Monday, August 7, 2017

Taxes, Behavior, and Regressive Incentives

Taxes, Behavior, and Regressive Incentives
As the latest attempts to repeal the Affordable Care Act have recently failed, it seems that Congress is moving on to the next item on their agenda: tax reform. I guess that's why I keep stumbling on articles suggesting drastic changes to the tax code: like eliminating the mortgage interest deduction.

My main beef is not with any specific deduction in our tax code. (Though the mortgage interest deduction is curious, to say the least.)

Rather, I think our system of deductions runs counter to the goals of our progressive income tax system itself. Looking at most of the incentives, the more you earn, and the more tax you pay, the more you benefit from the programs.

Let's take the 401k, for example. Anyone making up to $270,000 annually, from the humble custodian making minimum wage to the corporate attorney pulling in a quarter million in salary, can contribute the same amount: $18,000. That $18,000 is shielded from federal income tax.

Our attorney in the 33% marginal tax bracket has a strong incentive to save for retirement: putting in the full amount into his 401k would avoid $5,940 in federal income tax alone (and potentially much more, depending on what kind of match his company provides). He potentially avoids quite a bit more in state income taxes as well by saving for retirement, depending on where he lives.

But our custodian's incentives are much weaker. Assuming that he works 40 hours a week for all 52 weeks a year, his gross pay is only $15,080: well short of the $18,000 annual limit for 401k contributions. After accounting for the standard deduction and the personal exemption, our janitor still has $4,680 in potential taxable income, to be taxed at a 10% rate. So instead of avoiding 33 cents of tax for every dollar invested in retirement as the lawyer does, our custodian only avoids 10 cents. Investing $1,000 of his income (nearly 7% of his gross pay for the entire year) would only help him avoid $100 in taxes.

"But what about the Savers Credit?" you might ask. You're right: the savers credit is just the kind of program that creates a real incentive for those who pay less in tax. But our janitor is only scheduled to pay $468 in federal income tax, assuming he takes no other deductions or credits: he cannot even take full advantage of the $1,000 credit.

And if we assume our janitor might owe no federal taxes due to other deductions, his 401k contributions come with no tax incentives whatsoever, as the Savers Credit is not refundable.

A significant problem with our current retirement system is the way tax incentives are distributed. The more taxable income you earn, the greater incentive you have to participate in a 401k. And for those working poor who are putting in long hours at hard jobs but paying no federal income tax, they get no tax benefit by default. Beyond the fact that high earners already have more money to invest in retirement, they also receive greater benefits from the government for doing so.

It's the same story with other behaviors our tax system encourages. The IRS rewards us for putting money in a Traditional IRA (potentially in addition to a 401k), or saving for future health care expenses in an HSA, for paying mortgage interest on expensive homes (i.e. - those who would pay more than $13,000 in interest annually), or donating to charity. Many states mimic this system, by incentivizing high earners to invest in your children's education in a 529 with state income tax deductions.

In all these cases, the higher your income, and the higher your tax rate, the greater your benefit when you engage in certain behaviors. Those paying little or no tax have little or no incentive to participate, especially with programs like the mortgage interest deduction which hinge on having an expensive, debt-funded home.

Depending on your political bend, maybe that's the way you think it's supposed to work. If some of our citizens aren't paying federal income taxes, maybe they should not receive any additional tax incentives.

But we should acknowledge that those who pay very little in income tax (i.e. - the working poor) still ought to save for retirement, fund their children's future college expenses, and save for upcoming medical expenses. When the main vehicles to encourage this behavior are 401ks, 529 plans, and HSAs, we should not be surprised that those with very little or no incentive (or perhaps even negative incentives) don't participate in the programs very much.

An Alternative Approach
This is not a post arguing to take away benefits from upper middle class and wealthy families. But I'd like to see an alternative tax benefit offered to our citizens who have little incentive to defer income taxes, and have very little money to invest for retirement, healthcare, or college as it is. If we want to encourage these behaviors across all income levels, comparably large incentives should be offered to the working poor as are offered to the upper middle class.

In addition to our current system of tax deductions and deferrals, we could provide an alternative when filing: to instead receive a refundable tax credit, not unlike the Earned Income Tax Credit.

Under such a system, if a working mother of two earned $32,000 a year, she could, instead of putting money in a Traditional IRA for retirement, could invest in a new IRA that provided $1,000 in credits (i.e. offsetting any tax she owed) for the first $1,000 invested, and $500 for the next $1,000 invested. But even if she were paying zero in tax already, she would still receive the credit in the form of a refund after filing.

Similar, refundable credits could be offered for funding healthcare (i.e. - an alternative to the HSA), as well as for paying mortgage interest and charitable giving. If states were open to such a program, something similar could be done for saving for education (i.e. - an alternative to the 529).

