Fiscal Insight #12
Economic struggle is one of the main social and political undercurrents in America. One in seven families is officially poor. Many more live one paycheck from disaster. More than we want to admit, the poor are our brothers and sisters. Their plight may be our own past, present, or future.
For sixty years, preventing poverty or alleviating its effects have been major goals of government policy. Unfortunately and unintentionally, government at all levels is hurting the poor in four major ways. These barriers are like four Berlin Walls. To escape poverty, a family or individual must surmount all four of these walls:
1. Taxes on the working poor
2. Barriers to employment and enterprise
3. Forced purchases of certain services
4. Higher prices that the poor pay
The first two of these walls reduce the income of the poor; the second two reduce the quantity of goods and services that the poor can buy with their income.
This paper recommends several government actions to help poor Oregonians, at the federal, state, and local levels. The interests of the poor align well with the general interest. If we lift these burdens from the poor, we will lighten the burdens for us all.
Taxes on the Working Poor
Federal, state, and local taxes take 22% to 40% of the working poor's total income. For example, a working poor family of four with a nominal gross income of $16,000 pays more than $5,000 in taxes. Table 1 (available from Cascade) lists all the major taxes paid by three poor households in Portland, Oregon: a single man (earning $8,000 per year), a single mother with one child ($12,000 per year), and a married couple with two children ($16,000).
Payroll taxes create the greatest burden on the working poor, more than half of the total tax burden on many working poor households, with a total marginal rate that ranges from 14% to 20%. While the nation debates reforming or scrapping the personal income tax, most reformers ignore seven of the nine income taxes that workers pay:
Social Security tax - 6.2% from the employer and 6.2% from the employee on the first $61,200 of earned income.
Medicare tax - 1.45% from the employer and 1.45% from the employee on all earned income.
Oregon unemployment tax - Between 2.7% and 3.5% on the first $19,000 of earned income, employer-paid. Federal unemployment tax - 6.2% of the first $7,000 of earned income, employer-paid, with a credit for state unemployment taxes paid.
Oregon workers compensation tax - 1.7 cents per hour worked from the employer and 1.7 cents per hour worked from the employee.
Oregon workers compensation insurance premiums - compulsory (and thus a tax) and employer-paid. Premiums range from $0.48 per $100 of payroll to $39.75 per $100 of payroll. The percentage of payroll assessment, mandated by Oregon law, greatly increases this tax's harm, by raising marginal tax rates.
Local payroll taxes, such as the mass transit district payroll tax (Tri-Met tax) of 0.6176% of payroll, employer-paid.
All of these taxes are actually employee-paid, in the form of lower wages and salaries. Each worker has a marginal productivity, the amount of net value they add to the enterprise, which is the most that the worker can be paid. All payroll taxes (and the associated administrative costs) come out of that amount, reducing what the employee receives. Payroll taxes are paid by the working poor but not by persons receiving welfare (AFDC or other forms of public assistance), discouraging work as an alternative to welfare. The personal income tax is not a major problem for the poor. Federal and state personal income taxes combined take fewer than one out of every eight tax dollars from the poor households in this study. Many working poor families get more money back from the federal earned income credit (EIC) than they pay in federal income tax, helping to offset their payroll tax burden as well. That offset is included in this analysis; the tax burden is 22% to 40% of income even after considering the EIC. It is noteworthy that Oregon's personal income tax is close to a true flat tax already, applying the 9% top rate to even modest incomes and with no equivalent to the federal earned income credit.
The current popular "flat tax" plan would levy no personal taxes on interest, dividends, or capital gains income. Families relying on earned income would still pay up to nine separate income taxes on their income.
Indirect taxes are not withheld from payroll but are paid through higher prices. Property taxes on residential property are the major indirect tax that falls on the poor, passed on to them through higher rents. Some services are taxed by all three levels of government. For example, telephone service is taxed by the federal government (3% tax on long distance calls), state government (5% tax on exchange access charges to pay for 911 service), and local government (Portland franchise tax of 7%). A general characteristic of indirect taxes is that they are extremely regressive, with their worst impact on the poorest of the poor. The most regressive taxes, such as surface water runoff fees or drivers license fees, are flat charges unrelated to income. (Such taxes are very regressive because they take the highest percentage of income at the lowest incomes. However, such taxes also have the advantage of a 0% marginal tax rate; they do not increase with income.)
