this progression. First, the progression completely stops after $420,700, so the tax rate at $500,000 is the same as the tax rate at $10,000,000. That is an incredible difference in income without any increase in tax rate. And, second, the regressive payroll taxes make up for most of the difference in the progressive income taxes. I thought this best demonstrated with a visual aid, so I made an area graph.

When you consider these taxes together, our total earned income tax rates are much flatter than some lawmakers would have you believe. These are almost all higher than unearned income, i.e. capital gains, but I’m not getting into capital gains at this time. Also, I’d like to acknowledge that there are tax credits like the EITC and Child Tax Credit that reduce the taxable income significantly for lower income earners, but I’m also not getting into those at this time.

Our tax rates were not always this flat. Beginning in the early 1900’s, when income tax first begun, up until the early 1980’s there were typically more than 20 brackets that had rates progressing up to and exceeding 90%. During this time the United States had its economic ups and downs to be sure, but we also grew to be the world’s largest economy. Our seemingly incredibly high progressive tax rates did not prevent our economic growth any more that cutting them empowered it.

During the 1980’s President Reagan had our federal income taxes down to only 2 brackets which maxed out at 28% after only earning $18,550. In 1993 President Clinton brought us up to 5 brackets and 39.6% after $250,000. This brought us back to a slightly more progressive scale, but was still much lower than historical rates. During this time of exceptionally low tax rates which mostly benefited the wealthiest Americans the economy continued on status quo. It grew and shrank much like it did before. There were, however, a few stark differences. First, federal deficits and the national debt skyrocketed. Second, income inequality, the gap between the rich and poor, increased significantly, and the middle class began shrinking. And, lastly, money in politics grew to unprecedented levels. It seems to me that because the wealthy aristocracy was able to keep so much more of their income they chose to use that capital to influence politics more than ever.

Tax reform will be coming up in congress shortly. When republican lawmakers talk about tax reform, the rhetoric is usually about simplifying the system. They claim that the tax system is too complicated, and that may be true. Then they claim that to simplify the system we must eliminate tax brackets, or even shift to a flat tax. It is important to recognize when politicians propose the idea of a flat tax they are intending to change the last progressive tax, the federal income tax, to a flat tax, and leave the regressive taxes alone. The meager progression that we currently have barely compensates for the payroll taxes, and, without it, the lowest earners will carry a far greater share of the tax burden. History has shown that this sort of change does little to stimulate the overall economy. All it does is encourage generational wealth and an idle aristocracy.

To truly simplify the system we need to reduce the variety of taxes, credits and deductions. That will require more work. Taxes fund important social programs like social security and national defense. Credits and deductions encourage desired behavior like environmental protection and raising children. So lawmakers will have to work hard and evaluate which taxes can be merged and which deductions eliminated. The only way we have a chance to get the sort of tax reform that will improve the system for the everyday American is if enough of us educate ourselves about the policy issues and communicate with our representatives in a thoughtful way. I encourage you all to do just that.

Obamacare

I titled this blog post “Obamacare” ironically. I actually despise the name Obamacare. People who use the term seriously are showing right from the start that they literally do not know what they are talking about. The name of the law is “Patient Protection and Affordable Care Act”. It is reasonably shortened to “The Affordable Care Act” or even the acronym ACA. It doesn’t get much shorter than ACA; you can just say that. It looks like it is going to be around for at least a little longer, so it is a great time to review what the law actually does.

Much like the name of the law, in my experience people know very little about its substance. I’m not going to pretend like I’m an expert by any means. It is in fact a long and complex piece of legislation, but I am familiar with quite a few of its aspects. I work for a company defined as an applicable large employer, or ALE for short, by the Affordable Care Act. For this company I helped design and write the software that monitors our large number of employees for compliance with the law. I wrote the software that generates the tax forms called 1095C that, if you work, you probably have received along with your W2. And, I wrote the software that files our company data with the branch of the IRS responsible for Affordable Care Act information returns. So, I know a little bit about the topic, particularly on the employer regulatory side.

To understand the ACA you first have to understand insurance. For the insurance consumer, it is about the transfer of risk. You as a human being living in modern society have inherent risks. You may die unexpectedly and leave your family without a provider. You may crash your vehicle and cause a massive amount of damage to property, other people, or even yourself. You may suddenly develop a health condition that requires a great deal of medical care. For most of us, any one of these things could mark the end of the good life for ourselves and our family. That is where insurance comes in; you transfer some of the risk to a separate entity.