In addition to providing comparable incentives to the working poor to invest in retirement, healthcare, and home ownership, these dollars are very likely to be spent and end up back in the economy.

Who's Paying?
From the government's perspective, a dollar provided to the poor in credits isn't dissimilar to a dollar avoided by high earners via deductions. (Though to be fair, income tax that is deferred, as it is with a 401k and a Traditional IRA, will eventually be paid back to the government later in life. Well, usually.)

Still, it should be acknowledged that such a program would have significant costs: albeit potentially smaller than the costs of the existing tax benefits such as mortgage and charitable deductions. I'd propose trying to offset them by adding a new tax bracket on income above $1M, say 44%. (Odd hat tip to Steve Bannon, of all people, for floating a similar idea). Potentially, the federal government could offset these costs by lowering the amount of mortgage interest or charitable contributions that could be deducted.

Regardless, I am no politician or public finance expert, and what I've laid out is a half-baked, broad strokes idea. I'm positive that people much smarter than me (than I?) could devise a better plan.

But I believe that we should provide material incentives to our working poor, just as we do with the high earners and upper middle class families. If we think saving for retirement, education, and owning a home are behaviors we should encourage via our tax system, then we ought to extend that fully to people across the income spectrum.


*Photo is from feserc at Flickr Creative Commons.

46 comments:

  1. You know I like this idea--especially in context of retirement contributions. I also think with your argument for it being a boon to the stock market, you may even be able to convince corporations of taking on a additional tax to facilitate. Maybe. In that context, at least, you may have an easier time politically than taxing the individually wealthy. Maybe.

    Random side note: most custodians I know pull in an income closer to $40k+. May be because they work for the city, county or city schools in an area with a long though tragic history of unions, but I was surprised that the position tilted so close to middle class.

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    1. I think you're on to something with the stock market somehow compensating for this. Though I suppose that it would technically be a tax...but one that resulted in additional investments into their companies. The hard part is probably collecting the funds from myriad corporations who are publicly traded only (i.e. - privately owned companies wouldn't benefit).

      Good point about public servant custodians. When I was working at the university and taking classes at night, the other employees I saw who were fully taking advantage of the benefit were custodians. I don't think they were making close to $40k (under $30k as I recall, at least back in 2003 or so) but I totally agree that you see some higher wages with certain government & union positions.

      I suppose I just wanted to highlight someone making the federal minimum wage and showing how little it was over a year, even at full time for 52 straight weeks. Could have probably picked a better position though!

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    2. If they are unionized, which I'm not sure, but my references may have received a pay bump for that. Also, they could be embellishing. And yes, I think it was an excellent point and did not mean to diminish it! Apologies for getting contrarian.

      And that's true about privately owned companies. If you can sort out the details, you should totally pitch it to a politician as a campaign platform. Everybody wins.

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    3. *and by that "that" I mean the time they've spent in the position.

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  2. No worries at all about being contrarian. I do the same, almost all the time.

    And I'm sure there are plenty of custodians earning good wages. I recall a story from a while ago about a custodian clearing more than $200k annually in the Bay Area for taking all the overtime shifts he could!

    But there are a lot of people earning minimum wage, and it's not just kids on summer break. Those working poor really could benefit from a more even distribution of incentives

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    1. For sure! Been one of them myself, and it sucks. When someone tells you to save for retirement when your income doesn't allow you to pay the electric bill, it's literally laughable.

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    2. Exactly. This is where so much of the typical personal finance advice (and that includes the drivel you'll read on this blog) falls short. So many of our citizens are working, full time in many cases, and earning wages that put them right around the poverty line. Telling those folks to max out a 401k without any incentives is crazy!

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  3. LOVE this post, and I couldn't agree more. I think what many in the upper echelons of the middle class fail to realize is the degree to which their lifestyles are funded by the government through tax policy. I get sooo sick of hearing social programs for those on the lower end of the income scale referred to as "handouts" while tax benefits to the wealthier citizens are not - when both things are essentially tax funded programs!

    I've actually been bitten by this bug in the past. I chose a year when my business was slow to focus on some home improvement chores, including replacing my ancient furnace with a highly efficient model. I had carefully calculated the cost vs. tax credits of various systems, but I neglected to realize that I wouldn't have enough of a tax bill to get the full credit. Grrrrrr..... For me it was mostly an annoyance and a learning experience, but for a person without many financial resources, it would have been either a real financial burden or a complete disincentive to upgrade to a more efficient system!

    I can't help but think that this is what happens when the tax system is crafted by high income folks with a particular political agenda - ie: keeping the poor, poor. Perhaps I'm being too cynical, but this sort of thing just seems like an issue of basic fairness to me, and it's yet another example of how the system is biased in favor of the "haves" and against the "have nots."