Taxes take a great share of income. Taxes also discourage further earnings. Including indirect taxes, marginal tax rates on the three example working poor households range from 49 to 56%. However, all three of these households (by coincidence, not chosen for this attribute), fall into income ranges where the earned income credit phase-out adds to their marginal tax rate. In other income ranges, the earned income credit actually reduces the marginal tax rate considerably. Accordingly, we can only specify a wide range of marginal tax rates for the working poor, from about 20% to 56%, with 35% to 40% being typical marginal tax rates.
Barriers to Employment and Enterprise
This paper focuses on the plight of the working poor, but many people are poor because they are not working at all, not working full-time, or not working at a job that pays a decent wage. Government has created the following barriers to employment and enterprise by the poor:
Taxes don't just reduce incomes, but destroy jobs. For each percentage point increase in payroll taxes, employment falls by roughly one half of one percent. Oregon's payroll tax burden of 14 to 20% may thus account for much of our unemployment rate.
The employer-employee relationship has become legally burdened and risky, reducing employment. Each new employee is now a new potential lawsuit. Risk-averse employers avoid hiring those with little experience or education, often the poor who most need jobs.
Each 1% increase in the minimum wage produces job loss in the range of 0.15% to 0.25% of total employment. The combination of minimum wage laws and multiple, burdensome payroll taxes has nearly destroyed the market for legal domestic laborers in the United States.
Hundreds of occupations require professional licenses and hundreds or thousands of hours of education for certification, whether that education is truly necessary or not. To give some kinds of nutritional advice, prepare an income tax return, massage someone, dig a grave, or counsel the troubled all require licenses for practitioners.
Grants of monopoly or special privilege keep poor people out of many occupations. You cannot begin picking up your neighbors garbage for pay in Portland; you are infringing on the garbage hauler's monopoly. You cannot paint "taxi" on the side of your car and begin carrying passengers; a limited number of permits have been awarded by the taxi commission.
In several areas, government forces poor people (and all of us) to buy particular products whether we want them or not:
Oregon state law forces drivers to buy "pain and suffering" coverage as part of mandatory auto insurance coverage, whether they want this coverage or not. Allowing drivers to opt out of "pain and suffering" coverage would save $156 per year on the average Oregon car insurance premium.
The federal Social Security system is a forced purchase of a particular, inferior retirement program. Social Security's benefit formula is skewed in favor of low-income earners. However, even low-income workers would receive three to four times as much retirement income if they were allowed to invest in individual retirement accounts and private annuities instead of in Social Security.
An employee of a small roofing company is forced to spend more than one fourth of his or her potential income on workers compensation premiums. Jane the roofer might prefer to forgo death benefits for her spouse (especially if she is single) and a generous disability pension benefit (being willing to settle for more limited Social Security disability payments) and general job-related coverage (being willing to settle for specific coverage of the hazards of falling off a roof) -- if she could have more cash income instead.
Insurance is one of the most common kinds of forced purchase. There is some justification for requiring such a purchase to protect others when we inflict risks on them, such as requiring automobile drivers to be insured against harm to others. There is no justification for compelling individuals to insure themselves against particular risks; each person's life is his or her own to risk; each person's income should be his or her's to spend as they choose. For the poor person, the freedom to take risks is sometimes even more important. When poverty is the status quo, risk becomes rational. More than a few poor people would be better off having their Social Security dollars in their own hands, as seed capital to start an enterprise, rather than have those dollars confiscated for the promise of a second-rate retirement in forty years.
Higher Prices That the Poor Pay
Anti-poverty programs have focused on providing direct income for the poor or seeking to increase their earnings. Getting more for each dollar has been neglected -- why do goods and services cost so much? Many government actions hurt the poor by raising the prices that they pay:
-Tariffs and quotas on clothing and textiles cost a typical low-income household hundreds of dollars each year.
-Price and supply controls, quotas, and tariffs multiply the prices of basic food commodities, from dairy products to sugar to fresh fruit. In one notorious case, the U.S. Department of Agriculture kept two billion oranges out of consumer's hands, kowtowing to agribusiness.
-The federal monopoly on first class mail doubles postage costs.
-Unlike most of the United States, Oregon does not allow its citizens to pump their own gasoline, increasing gas prices.
-A poor family in North Portland, who recycle everything and produce no garbage, is still forced by the City of Portland to pay fees to a monopoly garbage franchisee chartered by the city.
-Building codes, development fees, land-use planning, and zoning all drive up housing costs, with a disproportionate impact on low-income families and on the supply of high-density, reasonably priced housing.
-Occupational regulations discourage or prevent low-cost provision of professional services to the poor. For example, the dental assistant who cleans your teeth when you visit the dentist each year is prohibited by law from practicing independently. She is more likely to be a woman; the dentist with the professional monopoly is more likely to be a man.
