Often Unrecognized Influence of Federal Income Tax Policy

Because the federal income tax is the largest and most costly tax in our country, it also influences economic behavior more than any other tax. Businesses take into account tax avoidance strategies into their decisions about what new investments to make in plant and equipment, how much inventory to hold, and even whether to show profits and declare dividends.

One of the most influential tax policies regards the deduction for mortgage interest. I can't remember where I read it, but I'm pretty sure that Americans spend more per capita on personal housing than any other nation. Wealth that could be used to invest in business is invested in housing that tends to be excessive relative to the rest of the world.

You want to see where the Reagan tax cut went, go drive along Bonneville shoreline into the various subdivisions where mansions exist that provide housing that is excessive for anyone's need. Americans with their houses live like Dukes and Earls, not the burgesses (bourgeoisie) that most capitalists pretend to descend from.

Go to places like Eagle Mountain and Saratoga Springs, and you see one case after another of people on fairly modest means occupying houses barely within or outside of what they could afford without the income tax considerations. For most people, the most valuable assets they have are their houses. Investments in the private sector tend to be retirement related if they exist at all for many Americans, and often, because of tax considerations, their houses have second mortgages on them to pay for everyday living expenses. This creates a dependence upon the value of one's house as the only asset one can exploit. And when the housing market goes down? Many are left with few options.

I believe our country would be better suited to pursue wise, and frugal residential land use. People don't need to live in a starter mansion, or have three or four mansions. I believe there should be a cap on the mortgage interest deduction of around $20,000 per year. This won't prevent people from getting into a home, but it will limit the incentive to overbuild and over-invest in real estate rather than in plant and equipment. Investments in plant and equipment increase American productivity. Investments in real estate, create short-term, and limited returns that ultimately do little for our economy.

What Obama’s Middle Class Tax Cut Would Mean to Utahns

Democratic Presidential candidate Barack Obama has floated the idea of providing a “middle class tax cut” of $1,000. His campaign appropriately points out that this would eliminate the income tax for millions of people. What would be the impact here in Utah? I guess it depends on what you consider to be “middle class.” My wife and I for the first time last year, broke the six figure mark for Adjusted Gross Income (AGI). I live in a modest house in a relatively inexpensive community. We have two vehicles, one a 1996 model, the other a 2002. Our federal income tax burden was around $10,500, equating to a roughly 10% effective tax rate relative to AGI.

In Utah, the average federal income tax for AGI groups are as follows:

0-5K---------------$10
5-10K--------------$87
10-15K------------$262
15-20K------------$482
20-25K------------$792
25-30K----------$1,130
30-35K----------$1,437
35-40K----------$1,777
40-45K----------$2,130
45-50K----------$2,554
50-75K----------$3,875
75-100K---------$6,747
100-250K-------$17,121
250-1,000K-----$88,804
Over 1,000K---$708,958

From http://tax.utah.gov/esu/income/fed2006/soi2006.htm#35

For filers reporting AGI less than $25,000, Obama’s plan would for the most part eliminate their income tax liability (depending on whether they file as single or married filing joint) and assuming that Obama considers middle income to include up through $100,000, the cut would reduce by over half the tax burden of filers filing between $25,000 and $45,000. As you increase in AGI, the percentage of a decrease in your tax burden goes down significantly. I don’t know whether the decrease would somehow disappear once someone reaches a certain threshold or would the decrease be in effect for everyone’s income to a certain degree.

For the record, I am supporting Barack Obama, but I don’t necessarily support the tax cut he is proposing. The myth that the middle class is over-taxed by the federal government makes good politics, but it doesn’t hold when given careful scrutiny. With deficits out of control, a declining dollar, wars being fought in two countries and crumbling infrastructure needs, I don’t think it is time for a tax cut. I believe a tax cut will make things worse, not better. A short-term infusion of money may help people pay their increased gas costs, but in the long run, we need to be spending money developing clean and renewable energy and developing better mass transit systems.

And though I am in favor of progressive tax policies, I think the current income tax is already fairly progressive. All Americans need to pay their fair share. Eliminating people from paying taxes reduces their investment in our country. To some extent I agree with Fareed Zakaria, in his book “The Future of Freedom”, that the need for taxes makes government responsible to the public. Our nation was not founded out of a rebellion against taxes, it was a rebellion about taxation without representation. And as our government spends more money than it takes in, the old adage is true, “if you are spending too much money, you don’t solve the problem by quitting your night job.”