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    1. Thanks, EcoCatLady!

      I don't know if the wealthy really are trying to keep poor people poor, per se. But they're definitely lobbying politicians to create and protect programs that allow them to avoid taxes, and to thus to get wealthier as a result.

      Completely agree that people are generally blind to the government benefits they receive, but are adept at finding those that others benefit from.

      And your example with a furnace is a good example of how regular deductions are distributed unevenly. If the goal is to encourage the purchase of more efficient appliances, why should high earners get more of an incentive? Seems weird.

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  4. 44% tax on the most productive citizens who provide most of the jobs and already pay most of the taxes while almost half of the people in this country pay no income tax at all. Sure, that sounds fair, to at least 45% of the country I bet.

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    1. I was hoping someone would chime in with that talking point!

      So, those earning over $1M provide "most of the jobs"? Interesting -- I thought small businesses did (though certainly, some small business owners make over $1M annually in salary.)

      Regardless, the point of the post was to give similar incentives for certain behaviors (saving for retirement, paying mortgage interest, and charitable contributions) that high earners already receive.

      How do you feel about high earners receiving these incentives from the IRS?

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    2. My gripe is with the soak the rich sentiment that seems to be the "easy" answer to every problem needing money. I never made a million $ in a year so I'd theoretically benefit from such a tax but I do not think it is fair to pick on any minority including the wealthy. Sure, 44% tax might be easily weathered by a millionaire but it was within my dad's lifetime that the US taxed income above $200,000 at 94%. So for every dollar you made above $200,000 you got to keep six cents. Does that sound fair? If not then where is the magic line between progressive and confiscatory? I don't know. I do like your concept but I am worried that as we become a nation where soon a minority of people will be paying any income tax that we can reach an unsustainable place. Great thought provoking blog!

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    3. To answer your question: no, I don't think a marginal tax rate of 94% sounds fair. I suppose that's why I proposed a pretty modest increase of roughly 5% above the current highest tax rate. As you noted, this is far below what it's been in our recent past.

      I also don't plan on "soaking the rich". But I'd ask again: how do you feel about high earners receiving lots of tax incentives from the IRS which the working poor do not receive?

      Would it be better, rather than having a modest increase on those earning over $1M, to offset the costs by taking away some of those incentives that the upper middle class enjoy?

      My hope would be to provide comparable incentives to the working poor which are ALREADY being received by those earning much more, and the point you're hitting on is how to pay for it.

      Perhaps you would prefer we just keep the current system in place?

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    4. Probably before we suggest raising taxes on others, we should be first willing to pay more taxes ourselves.

      What is your marginal income tax rate?

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    5. I was wondering if someone would take this line of argument. (i.e. - let's talk about the taxes you personally pay, rather than discussing tax policy itself.) Basically, going ad hominem. But I didn't expect it from you, Sam. :)

      But sure, I'll play. My wife and I are in the 25% tax bracket. When she finishes her PhD and goes back to work, I anticipate we'll end up somewhere in the middle of the 28% bracket.

      And I don't want to get too off track in the discussion, which is focused on providing comparable incentives to the working poor for the same behaviors that upper middle class and wealthy Americans already receive significant benefits for.

      If the way to accomplish that were to raise taxes on my bracket as well, I'd be open to that.

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    6. I think the claim that the highest earners are the "most productive" is dubious at best. A good chunk of these high earners do nothing but sit back and watch their money (which many of them inherited from their parents) earn money for them.

      But more to the point, I think that these sorts of "it ain't fair" arguments are really quite misguided. When the system allows the majority of the wealth to reside in very few hands, it's not good for the economy, because the money tends to stagnate. This depresses the economy - which isn't good for anyone (including those at the top who are hoarding all of the money). But when you distribute some of that money to people who will spend it, the money circulates and the economy prospers - which is good for everyone.

      The further problem with this sort of reasoning is that the vast majority of the people who are so worked up about the tax boogey man and wealth redistribution falsely believe that they would be worse off if the wealth were more equitably distributed. The truth is far, far different. This video is a good illustration of the situation. https://youtu.be/dttG9aIa9RQ

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    7. I've seen that video before, and I wish I'd included it in my posts on income and wealth quintiles. (Self-promotion ahead.)

      http://www.donebyforty.com/2015/04/middle-class-wealth.html

      http://www.donebyforty.com/2015/03/middle-class-how-about-middle-quintile.html

      While I happen to disagree with those arguing that taxing the wealthy at higher amounts is not fair (I mean, that's how progressive taxation works), I can't really argue with them that much, because I, too, am making an argument based on fairness. Basically, we're both just defending a principle: we just have different principles.