The role of the insurance company is to accept responsibility for these risks. They make it work because they accept the risks of a large number of people at the same time. They calculate the statistical chance of these calamities happening to individuals and set their premiums accordingly. The larger the pool of risk, the better insurance companies can predict and manage the risks they have accepted.

The next thing to know about the ACA is that many of the tenets of the law came from a conservative counter proposal to actual socialized healthcare. Way back in 1993, when President Clinton was in office, First Lady Hillary Clinton led a task force to fix our broken healthcare system. They were proposing a universal, socialized healthcare system. Obviously, that never came to fruition. At that time, the Heritage Foundation, a conservative think tank, forged a counter-proposal which many republicans supported. It included aspects of the ACA like the individual mandate, common markets, standardized benefits, coverage for preexisting conditions, and subsidies for low income individuals. The ACA does much more than that, but you can’t deny the similarities.

The most important thing to note is that the Affordable Care Act did not change the fundamental dynamics of the healthcare system that already existed. All the pieces remained in place. Private insurance companies, employer sponsored plans, and the selective socialized plans of Medicaid and Medicare continue to be the disparate healthcare system of the United States. What it did try to do was include more people in the system, and it tried to do that in several ways.

The first is called the individual shared responsibility provision which is commonly referred to as the individual mandate. Honestly, it’s not really much of a mandate. It is not criminal to be without health insurance; you pay a tax penalty. You can find the formula on healthcare.gov if you are interested in the details, but, basically, if you are doing pretty well, you could be looking at around $2,000 in additional tax liability. While that is not a trivial amount of money, I wouldn’t call it a mandate either. It is enough, however, to get people to think about joining the health insurance pool. Perhaps you are offered health insurance by your employer, but you are healthy and choose to be in the “Freeloader” group to save some money. Whatever your reason, the shared responsibility provision should be enough to at least reconsider.

Another way the ACA encourages people to join the health insurance pool is by subsidizing the cost. The exact formula depends on household income and family size, and you can review the details on healthcare.gov. To ballpark it, that same person who without coverage would be paying about $2,000 in additional taxes could be getting more than twice that amount to help buy health insurance on the exchange. That subsidy covers about half of the actual cost of the insurance, so you would still be spending more than you would be if you did nothing. However, you would have health insurance, so if you or a member of your family did have a medical problem you would avoid “Dying in the Streets”.

The ACA did not forget about employers. Employers are, after all, the largest source of health insurance coverage in the entire country, so there is also the employer shared responsibility provision. If a business qualifies as an ALE, Applicable Large Employer, then they are subject to the employer shared responsibility provision. An employer is classified as an ALE if they have an average of 50 full-time equivalent employees during the tax year. A full-time equivalent employee is an employee that averages over 30 hours per week.

Much like the individual mandate, it is not criminal to fail to provide health insurance to your employees. It is more akin to paying overtime, or break penalty pay. The details about the employer shared responsibility provision can be found on irs.gov. Basically, if an ALE does not offer health coverage that contains “essential” benefits at an “affordable” price to their full-time employees, then they are subject to about a $2,000 tax penalty for each full-time equivalent employee who is not offered coverage. While still not a mandate, it should be enough to reconsider not offering health coverage. There are many measurable benefits for employers to provide health insurance to their employees already, so this tax penalty is just a little extra encouragement.

One of our socialized programs was modified by the ACA as well. This is referred to as the Medicaid expansion. Medicaid is a joint federal and state funded program that provides healthcare for certain categories of low income people. Amongst others, Medicaid categories include: children, pregnant women, parents, and disabled. Prior to the ACA each state had its own requirements for eligibility. Typically, income would be at or below the federal poverty level, and only families with children were covered. The ACA sought to better standardize the requirements and include more people in the process. The ACA required Medicaid to be available for anyone whose income was less than 138% of the federal poverty level. In 2017, 138% of the federal poverty level is $16,400 for an individual or $33,600 for a family of 4 annually.

Originally, states were required to adopt the Medicaid expansion rules or lose their federal funding for their Medicaid program altogether. The federal government already pays for a majority of the cost of Medicaid in every state, and losing the funding would effectively eliminate the program. To assist the states with the expansion, the federal government would pay 100% of the cost of expanding the program for three years and 90% after that. However, the Supreme Court decision NFIB v. Sebelius ruled that requiring the states to implement the expansion was unconstitutional. That left it an optional part of the law.