Utah Republicans and Prop 13

There have been rumblings about some of our less than enlightened Republican legislators flirting with a Prop 13 sort of proposal, where properties are assessed based upon their acquisition cost. For the record, I am amazed that Utah's highly dysfunctional and one-partied state managed to produce something that I actually feel works rather well. It is called "truth in taxation." This provision in Utah law makes it so state and local government cannot reap a windfall from rising property values. This is something Utahns should be proud of. It makes the property tax much more fair than it otherwise would be. Utah's legislature has also instituted "circuit breaker" tax relief for those who risk losing their home due to property tax liabilities.

In many ways, Utah's response to the rising property values of the 1970's was enlightened by comparison to California's politically charged response. The one thing I would have changed, is to create the ability of the various entities to base their tax rates upon certain inflationary factors. The lack of such a provision has resulted in most state and local jurisdictions to rely upon fees that have had a tendency to be regressive.

Basing the property tax on acquisition cost creates inherent inequities. People with like properties will be assessed differently, based upon whether they bought their house during a time of residential inflation, or deflation. The property tax was designed to tax people equitably based upon the current value of their property, not based upon whether they moved here when the housing prices were high, or weak.

Democrats, need to be engaged in this process of defining policy options. My option, that I believe should be considered, is to base the residential exemption upon 45% of the median primary residential property in each county. This way, if new growth coming from starter McMansions drive up the value of Grandma Baker's house, it also increases the residential exemption available to counter it. You could also use the mean, but at this point, I would propose the median.

Democrats need to point out, that an acquisition cost property tax, will stifle companies moving their employees to this state, where they, with recent acquisitions, will shoulder the tax burden for those who have been here longer. It will also facilitate complex leasing arrangements rather than sales, and I haven't yet digested what that will mean to Utah's realtors.

My suggestion is this. We don't have a property tax problem that is not solveable. An acquisition cost system only worsens inequities, and potentially stifles economic growth here in Utah. This is my warning on the record, that this is a bad idea, proposed by people who haven't thought through the consequences, and are unlikely to stop because of them.

Utah's Burden of Federal Income Tax

In looking at Utah’s tax burden, the federal income tax represents a large percentage of that burden, particularly for those who make more than a modest income. The Utah Tax Commission has some interesting data on their website and I’ll be taking that data and examining it a little bit. The federal income tax is not as progressive as it was prior to the Reagan administration, when the marginal tax rate for the wealthy was at 90%. However, the federal income tax remains relatively progressive. For return year 2006, Utahns paid nearly $6.2 billion in federal income tax for individual filers. And though filers with Adjusted Gross Income (AGI) over $1 million represent only .19% of the population, they pay 23.58% of the federal income tax burden in Utah. Taking the effective tax rate of filers within certain AGI ranges produces the average effective tax rates as shown below:

------AGI Class(thousands)-----------Effective Tax Rate
________________>0____________________________-.22% _______________0-5_____________________________.38%
_______________5-10___________________________1.16%
_______________10-15__________________________2.09%
_______________15-20__________________________2.76%
_______________20-25__________________________3.53%
_______________25-30__________________________4.12%
_______________30-35__________________________4.43% _______________35-40__________________________4.74%
_______________40-45__________________________5.02%
_______________45-50__________________________5.38%
_______________50-75__________________________6.31%
_______________75-100_________________________7.84%
______________100-250________________________12.36%
______________250-1,000______________________21.10%
_____________Over 1,000______________________24.97%

What the chart shows, is that despite various tax cuts to the wealthy, the federal income tax remains a fairly progressive tax. What it also means, is that if you give future tax cuts in the income tax, the majority of the benefit will go to the wealthy because, frankly, they are the ones who are paying the most tax.
The chart below also shows the percentage of Utahns by AGI class and the percentage of the federal tax burden.