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    8. Well, that's an interesting point about both sides defending a different principle. And if I'm honest, I have to admit that I too think that wealth inequity is an issue of fairness. But I also think that if it's possible to put aside the whole question of fairness for a moment, there is also the fact that wealth inequity leads inevitably to economic stagnation. So it seems to me that those who would argue that the rich should be allowed to amass as much wealth as they can because it seems "fair" to them, are actually putting fairness above functionality - and I really can't see how that helps anyone.

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  5. I think a reduction in taxes, when you do not pay taxes, by it's nature will not affect you. Putting the injustice another way and I think you could just as easily suggest that since I have no children, some other type of annual credit should be given to me. After all, it would not then be fair that all those who do have children should get a deduction! Simply because I do not have those costs, should I be discriminated against!?!

    Practically speaking, Social Security is skewed to provide a higher percentage of income replacement for the lower income ranges and the middle classes need to set aside a higher percentage of income outside of social security for themselves. SocSec pays 90% of the first 885.00 per month (this amount changes each year). Income above that is just 32% until 5,336, then only 15%. Your janitor, at 15,080 would receive income replacement of 73%. Someone making the per capita wages of 26,964 would receive only 55%. Someone 'rich' making 100,000 a year as a single person, just 32%. In order to maintain any level of life style once retired, they will have to have saved additional funds in the form of IRAs, etc. Additionally, It's important to note that these are not just difference in a retirement pay scale. Because SocSec is a guaranteed lifetime annuity with inflation protection it's not as simple as saving the difference. In order to maintain a similar standard of living enough must be saved not just fund the extra amount but also to account for two or three decades of inflation. I suppose you could suggest that above the poverty level people should not be assisted any further with retirement planning but I suspect those making 25,000 a year would take offense.

    Finally, not many 15,000 dollar a year earners out there are putting any amount into a 401k so I suspect that the conversation is moot. At a certain point your income falls below where you can contribute. Run the same numbers again with a median income family and they will have both some money to save into their 401ks, and some money to save on their taxes from doing so.

    And as two bonus points: On traditional contributions these taxes are only deferred. They are eventually repaid as well as taxes on all the accumulated gains. On roth contributions, those in much lower tax brackets will pay substantially less taxes on their contributions and then later be able to remove them tax free.

    For what it's worth, I actually agree with removing the mortgage interest deduction. It benefits are vastly overrated. ;)

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    1. Thanks for the thoughtful reply, Morgan! Lots to unpack there.

      "Putting the injustice another way and I think you could just as easily suggest that since I have no children, some other type of annual credit should be given to me."

      Well, that's not exactly analagous. My argument is that people at a lower income should receive the same incentives for the same behavior as those with higher income. So if higher income individuals were receiving child credits but the working poor weren't, that'd fit in the theme of the post (rather than those with kids vs. those without).

      "Social Security is skewed to provide a higher percentage of income replacement for the lower income ranges and the middle classes need to set aside a higher percentage of income outside of social security for themselves."

      Well, to a point, but then SSI doesn't apply to income above the low six figures. It's actually a flat tax: one of the few in our tax code that is not progressive, and then becomes heinously regressive after a certain point. I'd say Social Security is a good example of a tax that really rewards high earners.

      "Finally, not many 15,000 dollar a year earners out there are putting any amount into a 401k so I suspect that the conversation is moot."

      I disagree entirely. We have yet to see how these low income individuals would contribute if they received 401k matches as well as huge tax incentives. Isn't it a bit presumptuous to assume what they would do?

      And the system I've proposed would provide a 1:1 credit for the first $1,000 contributed: namely, the government would reimburse them for the first grand. With the right financial literacy education and roll out, I think we'd see lots of the working poor contribute.

      "On traditional contributions these taxes are only deferred. They are eventually repaid as well as taxes on all the accumulated gains."

      Yes, as I noted in the post.

      As for the Roth contributions, the incentives are preposterously far off in the future and extremely weak, as retirees' tax rates are typically very low anyway, and would almost certainly be low for a low income retiree.

      "For what it's worth, I actually agree with removing the mortgage interest deduction. It benefits are vastly overrated. ;)"

      Oddly, I am not arguing to remove such a benefit to owners of very expensive homes. Only that we ought to provide some similar benefit to low income people who own homes, and still pay interest.

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    2. "On traditional contributions these taxes are only deferred. They are eventually repaid as well as taxes on all the accumulated gains."

      This argument, often utilized, is a bit of a misdirection. It implies tax neutrality when in fact it is nothing of the sort. One of the major benefits is to reduce taxes by shifting income to lower tax years.

      That's what I spend a lot of time thinking about with respect to my own accounts anyway. And often going undiscussed in this discussion, is the ability to 100% avoid high state income taxes on those contributions (by moving to a low tax state before retiring).

