Wednesday, April 18, 2012

Titanic and Taxes

April 15th is the 100th anniversary of the sinking of the Titanic. That date, of course, is more famous as the deadline for submitting our income tax forms. But it falls on a weekend this year, so procrastinators get a brief reprieve.

The Titanic was sunk by an iceberg, and every grade-school child learns that most of an iceberg (about 90 percent) is hidden below the water’s surface — part of what makes it so dangerous to ships.

Taxes and government spending have the same characteristic. They are often “hidden” to us.

Sometimes, it’s because the tax is subtle — for example, the various taxes on cell phones. (have you looked at your bill lately?)

Sometimes, it’s because we don’t pay much attention to politics, focusing on a few policies because we’re busy mowing our lawns and raising our children.

Maybe we get upset about a certain tax — for example, federal income taxes or local property taxes — but largely ignore other taxes.

Or maybe we get irritated with some aspect of government spending — for example, on the military or welfare programs — but miss the bigger picture.

What is important but overlooked with the icebergs of government spending and taxation?

First, consider federal income taxes. With complaints that the wealthy do not pay enough taxes, many people want higher marginal tax rates on the rich. (Interestingly, our federal income tax system—with marginal tax rates ranging from 1-7 percent — debuted the year after the Titanic sank.) But the larger issue is tax loopholes — income deductions and tax credits — that lower taxes paid, independent of tax rates.

Second, consider state and local income taxes. At the federal level, families with children don’t pay much in income taxes until their earnings are in the upper-middle class. In many cases, though, their state and even local income taxes are higher. In fact, those with income at or below the poverty line still pay state income taxes in 15 states.

Third, federal “payroll” taxes on income (the Federal Insurance Contributions Act or FICA)) are far larger for most taxpayers than federal income taxes of the Form 1040 or April 15th variety. More than 80 percent of wage-earners pay more in federal payroll taxes on their income than they pay in federal income taxes. We don’t notice it since the money is quietly sucked out of our paychecks and we don’t fill out any forms for it.

How can this happen? FICA has no deductions and no exemptions. So, unlike income taxes, the 15.3 percent tax is applied to every dollar earned. And most people believe the fiction that the employer pays half of FICA. But the employer shifts most of the burden to employees, as surely as the local gas station shifts the burden of gas taxes to customers.

Fourth, debt amounts to future taxes. We’ve had a decade of impressive debt at the federal level. With Medicare and Social Security, we have huge entitlement programs and the baby-boomers retiring. And many states have unsustainable pension programs. Although it’s politically attractive to spend money now and to push taxes into the future, there is a limit to what can be done to delay.

What will it take to sink the American economy? How much debt is too much? No one knows. But the icebergs are getting larger and our ship is getting closer. Who will steer us away from doom?


At April 20, 2012 at 9:17 PM , Blogger Bill said...

So Eric-
What is the crux; that is the $64,000 question, right? I believe it extends beyond the tax situation, however; let’s keep it within these bounds for a moment and perhaps expand it as needed.
Your argument rightly points to ignorance or apathy as the preventative factor to real tax reform. There are too many people abusing the general misunderstand of statistics and tax law to convince people to compare marginal and effective rates and such. I read an article that pointed to a fundamental issue in current policy (politics), which is that reform is currently viewed as a binary decision. Either lower or raise taxes; raise or lower spending – there is no marginal thought in their approach, which is a huge mistake. The buffet rule, closing loopholes, making one segment pay “their fair share” is both tearing our country apart and getting us nowhere.
This type of thought is expanded to policy mistakes which could cost the country its position in the world. Cost saving measures such as eliminating the penny, replacing the dollar bill with the dollar coin and reducing postal service frequency are dismissed as being drops in the bucket. You were one of the people that helped me understand that a bucket is filled with drops!
As a relevant tangent I would argue that one could expand that logic to a broader claim that the political economy is so far removed from the average citizen that they feel detached (rightly so or not) from the system so there is a small faction of individuals that control the fate of the country.
I make this assertion to open a debate on what a solution may be instead of focusing on the individual problems we see, however entertaining that may be. I believe that one builds no value in presenting an issue unless they offer solutions as well.
I believe the fundamental issue with our republic is that the common citizen is under represented today by government, which breeds inefficient policy. When our country was founded the per capita representation may have been adequate however our population has grown dramatically without a like growth in representation therefore we are 'less represented' than our ancestors. This allows an environment of special interest lobby control.
Perhaps, if we thought that our representatives were either more accessible or more betrothed to our wills and wishes we would be more active in the political system and our own governance. How do we make this a reality?
As an aside, you mentioned the cell phone tax; have you looked at the ‘Apple tax’ on cell phone usage?
By the way, do you know anyone at GMU? I finally have gotten around to Econ grad school and am waiting for a decision… you know how it is; just trying to get an MA…


At April 23, 2012 at 5:54 PM , Blogger Eric Schansberg said...

Bill, thanks for your comment.

I know some people at GMU, but none of them all that well.

I have not looked into the Apple tax. If you have a good link, please share it!

At August 31, 2012 at 12:50 PM , Blogger Bill said...

I apologize for not getting back to you sooner regarding this. I use the term 'Apple tax" to refer to the secondary costs associated with the distortion to the cell phone market that standard cell phone subsidies (rent to own plans may be a better description) causes. A critical assumption is that carriers will not, in the long run, accept a lower profit margin for substitute goods.

The current system is built around contracts that allow providers to offer hardware at ‘discounted prices’ (which are not discounts at all, it is a financed cost built into the service contract [perhaps used to increase the market by lowering entry costs] but I am already to brackets so maybe we skip that point for now). Where the problem enters is that these discounted prices become the ‘real’ prices to consumers regardless of what the provider has to pay the hardware manufacturer for the unit.

Apple has the most expensive hardware on the market, having a higher marginal subsidy when compared to its nearest competitor. As an overly simple example: a consumer can pay $200 for an iPhone with a retail price of $800 or can buy a similarly equipped model for a $100 fee and a retail price of $450. This amounts to an additional $50 per unit subsidy for iPhone purchases which must be recouped somewhere. Each of these units has identical contract offerings (price, usage, etc.). In this example, anyone who does not buy an iPhone is being taxed by those who do through the disproportionate subsidies.

Said differently if you get an iPhone and I get a non-iPhone the transactions break down like this:

*Assumptions - a contract length of 24 months and a cost of $75/month.

The net profit to the provider is $1200 for an iPhone and $1450 for a non-iPhone. Assuming these two goods are substitutes in the eyes of the provider (as a means to a profit) each unit they sell and service should have near equal returns. Even if demand is higher for iPhones providers have the option to set the subsidy; furthermore, can we even comment on true demand since the full cost is not internalized by the consumer? The difference in profit illustrates how the consumer of a non-iPhone subsidizes the iPhone user.

Next is the data consumption. iPhones (especially those equipped with Siri – use a disproportionate amount of data bandwidth when compared to competitors. Since the contracts, to this point, have not discriminated between iPhone and non - iPhone users, people who do not have the units are subsidizing the high data usage of the iPhones.

Apple has benefited from this hidden tax. Since individual consumers are not bearing the full cost of their choice, or at least not directly, people are consuming more of the product than they would otherwise.

Carriers are currently setting up plans to account for these issues. Some are reducing the subsidy by raising the price of the initial unit, others are moving away from the unlimited data plans to unit based pricing. It is my opinion that Apple will not continue its meteoric rise in wealth if the true costs of its products are bore solely by those who consume them.


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