OK, I’m starting to pay more attention to what the candidates are saying regarding tax and budget policy, now that there are only two candidates to follow. Obama’s announcement on Friday regarding his proposal to raise Social Security’s maximum taxable income level was news (here’s an AP story) because for the first time he explicitly spelled out to what level the taxable max would be raised. And while I give his campaign lots of credit for coming out with the details, I’m disappointed that those details were not as sensible as I had hoped–no plain “eliminate the maximum” (now at $102,000), and no simple “raise the maximum to $___”.
Instead, Obama is proposing that the current Social Security payroll tax of 6.2% apply to wage incomes up to the current maximum of $102,000, not at all to the wage dollars earned between $102,000 and $250,000, but again for wage dollars above $250,000. This is what the “donut hole” term refers to.
(Now brace yourselves for some math… or skip the next paragraph and trust me, if you’d rather…)
In other words, someone with wage income of $150,000 would see no change in payroll taxes from current law (the tax would still be 6.2% of $102,000 (the taxable maximum) or $6,324, for an average or effective tax rate on a $150,000 earner of $6,324/$150,000 = 4.2%. But someone with wage income of $500,000 would see an increase in payroll taxes from what under current law is the same maximum tax paid by anyone with income over $102,000, of $6,324, to what under the Obama proposal would be $6,324 + ($500,000-$250,000)*.062 = $6,324 + $15,500 = $21,824. That’s an increase in the effective tax rate for the half-millionnaire, from $6,324/$500,000 = 1.3% to $21,824/$500,000 = 4.4%.
So what the rather capricious “donut hole” structure buys the Obama campaign is some consistency in their general theme that taxes on the rich (implicitly defined as those with incomes above $250,000) are too low and that the federal tax system overall is not progressive enough. The “donut hole” structure turns a tax that is proportional up to the taxable max and regressive (with effective tax rates declining as income rises) above the taxable max, into a tax that becomes progressive (with effective tax rates rising with income) at very high incomes (beyond $250,000). Yet the “hole” part of the “donut hole” means the payroll tax would still be regressive when one compares the burden of anyone below the current taxable maximum (who can legitimately be considered “middle-income”) with anyone above it–because anyone above $102,000 has at least some income that would be completely exempt from the tax. (Only people with wage income below $102,000 would pay an effective tax rate as high as the statutory marginal rate of 6.2%.)
This strikes me (and Len Burman of the Tax Policy Center) as a very messy and inefficient way to try to introduce more progressivity into the federal tax system. It doesn’t work well because it goes at it through the wrong tax instrument, through a payroll tax that is intended to be mostly proportional in incidence, instead of going at it through the parts of the federal tax system that are actually intended to be progressive–such as, for example, the individual income tax, and in particular (if we care mostly about adding progressivity at the very top) the alternative minimum tax.
Note that you won’t find this “donut hole” way of raising Social Security taxes in revenue option #39 of CBO’s “Budget Options.” (You will find various income-tax ways of making the overall tax system more progressive–or less progressive–though.)
Here’s the radical idea I have: look at the purposes and inherent structures of the taxes we have, and work to improve these taxes so they achieve those purposes more efficiently. Keep Social Security payroll taxes mostly or even entirely proportional, by raising or even eliminating the taxable maximum. If you’re worried about those people who earn between $100,000 and $250,000 that the candidates sometimes refer to as “middle income” (so I’m one of them), then that probably stems from the fact that you know that the alternative minimum tax is sort of unfair on folks in this income range, compared with the really rich people with incomes above $500,000. But if that’s why you feel sorry for these people (i.e., feel sorry for me), then fix the part of the tax system that is responsible for the inequity. Don’t go arbitrarily mucking up one part of the tax system (the payroll tax) to treat the symptoms of disease coming from another part of the tax system (the AMT and its interaction with the rest of the individual income tax).
So today I did a little Tim Russert-style investigating as to how the Obama campaign would have come up with this idea for a payroll tax “donut hole.” I had not heard the “donut hole” concept floated about before, but it turns out that was because I wasn’t really focusing on the candidates’ tax and budget proposals before.
It turns out that back last September, Senator Obama published an op-ed in the Quad-City Times that said, regarding Social Security reform (emphasis added):
I do not want to cut benefits or raise the retirement age. I believe there are a number of ways we can make Social Security solvent that do not involve placing these added burdens on our seniors. One possible option, for example, is to raise the cap on the amount of income subject to the Social Security tax. If we kept the payroll tax rate exactly the same but applied it to all earnings and not just the first $97,500 [the taxable max in 2007], we could virtually eliminate the entire Social Security shortfall.
In other words, in September 2007, Senator Obama seemed to be floating the idea of eliminating the taxable maximum altogether. (But note: Obama was already saying last fall that he did not want to cut Social Security benefits by, for example, raising the retirement age. That’s pretty explicit in the above.)
Meanwhile, also in September, Senator Edwards had a different idea for how to raise Social Security taxes, as reported in this ABC News story (which incidentally also quotes the above Obama op-ed as well as Concord’s Bob Bixby):
Former Sen. John Edwards, D-N.C., has also talked about raising the Social Security tax cap. But he would do so in a more limited way than suggested by Obama.
While Obama has suggested imposing the 12.4 percent tax on all income above $97,000 per year, Edwards would only impose it on those making more than $200,000 per year. Income between $97,000 and $200,000 would continue to be exempt from Social Security taxes under the Edwards proposal.
“I do think we need to have a bubble above $97,000, probably up to about $200,000 so we don’t raise taxes on middle-class families,” Edwards said at Thursday’s AARP forum. “But, above the $200,000, these millionaires on Wall Street ought to be paying their Social Security taxes.”
And by November 11, in an interview with none-other-than Tim Russert on NBC’s Meet the Press, Obama was floating the idea of the “donut hole”–as reported in this MSNBC article which includes a link to the video:
[D]uring an interview on NBC’s “Meet the Press,” Obama said subjecting more of a person’s income to the payroll tax is the option he would push for if elected president.
He objected to benefit cuts or a higher retirement age.
“I think the best way to approach this is to adjust the cap on the payroll tax so that people like myself are paying a little bit more and people who are in need are protected,” the Illinois senator said.
“That is the option that I will be pushing forward.”
…Obama’s proposal could include a gap or “doughnut hole” to shield middle-income earners from paying more in taxes, he said.
(Also note: he was still objecting to benefit cuts/higher retirement age–and Tim Russert was giving him a hard time for having taken real solutions “off the table” when they had been on the Obama table earlier in 2007.)
I wish Senator Obama had stuck with what seemed to be his first instincts on the Social Security tax–to raise the cap in a simple, sensible way. I think as time went on he started thinking too much and trying to do too many things with it–trying to please too many people. And that’s the discouraging part–that such mucking up of well-intended policies can happen even during the campaign, well before the elected President has to do such mucking up (”compromising” is what it’s called) in order to find agreement with a diverse, bipartisan Congress. It shouldn’t yet be time to bring out the donuts.