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    3. Exactly! The reason tax deferral is such a good idea is that the net taxes paid are expected to be less, and there's the added bonus of investing MORE money decades earlier. The compounding on these additional funds is hugely beneficial.

      When you add in strategies like the 5 year pipeline for early retirees, FIRE folks are literally paying no income tax on these retirement accounts, in some cases.

      Agreed on impacts of mobility, too. I wonder how many people try to earn their fortunes in Texas or Florida, then go off and retire to a state that tries to raise most of their money from income tax...

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    4. I wanted to respond in kind so we could have some true exchange here but, I don't know about on your end, but the 'reply' box is less than an inch tall and about 3" wide. It's very difficult to reply thoroughly. I'm going to try to bullet point it back to you instead of cutting and pasting into yours. :)

      Your argument is that the person should receive a refund (credit) based on money they never spent. I do not spend money raising children so do not qualify for that particular credit and the janitor does not make retirement contributions so he does not qualify for that credit. Discussing how to return/reimburse/credit them for the contributions is a misdirect at best.

      SocSec can be considered a flat tax when collected but is certainly extremely progress when distributed,providing substantially more benefits to per dollar contributed for lower earners. While someone making 300,000 dollars per year will not pay this tax on much of their income, they will receive no additional benefits for it.

      At 15,000 per year, your assumed single janitor is near poverty level and eligible for Medicaid and other social services. The discussion is actually revolving around if he is missing out on benefits (by not saving money on taxes he is not paying) on the funds he can contribute on his own. With those income numbers I do NOT think it's an assumption that he is not putting funds away, there IS a reason it's poverty level. Your comment that he may contribute if we subsidized it dollar for dollar is not him contributing to the retirement account but the taxpayers doing so for him because he cannot afford to do so. We already do this in the 90% return I mentioned earlier on SocSec funds.

      Briefly, You seem to be of two minds on the roth/traditional area. In one post you say that Roth virtues are extremely weak, in another you suggest that the compounding of funds is hugely beneficial. Funds in roths in the future, purchased at their extremely low interest rates now, will also help to avoid the further taxation of their social security benefits when they do receive them.

      Finally, just a quick note that many people do NOT move to a lower tax bracket in retirement. Early retires are likely the exception on nearly every financial question so as an example they are a poor one. Those in the 90% income replacement range, those we are discussing, will by definition be replacing most of their income. Above a certain threshold (which decreases progressively each year) social security is taxed.

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    5. I am not a public finance expert but what I do on a day to day basis is meet with individuals and small businesses, working class generally, to create budgets, set up retirement plans, handle personal financials. I am the person in the room while we argue over the amount they have to dedicate to an IRA. My comments here are not based on how to fund your scenario, we can discuss increasing taxes on any group you like, they are about what is already being done and the best way to increase benefits for the poor in a way that is effective. Unfortunately, it doesn't seem as if the goal is to actually provide relief for the impoverished, just to make sure that the 'rich' aren't receiving a benefit that the poor are not. :(

      For instance, I would suggest increasing that first 90% bracket to 100% as something that could be discussed. It would require no input, no understanding, no individual response and yet would deeply affect the lowest tier of earners. If you like, we can assume that this is paid for by reducing the top 15% rate or even removing it entirely. What this does not do is make us feel 'good' by making sure that the poor receive a dollar rebate on their taxes each year.

      I support addressing a variety of tax related issues but I prefer to make the system simpler and more direct. If we believe that contributing our tax funds towards low income retirement accounts is a worthy goal, then lets do it in as effective a way as possible. Instead of issuing those funds only to those who are savy enough to fill out the correct forms, who are able to keep from tapping their growing accounts, who are able to make good investment choices and not be swindled, let's use those same funds to increase their social security payments.

      Then, on funding, it's true that I do not appreciate the idea of my taking money from one man to give to another. It feels inappropriate. The question doesn't seem to be 'Is it okay for this man to work 8 hours a day and be paid for only 4 of them?' but only 'At what point will this man work less?' which is very discouraging for me. Is the idea to flog the man to get maximum return? Or is to ask for a fair level of supporting the society? or is it neither of those? I don't know.

      Again, I can barely see these words on the screen so if my sentences read oddly it's because I can only see one or two at a time. Nice discussion regardless.

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    6. First, sorry that the text is hard to read. I know less about website design than your average 6th grader, so I don't know if there's much I can do about it.

      Again, lots to unpack. I'll try to keep in short.

      -I see what you're trying to do with the child credit analogy, but I just don't think it's analogous, or at least the best analogy that can be made. If wealthy people were getting child deductions but no such incentive were given to low wage earners, then it would line up. Anyway, it's a nit. No need to belabor the point further.