AGI Class(thousands)_______Returns Filed_____%Income Tax Paid
>0 _______________________1.21%_______________.03%
0-5_______________________8.11%_______________.01%
5-10______________________8.50%_______________.13%
10-15_____________________7.93%_______________.36%
15-20_____________________7.83%_______________.65%
20-25_____________________7.17%_______________.98%
25-30_____________________6.31%______________1.23%
30-35_____________________5.56%______________1.38%
35-40_____________________4.94%______________1.51%
40-45_____________________4.46%______________1.64%
45-50_____________________4.06%______________1.79%
50-75____________________15.34%_____________10.26%
75-100____________________8.52%______________9.92%
100-250___________________8.47%_____________25.01%
250-1,000_________________1.40%_____________21.52%
Over 1,000________________0.19%_____________23.58%


It is interesting to note that filers with an AGI of less than $50,000 pay less than 10% of Utah's federal income tax burden.

These figures have certain implications. First of all, any attempts at a flat federal income tax would massively redistribute the tax burden from those making making over $100,000 a year to those making less. Also, any attempt at gutting the federal income tax and replacing it with a tax on consumption (a regressive tax), would even more massively redistribute the tax burden. And though conservatives will often argue that a flat tax or consumption tax is more fair, that fairness needs to be explained to Americans of all stripes about what it will mean to their own overall tax burden.

As mentioned before in other posts, I have indicated that Farmers generally don’t pay any taxes. Statistics from people who file a schedule F, shows that Utah’s agricultural production results in a net decrease in federal and state income taxes. Given what farmers and ranchers are allowed to expense and capitalize, every AGI class showed negative earnings and therefore reduced the federal tax liability of those who engaged in agricultural activities. The 17,414 schedule F’s for return year 2006 resulted in $137.7 million in farm losses which were deducted from Utah’s federal and state income tax base, of which over half of that amount or $76.2 million was from returns where the AGI exceeded $50,000 for return year 2006. It is interesting to note that 55% of the returns filed which filed a schedule F had an AGI over $50,000 for 2006. What this means, is that there may be many engaged in agriculture who do so part-time, and the purpose of which is to reduce federal and state tax liabilities on their more considerable sources of income. Now because we have to eat, I do think there are some good reasons for helping our farmer’s out and encouraging land be used for agricultural purposes, but I do think it is fair to the citizens of the state to recognize the degree to which they are in fact subsidizing farmers in our state by paying their share of our tax burden to provide services for our schools, roads and other worthwhile services.

Tax Policy in Utah #1- Property Tax

Property tax is a significant funding source for a wide variety of local government services. From your school district, to killing mosquitos, from building local roads, to providing meals on wheels, the property tax is a much used tax. One of the benefits of the property tax from a governmental level is that it is typically more stable than consumption taxes such as the sales tax, or the income tax, which quickly responds to economic conditions.

Utah's property tax faces what is actually something that works quite well. It is called "truth in taxation." What truth in taxation means is that, increases in property values cannot be used by the government as a windfall. New property tax revenues must come from "new growth", not merely a re-appraisal of the value of property. Property tax rates are based upon the budgets of local entities, not upon the values of property. If you receive an increase in property tax, it is more likely that it is based upon a reappraisal of the value of your property, not upon the tax rate charged to you.

Now there are some peculiarities to Utah's property tax structure. One of those is what is referred to as the "residential exemption." Every Utahn's primary residence is granted an exemption of 45% of the value of their residential property. This means that someone with more than modest means and owns a $20 million mansion will recieve a $900,000 exemption from property tax. Some states have decided upon a lump sum exemption for residential property which makes the property tax much more progressive, but Utah values it's mansions and those who occupy them.

Other interesting things about Utah's property tax, is that it is not gauged for inflation. The tax rate setting process allows no increase for the increases in cost. Local government is then required to provide the same services as last year with the same resources, but have to pay their staff additional wages to compensate for increases in the cost of living. The result is that local governments often have to resort in increasing various fees to make up the difference. And fees are inherently regressive.

Also of note is the fact that secondary residential properties receive no residential exemption. As a result, someone who owns a $150,000 home in Murray who also owns a $85,000 cabin east of Kamas, may find themselves paying more property tax for their cabin than for their primary residence.

Another interesting aspect of the property tax process is that small and large business, without any exemptions, pay full property tax on their personal property (equipment, furniture and fixtures, etc.) and are required to keep track of what equipment they keep, and what equipment they discard on "personal property affidavits" that they file with their country assessors. However, influential companies often approach their county assessors or the Tax Commission and seek special consideration. County Commissions, operating as the county's "board of equalization" is often likely to give special favors to businesses with "clout" in their county. In this regard, there are some significant inequities in Utah's property tax administration. Utahns are rarely aware of the degree to which their own county commissioners have the power to reduce the tax burden upon prominent businesses and push that burden upon the other property owners living in their county. And their local press is rarely aware of these decisions and provide adequate oversight.