Most states implemented the expansion even though it was optional. The last count was 32 states, including the District of Columbia, implemented the expansion and 19 states opted out of the expansion. By and large the states that opted out are the most conservative states. It appears to me, that these 19 states have chosen to opt out for purely political reasons. Participation in the Medicaid program has always been optional. Nonetheless, all of these 19 states choose to participate in the program. On average each of these states accepts over 5 billion dollars annually from the federal government to help pay for it. It does not appear to be the program or the federal funding they are against. These states have simply chosen to oppose anything President Obama supports even at the expense of the health of their own constituents.

The next piece of the puzzle is the private insurance company. First, they are required to cover ten essential health benefits. You can review the entire list and definitions on healthcare.gov. They include the basic health services you would expect like ambulance, maternity, prescription drugs, lab service, hospitalization and mental health. Additionally, insurance providers may not reject you, charge you more, or refuse to pay for essential health benefits for any preexisting condition.

Perhaps the most understood and widely accepted statute of the ACA is the one that requires insurance companies to allow adult children to remain on their parent’s family coverage until the age of 26. It’s easy to understand and makes a lot of sense. Young adults are far healthier on average than the older insured. Keeping them in the pool is a good way to spread risk across a less expensive demographic. It’s also a group that has more difficulty affording coverage. Perhaps college is taking longer. Perhaps they are having trouble finding full-time employment with benefits. Whatever the reason, they can stay on their parent’s family plan a little longer while they figure it out.

In order to encourage competition between health insurance companies the ACA also created the Health Insurance Marketplace. A state could set up their own health insurance exchange or opt to use the one set up by the federal government. Available plans were grouped into 5 categories based on the percentage of medical expenses covered. Typically, plans covering more expense had higher premiums. With the health coverage and rate categories standardized, insurance consumers could use the common market to easily compare rates among the providers.

All of these things together were designed to increase the quantity of people in the health coverage pool. Theoretically, a larger pool could be run more efficiently and per capita costs would go down. In order to ensure these savings were passed down to insurance consumers the ACA contained a provision known as the Medical Loss Ratio. Also known as the 80/20 rule, the Medical Loss Ratio requires that insurance companies use 80% of their revenue from insurance premiums on healthcare related expenses. That left 20% for administration, marketing and profits. The ratio varies a bit depending on the type of pool being covered, but in a nutshell that is the 80/20 rule. If an insurance company did not meet their required ratio, then they would have to issue rebates to their customers. Many providers already operated within this range, but some have had to pay these rebates. Each year the amount of rebates goes down as insurance companies adjust to the regulation.

So, did it work? The answer is, sort of. Certainly a much smaller portion of the population remains without health insurance. In 2010 about 16% of Americans were counted as uninsured. Now only about 9% remain uninsured. It was a bit of everything listed above that brought more people into the insured camp. Costs continue to rise. Sometimes less than they were rising before, but sometimes just as much or more. The insurance regulations and the marketplace make it easier for consumers to shop around for the most affordable coverage. However, some markets only have a single provider, so that isn’t really helping there. There is an incredible amount of hyperbole and misinformation from both supporters and opponents of the law. In my opinion the state of healthcare in the United States is marginally better now than it was before the ACA.

On a personal note, while I freely admit the Affordable Care Act is incredibly lacking, it probably saved my father’s life. He wasn’t quite old enough to qualify for Medicare, was not offered coverage by his employer, and was unable to afford insurance on the private, individual market. He appeared to be healthy, but, because of his age, the market wouldn’t touch him. When the Affordable Care Act went into effect he could no longer be denied coverage or be charged more because of his age. Then with the help of a marketplace subsidy he was able to afford health insurance for the first time in over a decade. He got a physical as part of the new insurance plan and the doctors discovered colon cancer. The cancer was caught early enough that the doctors were able to remove it without having to go through prolonged treatment. If the cancer remained undiscovered until he was eligible for Medicare chances are it would have been much worse; probably fatal.