      -I agree that the benefits of SSI are progressive, but that the tax itself is flat and become painfully regressive above $118k. So both can be true. Regardless, I think it's a bit tangential to the discussion of tax deductions and credits. As far as a tax, very high earners pay a LOWER effective tax rate than our janitor earning $15k. That he might see a better return on this 30 years from now in retirement is true. But it warrants mentioning he has a higher SSI tax rate TODAY than a guy earning $1M.

      -Re: the janitor saving for retirement, I'd reference the EITC. The hope is that after subsidizing the initial $1,000 contribution, and then giving half that subsidy for the next $1,000, is that the benefits of those investments would begin to spurn further investment, potentially provide some income & dividend, and perhaps result in a virtuous cycle.

      -Re: Roths, I don't see it as a contradiction. Investments have their own incentives (i.e. - they compound and increase in value). When I stated the Roth has a weak incentive, I am referring to the tax incentive offered to someone already paying zero (or close to zero) tax. I don't think telling him he'll also pay $0 tax 30 years from now is a strong incentive re: taxes. Maybe you disagree, and that's okay.

      -As for whether future retirees are going to be in higher tax brackets, I admit I have no crystal ball here. I believe the average person will have lower taxable income and likely pay a lower effective tax rate in retirement. If you think otherwise, might I ask if you're using something like Roth 401k contributions, or if you're actually deferring taxes?

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    7. And, in reply to your second comment...

      "Unfortunately, it doesn't seem as if the goal is to actually provide relief for the impoverished, just to make sure that the 'rich' aren't receiving a benefit that the poor are not. :("

      I don't think that's fair at all. The point is to provide NEW benefits to the poor, clearly, without taking away benefits from high earners. It seems logical to encourage the same behaviors, in my opinion.

      "What this does not do is make us feel 'good' by making sure that the poor receive a dollar rebate on their taxes each year"

      That's a pretty cynical take.

      Very quickly, yes, I'd be open to increasing SSI payments but happen to also see the merit of people saving for their own retirement in addition to that, especially since SSI may not be as financially sound long term, given demographic changes

      Re: "taking money from one man and giving it to another" that probably explains our disagreement here.

      Anyway, thanks again for commenting. I'll bow out here, but maybe others would like to continue the discussion.

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    8. Good discussion. Just one comment because I have a LOT of first and second hand knowledge in the mobility area.

      "Finally, just a quick note that many people do NOT move to a lower tax bracket in retirement. Early retires are likely the exception on nearly every financial question so as an example they are a poor one."

      You are probably correct by saying "many" or even "most" people don't move, but that obfuscates the fact that a certain small WEALTHY percentage DO move. I live in NJ presently and everybody I know in the higher tax brackets move or plan to move. Yes, my wife and I would be considered wealthy as we reach the highest tax brackets each year and in NJ that adds another 10% to each incremental dollar earned.

      My wife's own boss, who hasn't even retired yet, has already moved to Florida and is now spending less than 180 days in NJ in these last couple of years before his retirement (ostensibly to establish presence so that when he retires he can cash out his equity free of NJ). We ourselves have a "postpone income until we leave the state" plan. All legal. There are some legitimate financial instruments for such things.

      I'm amazed at how many measures there are to legally avoid taxes and most people have no concept of them. I'm sure if I made even more money, I'd reach a whole other echelon that I myself have no concept of today, because it would involve lawyers and bankers to work for me year round.

      Don't be a fool and assume the 1% and 0.1% (MAJOR differences between those two groups by the way) are paying "list prices".

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    9. And after that long email I'm now realizing you said don't move to a lower tax "bracket" when they retire (I thought you were commenting on state). That being said, much of my point still holds. By moving states in retirement, you DO move to a lower tax bracket when you retire.

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  6. So many good points on both sides here. I'm staying out of this one. :-)

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    1. Ha! Yes, I didn't realize writing this that so many people would have strong opinions.

      I didn't anticipate that suggesting a modest increase on those earning over $1M in taxable income (a year!) would bring about so many defenders of the wealthy. ;)

      Seriously, I do think taxes are, for whatever reason, a really hot button topic even if the tax doesn't impact the commenter. Taxes speak to our concept of fairness, and we have differing ideas of what is fair.

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  7. I am a public finance expert and none of what you say is crazy.

    I will note that for truly low earners, Social Security will replace a pretty high percent of their income, so it is possible that they don't "need" to save for retirement (with the assumption that quality of life in retirement shouldn't be different than quality of life while working). That's an area of open debate for people who study this part of public finance.

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    1. Morgan made a similar point that I think I glossed over. You're right, the part of the Social Security benefit before the big 'bend' really is generous to the poor.

      I suppose I still like the idea of giving similar incentives to the working poor that the rest of us already enjoy. They might surprise us!