There are exemptions from property tax that are significant and notable. Farmers pay virtually no property tax. Their equipment is exempt from property tax as is their livestock. The value of their land is appraised on the basis of it's agricultural production value, referred to as "greenbelt." Whenever I hear farmers or ranchers complain about taxes, I pretty much roll my eyes because they are exempt from just about every tax imaginable, and even receive federal subsidies. Pay taxes, and then you have a right to complain about the government. However, what the exemption farmers receive regarding greenbelt (land values) creates a situation where if that land is developed and used for non-agricultural purposes, back taxes are due and is a major irritant to developers and farmers seeking to cash in on the value of their land. It is referred to as roll-back taxes and it is a deterrent to development, but also keeps land ihn agricultural use long after it is feasible.

Property tax is a "constitutional tax" in Utah, which means that it is based upon Article XIII of the Utah State Constitution. Exemptions to the property tax therefore cannot be based upon statutory provision but must require an amendment to Utah's Constitution. The variance from this is an exemption given to the blind that is based upon statute. If that statute was ever challenged, it would certainly be viewed as unconstitutional. Howevand er, no one so far has seen property the most economical use of property. Holding property for mere speculative purposes becomes expensive. Hoardng land comes with a cost. Major corporations like Kennecott find it in their interests to lease their land to farmers adjacent to their operations and have them as buffer zones occupied in agriculture. This aspect of Utah's property tax laws encourages "green space" which many of us find valuable.

Anyway, these are some of my thoughts and analysis regarding Utah's property tax. I welcome the input of other bloggers.

The Reagan Myths

Watching Republican presidential candidates fall over themselves trying to convey themselves as "Reaganites" was enough to make me disgorge my lunch. So many people embrace Reagan as this mythical figure is irritating to me. Reagan proposed and accomplished huge tax cuts yet never articulated where he would pay for them. He blamed Congress for the deficits that his administration incurred, yet he never, and I mean never, articulated what should have been cut. He increased military spending, and would not countenance reductions regarding Social Security or Medicare which represented a huge proportion of federal spending.

On many levels, Reagan was one of the worst Presidemts of the United States. He bought some temporary prosperity by going into debt, an option available to all of us, if we are so inclined, and in fact, we seem to be inclined. But Reagan was a Keynesian on steroids, going well beyond any self-respecting Keynesian would go.

And now, it seems that Republicans embrace the myths of Ronald Reagan, much to the hazard of our Republic. Cutting taxes, without articulating which expenditures you are going to forgo doesn't make sense at a national level any more than they would at a personal level. But Republicans seem all too eager to embrace short-sided tax cuts for short-term political benefit. It is amazing to me that people worship the myths of Reagan. Of course, I've seen equally implausible myths believed in with great sincerity.

Why I Oppose Vouchers

In this post, I will outline my reasons for opposing the use of publicly funded vouchers for private school education.

1- I am opposed to using public money to promote a religious agenda. When you look who is supporting vouchers and why, it is apparent to me that one of the driving forces behind this movement is to provide public funding to Christian or Mormon schools. Supporters may counter that not allowing vouchers means the government is funding a secular or atheistic agenda. I disagree. Nothing I ever saw in the public schools promoted atheism or secularism. I just don't buy the argument that failure to fund someone's religious agenda is by default a funding of someone else's agenda.

2- Public funding in my view requires that there be public control. Right now, I vote for members of my school board. I have influence over how they prioritize both the placements of schools as well s the curriculum used. The degree to which I or other taxpayers would have control over private schools which receive public funding is questionable and indirect. I also question whether private schools want any degree of oversight. I also question whether or not our state education establishment is prepared to develop auditing programs to ensure that private schools are following public guidelines that should be inherent in public funding.

3- Those who will gain the most immediate benefit from vouchers are those who can already afford to send their kids to private schools. Given Utah's generally regressive tax structure, how can you justify giving out a payout from public funds to those in the highest income brackets from middle to low-income taxpayers? Frankly, you can't.

