Are All Taxes Created Equal?

On Friday, I discussed a Citizens for Tax Justice report advocating for the Buffett Rule. I'm officially done wasting time on the Buffett Rule itself. Today I'll discuss a collateral issue raised by the CTJ report.

[1] CTJ argues that any comparison of effective tax rates paid by individuals must include payroll taxes. Some critics of the Buffett Rule have solely focused on income taxes paid by individuals in various tax brackets. I haven't studied the issue in enough detail to draw a firm conclusion. However, the CTJ argument would be considerably weaker if payroll taxes were excluded from the math.

Are payroll taxes equivalent to other income taxes? Where do we draw the line between taxes that should be included in the computation of effective tax rates, and taxes that should not?

Payroll taxes primarily fund Social Security and Medicare payments. Social Security and Medicare are "social insurance" programs. An individual's payments into Social Security and Medicare resemble insurance premiums (albeit mandatory insurance). Most notably, an individual's Social Security benefits during retirement depend on the amount of "premiums" paid during his or her working career. The "premiums" are pooled into trust structures; the trusts "invest" net cash inflows into Treasuries; and the trusts will redeem the Treasuries to cover net cash outflows.

If payroll taxes are (effectively) insurance premiums, then they should be excluded from the effective tax rate computations. The fact that government "collects" the social insurance premiums does not transmute them into the equivalent of income taxes. Ultimately, social insurance results in a direct payment to an individual beneficiary. Social insurance premiums which support direct payments to individuals are not comparable to income tax revenue that fund other government operations. Sure, we all derive some indirect benefit from government expenditures on defense and transportation and agriculture. But there seems to be a qualitative difference between payroll and income taxes that justify excluding the former when computing the effective tax rates paid by different income groups.

Note that Social Security and Medicare may be "insolvent" under current projections, meaning that government receives an "F" for its stewardship of the social insurance programs. We might have solvent programs if we handed the keys over to actuaries and sent the politicians home. However, an insolvent social insurance program is still social insurance.

[2] All that said, the political right generally discusses payroll taxes as if they are income taxes borne by the employee or self-employed individual. They certainly "feel" like taxes to me. If the right presses that argument, then I agree with CTJ that payroll taxes should be included in the effective tax rate computation. Let's compare apples to apples, not apples to oranges.

[3] Some economists theorize that labor bears a portion of -- and perhaps all of -- the corporate income tax. Two interesting observations.

First, under CTJ's methodology, the effective tax rates paid by all taxpayers would increase if we assume that employees bear a portion of the corporate income tax. I'm not sure how the burden would be shared among low-, middle- and high-income employees. Food for academic thought.

Second, if the theory is correct, it dismantles the argument underlying the 15% tax rate for qualified dividends and capital gains. If labor, and not capital, bears the burden of corporate income taxes, then the owners of capital should not receive preferential tax treatment upon a corporation's distribution of previously-taxed earnings. I'll wait patiently for a counter from the Wall Street Journal editorial board.

[4] Back to CTJ's premise that payroll taxes should be included in effective tax rate computations, because they are economically borne by employees (not employers). As discussed above, payroll taxes are equivalent to social insurance premiums. If we include social insurance premiums in the effective tax rate computation, how about other amounts paid by an employer for the benefit of employees?

For example, many employers offer generous health insurance benefits for employees on a pre-tax basis. Absent the tax preference and historical legacy of U.S. health care, employers would increase wage income to employees, and employees would use the increased wages to purchase individual health insurance policies. Like social insurance premiums (payroll taxes), employees bear the economic burden of employer-sponsored health insurance premiums.

Obamacare mandates that all individuals must obtain health insurance or pay a penalty. Should the payment of health insurance premiums be viewed as a "tax" for the same reason that social insurance premiums are viewed as a "tax"? Does the fact that a federally-mandated insurance program is administered privately really matter? Wouldn't that be a triumph of form over substance? If we include health insurance premiums in the effective tax rate computation, middle-class effective tax rates would skyrocket, and effective tax rates for higher-income taxpayers would also increase dramatically. However, the political left might not be enthusiastic to highlight this fact in public debate.