SCOTUS Blocked

This post is about the legislative shenanigans currently going on with regards to the confirmation of a judge to the Supreme Court of the United States. I keep thinking that the Trump administration has sunk so low with their blatant lies and hypocrisy that nothing they could do would surprise me. I continue, however, to be shocked and amazed by the gall of these liars. Today, White House press secretary said this with regards to the senate confirmation of President Trump’s Supreme Court nominee Neil Gorsuch.

“And I think Democrats are setting a very dangerous precedent when it comes to how they want to do this, because this isn’t about voting against somebody or having an issue with them. It is literally trying to stop using the filibuster for something it has never been intended for, nor has it ever really been the principle that we would vote down somebody who is qualified.”

Wow. Just wow. I’m sure the internet and media outlets are going to be all over this, but I don’t care; I’m throwing in too. It was the republican use of filibuster to block nominees and legislature during the Obama administration that was unprecedented. They used this method hundreds of times, more than twice the number of times than during any other administration ever. It was used so much that the Senate changed the rules to disallow a filibuster on presidential nominees with the exception of the Supreme Court. To be fair, there are some semantics around what constitutes as a filibuster versus a cloture vote, and different people count the tally differently. That said, I don’t think it’s far-fetched to say twice as much. According to the Senate’s website cloture was invoked 352 times during President Obama’s two terms. In contrast cloture was only invokes 141 times during President Bush’s two terms and a measly 69 times during President Clinton’s two terms.

During President Obama’s two terms there were three Supreme Court vacancies. His first nominee Justice Sonia Sotomayor was confirmed by a wide, filibuster proof majority of 68 votes. There were threats of filibustering, and there were threats of changing the rules to disallow filibusters then too. In the end there wasn’t enough support for a filibuster. His next nominee was Justice Elena Kagan. A handful of republicans got on board with her as well and created a filibuster proof majority of 63. So, while it is technically true, that President Obama’s Supreme Court nominees were not filibustered, that was more a function of not having the votes than it was some moral aversion to using the filibuster.

What about the third vacancy of the Supreme Court during President Obama’s tenure in office? This was the vacancy left by the death of Justice Antonin Scalia. This is a guy who equated homosexuality with bestiality and murder; yeah, murder. He defended the death penalty because if you are a Christian then death isn’t that big of a deal. You want to read some crazy shit? Look up some of Justice Scalia’s dissents. He was a real medieval sort of thinker; a real conservative hero. And, the republicans were not going to go quietly this time.

Senate Majority leader Mitch McConnell immediately decried that with slightly less than a year left in President Obama’s second term no Supreme Court nominee would even be considered. No need to vote, no need to filibuster, we will just not do our job at all and the vacancy will remain. Nothing like this had ever been done before. If anyone was still not sure that republicans were using unprecedented tactics to obstruct the government from even functioning, this should have been your wake up call. President Obama countered by nominating Merrick Garland. During the previous Supreme Court vacancy republicans explicitly suggested Merrick Garland as a “consensus nominee” that there would be “no question” that he would be confirmed. Still, republicans refused to take any action.

It is appalling to me that the unprecedented, egregious republican tactics will probably work. The democrat’s potential filibuster of Neil Gorsuch is not unprecedented. Rather, the new precedent set by republicans during the Obama administration. That precedent is for one party to use any technicality possible to obstruct the opposition party from effectively governing. Then find some way to rationalize your actions or inaction.

It is my opinion that every democrat should use any tactic, or technicality possible to block any Supreme Court nominee until Merrick Garland is confirmed. Any republican with integrity should stand with them and admit that the refusal to consider Merrick Garland amounted to nothing less than a shirking of responsibility and an abuse of power. Confirming Merrick Garland will be the best way to begin to roll back this dangerous precedent that developed during the Obama years and culminated in the absolute refusal of the Senate to meet their constitutional obligations.

I even have a few suggestions for rationalizing the actions:

“We will consider President Trump’s nominee for the Supreme Court when President Trump has a Supreme Court vacancy. Right now we should be focused on filling President Obama’s vacancy with President Obama’s nominee.”

I’ll indulge in a little speculation with this one:

“The American People deserve to have their Senate confirm a Supreme Court justice nominated by a President who is not under investigation by the FBI for colluding with a foreign nation to commit election fraud.”

This one will hurt a little bit for some of you:

“We should wait to confirm a Supreme Court nominee until we have a president who won the popular vote.”

And this one is just sort of funny (maybe):

“A Supreme Court vacancy should not be filled during the last year of a president’s term.”