      The EITC is a success story, in my mind. I'd just like to steal that idea and see if refundable tax credits spurn good behavior in other areas.

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    2. I'm pretty much on the same page as N&M on this one. If true tax reform is going to happen in the near term, I'd rather it focus on strengthening social security (my favorite option would be removing the cap without an increase in benefits to high income earners), and then attacking the mortgage interest deduction which is my least favorite tax deduction - but I believe I've been down that latter road with you before. =)

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    3. I was thinking off addressing SSI but it's kind of outside the scope of deductions/credits. But I agree: SSI needs to be strengthened (i.e. - funded more fully).

      This is another great example where very high earners (over $118k) get an incentive that the rest of us do not. Above that figure, they get a tax break with SSI. To me, it is nuts that someone earning $250k annually pays a lower SSI tax rate than someone earning $25k.

      And re: mortgage interest, I don't have much hope that it would be taken away. If we go with that assumption, I'd like there to be some sort of similar credit/benefit provided to people who own homes with less than $13,000 in interest paid a year (say, homes with something less than $280k or so borrowed at today's rates).

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  8. Interesting concepts put forward. While I'm not a "defender of the wealthy" :-) I do find it a difficult pill to swallow that it is considered fair at any income level for a government to take 44% of any citizens income. I realize the effective rate is lower and that plays into your argument but I still don't think I can get there.

    I agree with the basis of your post that the tax code very much encourages certain behaviors. We see it with incentives and taxes on products, lifestyle(marriage), deductions etc so you certainly nailed that. I suppose that is a whole different debate so back to your post....

    You mentioned, "But even if she were paying zero in tax already, she would still receive the credit in the form of a refund after filing." Would this credit be required to go into some form of IRA or would it simply be a credit that she sees as an ordinary refund? If it is simply a refund, I see zero chance of that being put in savings and getting the result that you are hoping for.

    Great read, BTW!

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    1. Thanks, Michael.

      Think of this particular aspect (i.e. - the $1,000 credit for putting $1,000 into an IRA or 401k) as a modification of the existing Savers Credit (which is not refundable). That is, if a person of low income puts $1,000 into a retirement account in 2017, then when they file in 2018 they will get a $1,000 refund that they can do whatever they want with. However, they'd have an incentive to put that same money into an IRA again.

      So they'd only get the incentive AFTER they'd demonstrated the behavior.

      There'd likely need to be some sort of rule about taking the money out, perhaps with some exceptions as there are with Roth IRAs.


      As for the 44% bracket, we could also simply frame it as paying 5% more, and only on the income above $1M, that they already pay 39% of. That is to say, it's a pretty modest increase.

      Still, there is likely a point at which you overtax. Is 39% the highest we should go? Maybe.

      But we were at 50% as early as 1986.

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  9. I wouldn't frame the issue as comparing high-earner tax incentives to low-earner tax incentives. Taxes are the strongest tool the government has to influence behavior of the masses. First step is to decide whether the targeted behavior is worthwhile for the country, and thus whether a tax deduction should be provided.

    For example, home ownership and charity have been deemed good things for the country. So high-earners get tax deductions to encourage buying a home and donating to charity.

    For low-earners, these values can be encouraged by the government in ways other than tax deductions. Presumably, low-earners are the likely beneficiaries of charities. Regarding housing, HUD is the government program to help low-earners obtain ownership. For retirement, as noted above, Social Security provides more dollar-for-dollar payback to low earners.

    Just keep in mind that the government can provide incentives to different levels of taxpayers through multiple programs/systems. The "fairness" should be analyzed using the totality of programs/systems, not just within a specific (tax) system.

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    1. That's a good point, Adam. The issue is certainly complex and there are more levers than taxes. And yeah, we could address whether incentives for home ownership should exist at all. (But that is a different discussion. So long as the government would provide tax inventives to the wealthy to own, then I'd argue something similar should be provided to those struggling just to own a home.)

      Additionally, I find the existing incentives for the working poor to invest in retirement, in particular, to be ineffective. That's why I'd like to see a refundable tax credit. I personally believe that once you invest and see the returns that happen over time, then the investments provide their own incentive to continue.

      I don't particularly love the idea that charities are supposed to pick up the slack while we're giving tax incentives to high six figure homeowners. But I'll concede that many people benefit from them. I just have to note the irony that wealthy donors are getting a strong incentive to give to those very charities, by avoiding taxes in the process.

      But I like your point that there are myriad programs that help out the working poor beyond tax incentives, like HUD.

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    2. I personally think the incentives for home ownership should be reduced or eliminated. At this point it inflates the housing costs. But I'd probably feel different if we were back in the 70's era of 15% mortgage rate.