4- Vouchers will generally only provide people with considerable funds available to consider private schooling as an option. For those in lower income situations, the voucher will never be enough to provide a true choice to send their kids to private schools.

5- Competition between private and public schools is over-rated and has many drawbacks to the public objective of having a well-educated citizenry. Private schools will have several advantages in this "competition" that very well may undermine public education as a whole. Private schools can deny kids on the basis of academics, whereas public schools cannot. Would private schools be required to accept kids with disabilities such as mild autism, ADHD, or kids with other problems? What will this mean for public funding for kids with various disabilities? If public schools find themselves losing the competition, what options will be available to them to make up the difference? Private schools can go to the capital markets to obtain new resources. What if legislators are unwilling to fund the needs of public schools in order to allow them to be competitive?

6- On what basis would a voucher be denied to students who enroll in a school. Example, let's say an Islamic fundamentalist group establishes a private school for their children to teach them jihad against the west, weapons and explosives training, and terrorist tactics? Without proper overshights, have we as a country just funded our own demise?

7- I find it interesting that so many Utahns who find socialism in every government program, fail to see it when there becomes public funding of private enterprise. I think we as a society should always be cautious about providing public funding for private businesses. Competition between the private and public sectors can have good results. FEDEX, UPS and other delivery companies directly compete with the United States Postal Service. However, public funding is not, and should not, be used to fund UPS or FEDEX. The same is true for private schools.

8- Why should public funds go to a private school that may in fact be discriminatory? Getting back to religious schools, is it reasonable to assume that a Mormon school would require some sort of approval process in order for a student to matriculate there? Same with a Christian, Muslim or Jewish school. What if a Christian school right accross the street from an atheist denies a child's application on the basis of the child's parents outspoken belief that Christianity is bogus?

9- My final concern deals with the social consequences of dividing ourselves on the basis of one critieria or another. If Christians only deal with Christians, Mormons with Mormons, the rich with the rich, will we be able to empathize and appreciate others. Public schools bring together a cross-section of kids and place them together. If someone wants to exclude their kids from association with the wider world, that is their prerogative, but I don't believe that exclusion should be publicly funded.

10- Because I believe the most important priority we as a society should be making is ensuring we have as high a quality education as possible that is available to everyone. I believe vouchers have more of a down-side to this objective and it takes away the focus all of us should have on making public schools better. To me it is a punt on second down when we should be devising the right play and the right execution, we are kicking the ball to the opposition and hoping they do something with it.

Reagbushonomics Essay 3- The Fallacy of the Laffer Curve

Deficits must be paid for one way or another. Some third world countries have the bad habit of simply printing more money, creating inflation. However, debtor nations have wisened up to that tactic and loan in dollars or a more stable currency and require payment back into that currency. The U.S. dollar has for many years been a primary international currency that funds nation-states.

In the United States, the way deficits are handled is to finance them through U.S. treasury bonds and other government issued investment vehicles. This method of finance in fact dismantles the logical fallacy that is the laffer curve. The laffer curve is at the center of the basic philosophy of what Reagan was hoping to accomplish. By lowering taxes, especially taxes in higher income brackets where there is a high degree of investment vrs consumption, the assumption was that there would be an influx of capital into the marketplace, fueling growth that would bring down unemployment and increase tax revenues. However, when you look at the basic calculation behind this logic, it doesn’t make sense.

Let’s say on average, the income tax reduction went to 40% investment and 60% consumption. So for every $10 dollars of income tax relief, $4 went into the capital markets. However, for every dollar of deficit you run up, 100% of that money comes from the capital markets, resulting in a net decrease of $6 from the capital markets. The results of this was a predicament during the Reagan administration, that real interest rates (interest rates less the inflation rate) actually increased. When real interest rates are high, it has a negative affect on the net present value of all future returns on investments ROI. It also requires business to shy away from long-term investments in favor of short term.

The results in the 1980 capital markets was a foregone conclusion. Welcome to the era of junkbonds, and leveraged buyouts. A focus on existing assets rather than investment in future assets hurt the economy of the Reagan years and that lack of investment in plant and material in many industries resulted in a serious decline in the manufacturing sector in the United States and a significant realignment and displacement of the U.S. economy. Luckily for the U.S., we were bailed out by a technological revolution and the creation of many new products. However, the manufacture of U.S. created products began in the Reagan years, and continues today, to be overseas. The day of the good paying manufacturing job was virtually at an end, compliments of “Voodoo Economics.”