      Regarding changing incentives for working poor to invest in retirement, that would be worthwhile. Though it would probably need a mechanism to prevent early withdrawals or else most people would drain their accounts.

      It is a complex issue. I think the first step to make any programs effective is personal finance education. The vast majority of people (high-earners, working poor, and everybody in between) are well conditioned to only think short term about finance. Our lives are reduced to monthly payments, which is why it's "hard" for people to save and also why people with big houses love the interest deduction. Monthly paychecks and debt payments are the current basis of the economy and the government won't change it due to negative impacts on businesses.

      I don't think changing tax incentives will have much impact unless people can see the long term outcomes. People who frequent the personal finance blogsphere "get it" but others don't, and can't make someone learn. My guess is that every single FIRE blogger/follower had a moment of insight at some point that forever changed one's perspective of money/consumerism/marketing/investing/life. Figure out a way to disperse that insight along with the refundable tax credits and good things would happen. Without it and I don't see much impact.

      tl;dr - People are bad with money. Tax incentives are more effective after people read good bloggers like Done By Forty. Carry on! :)

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    3. Agreed on controls for the incentives (e.g. - funds must stay invested for X years or the incentive must be paid back). And I was going to write a whole section on a rollout/education program, but thought the post was already too long and kind of wonky.

      I personally am lukewarm on the effectiveness of formal financial literacy education, but agree that there's a need to improve our knowledge overall. How to accomplish that? I dunno: that's a problem for smarter people than me.

      I certainly wouldn't encourage people to read my blog for personal finance education though. This place is like intentionally devoid of practical advice, but it's lousy with pretentious ramblings. :)

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    4. Yes, Adam, that's what I was trying to say with the discussion being about feeling good by swapping evensteven tax credits rather than about being effective as a movement towards lowering poverty in retirement. Well done for being more clear about it than I. :)

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  10. Such an interesting post. I can't help but think about how many, many, many different factors are at play because our tax system is SO convoluted, so it's hard for me to have an opinion.

    The one piece that I always get stuck at from my personal projection of my own situation is the inadvertent incentivizing of leaving the full-time workforce. These types of tax credits may make sense if limited to full-time workers (given the already established, albeit not necessarily adequate, poverty and unemployment relief programs).

    As a self-employed single parent with two dependents paying the ironic self-employment tax, self-pay high deductible health insurance (with significant ongoing medical expenses as a type 1 diabetic), and having no retirement matching, I have run the figures roughly in the past and found that if I stopped working (and spent a good 5 hours a week gaming the system, because it is a LOT of effort to get on and maintain Medicaid, food assistance, etc), I could actually live off that pretty decently. That's pretty attractive a few days out of the year (mainly those quarterly tax prepayment days).

    I always find the unintended consequences of policies so fascinating. Nothing is ever perfectly direct - it does certainly come to the best possible policy and measuring the impact to see where we landed, that last part being the critical step that most all of us, whether trying to pay off our debt personally or get low-income earners to save across the country, fail to do effectively, therefore spinning our wheels.

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    1. Emily, interestingly, I resemble your remark. My spouse, who worked 60 hours a week for 15 years, finally dropped down to 28 hours a week this past year. In the end, between federal taxes, state taxes, health incentives, etc, we lost 60% of his pay before we ever saw it. Once you included the time preparing for work (commutating, etc) he was only being paid for 25% of his hours. Because we could afford for him to work less, we do so.

      It is indeed possible to incentivize, or disincentivize, full time work. Nice post.

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    2. Emily:

      Totally agree that there's a need to study the impacts of these programs. I think government and academia do a better job of this than most, but it's important to understand if the help actually provided the impact anticipated. Freakonomics had a great episode on something similar last month.

      And agreed that there are sometimes incentives for bad behavior with these programs as well. I suspect that abuse/fraud is much more common than I'd like to admit.

      Still, I remain undeterred. I'd prefer that our tax dollars go to help those in need, even if the collateral cost is also helping those who aren't.

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    3. While some people see incentives like that and run with it, I'd argue that the vast majority run the other way towards independence. Many lower income people I know have a low opinion of those on welfare and don't apply themselves. Maybe other states are more generous, but in mine living off welfare is less than comfortable.
      Emily, do you deduct your healthcare premiums as a self-employed individual? If so, then maybe you could qualify for some programs already. Our state asks about that deduction specifically on the application, though I'm not sure which program it applies to, or if your premiums are very high with an HDHP. Worth looking into, though.
      I'd be interested in Nicole and Maggie's take on this. $1k reimbursement hardly seems like enough to leave the workforce over, but I'm no economist.

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    4. "I could actually live off that pretty decently"

      No, no you couldn't actually and this sort of talk is damaging and untrue.
      Anon in Massachusetts

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