In the next essay, I will address some other by-products of Reagbushonomics and how it impacted income distribution in the U.S. and address the unintended Keynesian aspects of Reagbushonomics.

Reagbushonomics Essay 2: Spending, the Other Half of the Equation

This part in the series will focus on the fiscal policy of the Reagan administration, his priorities and it’s impact upon deficits and the national debt. Ronald Reagan put a great deal of weight into the idea that a major tax cut was necessary. Successfully selling that idea upon a skeptical Democrat-controlled Congress was not easy, but it was passed never the less.

The other half of the equation that got lost was the need to decrease spending at the same time. Reagan’s budget director David Stockman slashed away at certain departmental budgets. However, at the same time that Stockman was proposing massive cuts to certain budgets, he was confronted with another reality. Reagan had been critical of his predecessor in allowing the U.S. military to become weakened and vulnerable during Carter’s administration. Notwithstanding Carter’s development of the Trident Sub program and his failed attempt at his original proposal for an MX Missile system (mobile missiles), conservative think-tanks, many funded by arms manufacturers, had worked on selling the public on the idea that the U.S. was militarily weak relative to the Soviet Union. The result was a massive increase in military spending during the Reagan years. Military spending grew during the 1980’s from $136 billion in 1980 to $282 billion in 1987.

Reagan also was reluctant to do anything with social security or medicare, both large components of the budget. The results were quite predictable. The budget deficits that were so alarming during the Carter administration were exceeded greatly and were now approaching $200 billion by 1983, this during a period of relatively high interest rates. These deficits needed to be funded by the Government issuing bonds, bonds at dangerously high interest rates. As a result, interest expense would increase as a part of the federal budget every year. From 1980 to 1984, interest expense would nearly double going from $64 billion in 1980 to $111 billion in 1984. By 1987, interest expense would be $138 billion.

By the end of the Reagan administration, the national debt as a percentage of gross national product (GNP) had gone from 26.8% to 43.2%. The impacts these deficits upon capital markets and upon the distribution of wealth in the United States will be the subject of Essay 3 of this series.

Reagbushonomics Essay 1

This post is intended to be a first in a series of posts that deal with the economic viability of Reaganomics and it’s 21st century variant, Bushonomics. This first essay will talk a little about definitions and touch on the history behind these economic policies as they’ve been proposed and passed into law.

In 1981, Ronald Reagan assumed the presidency and proposed a dramatic shift in the role and size of the federal government. Assuming the presidency during a time of double digit inflation and interest rates, there were also deep-seeded economic rumblings that were occurring in major industries in the United States such as steel, automobiles, and other heavy industries that were capital intensive and burdened with large numbers of relatively well paid working class jobs.

Reagan’s first and foremost objective was to lower taxes. Most of the tax cuts were earmarked for the wealthy. There is no doubt, that marginal rates had become out of control in the higher income brackets. If I remember right, the highest marginal rates were around 80%. The results were, extensive and pervasive tax avoidance strategies among those in the higher brackets. The result of such a high bracket could also be seen as federal redirection of resources. With such high marginal rates, investment and consumption decisions were being based more and more on their tax impacts rather than the NPV (net present value) of expected returns on investments.

Even so, any proposal for a tax cut faced a daunting reality. The last year of the Carter administration, the federal budget deficit increased to $57 billion, at the time a most alarming amount. Republican economists argued that this deficit was driving down the value of the dollar and helping to fuel the inflationary pressures that ultimately did in the Carter administration.

How to resolve that problem came to the heart of an ongoing debate regarding the impacts of tax policy on economic growth. Reagan’s argument was that a dramatic decrease in the tax rate, especially for those in higher tax brackets, would fuel economic growth that would actually raise income tax revenues and bring down the deficits the U.S. experienced during the Carter years. This assumption was derived by Arthur Laffer, and was articulated in what came to be known as the “Laffer Curve.” Ironically, while making this claim during the Republican party’s presidential nominating process, Reagan’s opponent, George H.W. Bush, referred to this philosophy as “voodoo economic.” The second essay in this series will talk about the impacts of the Reagan tax cuts and whether those assumptions panned out.