1. Lighten the heavy burden of taxes on the poor.
Include payroll taxes and excise taxes in the current discussions of sweeping federal tax reforms. At the federal level, begin transforming unemployment insurance, Social Security, and Medicare into savings accounts owned by individual participants. At the state and local level, reduce or repeal the multiplying excise taxes and fees that disproportionately hurt the poor.
2. Legalize work.
This recommendation is best implemented at the state level, by the state legislature. Recognize the economic liberty right of each individual to earn a living without government permission, without paying special fees or licenses, and without restriction unless public safety is clearly involved. This right would include the right of anyone to act as an independent contractor, without having to meet arbitrary government criteria. This right to work means that the burden of proof for any occupational regulation must be on the regulator. We might legitimately require that a surgeon be a doctor of medicine, but not that a local healer who treats colds and scrapes be a doctor.
3. Force people to buy insurance only when they impose risks on others, not when they
choose to assume risks for themselves.
We can justify compulsory liability insurance to protect other drivers, but not compulsory workers compensation insurance. This recommendation is best implemented at the state and federal levels. The state controls compulsory auto insurance and workers compensation insurance, while the federal government mandates Medicare, Social Security, and unemployment insurance.
4. Eliminate special interest regulations that raise prices on basic goods and services. At the federal level, end special interest import restrictions and farm programs.
Let our shops be filled with inexpensive clothing and economical foodstuffs. At the local level, let people build housing without permission from the local commissars. In our state legislature, carefully consider whether the average Oregonian, with fourteen years of education, can be allowed to pump their own gasoline. At every level of government, stop chartering monopolies that raise prices and eliminate consumer choice.
Finally, realize with renewed charity and sympathy that the plight of the poor is not entirely their fault, that we have collectively constructed a government and an economy that are unfriendly and at times indifferent to the neediest among us. It is time to tear down these walls around the poor so that we can all join together in building the American dream.
The assumptions for indirect and miscellaneous taxes are as follows. Gift and inheritance taxes are assumed to have no impact on the poor. Corporate income taxes are assumed to be paid 50% by stockholders and 50% by the general economy (through higher prices and lower wages). All other taxes are assumed to be paid 100% by the general economy. The denominators for taxes paid by the general economy are assumed to be gross domestic product (federal) or its state equivalent.
Endnotes 1-30 pertain to data in Table 1 which describes specific taxes on several classes of working poor Oregonians. The table is not including in this web version of the document. It is included in the printed document, which can be obtained by contacting Cascade Policy Institute.
1. When an employer spends an additional dollar on an employee, part of that dollar goes for payroll taxes and is not visible in the employee s nominal income. However, these taxes fall on the employee and total income including payroll taxes is a more accurate denominator for marginal rate computations. For the low-paid employees described in this paper, employer-paid fringe benefits are not a major part of compensation, though such benefits reduce effective marginal rates slightly for professional and executive employees.
2. Social Security Manual: 1995 Edition, The National Underwriter Company. The Social Security wage base for 1994 is $60,600 (page 44). The Social Security tax rate is 6.2% on employers and 6.2% on employees (page 187).
3. Social Security Manual: 1995 Edition, The National Underwriter Company. All wages and salaries are subject to the Medicare tax. The Medicare tax rate is 1.45% on employers and 1.45% on employees (page 188).
4. The rate is 3.5% on the first $7,000 of earned income + 2.7% on earned income from $7,000 to $19,000 (using the new employer rate).
5. 6.2% of the first $7,000 of earned income, minus (as a credit) all of the Oregon unemployment tax paid at a rate of 5.4% or less, even when paid on a larger wage base.
6. Letter from Kerry Barnett, Director of the Department of Consumer and Business Services, to Oregon employers, dated November 1, 1994. The new January 1, 1995 assessment rates are described in that letter and used in this paper. The single worker with no children is assumed to work 1,600 hours per year, while each of the other two earners is assumed to work 2,000 hours per year. The rate is 3.4 cents per hour worked, of which half can be deducted from the employee s pay, yielding the rates shown of 1.7 cents per hour each for the employer and the employee. Note that workers compensation assessments are not the same as workers compensation insurance, which is a separate, compulsory purchase (a.k.a. a tax).
7. Oregon workers compensation insurance premiums vary widely depending on occupational category. The single man is assumed to work in the food service industry (premiums of $5.08 per $100 of gross payroll). The single mother is assumed to work in an office clerical position in a small business (premiums of $0.66 per $100 of gross payroll in the assigned risk pool). The earner in the married couple is assumed to work in the food service industry (premiums of $5.08 per $100 of gross payroll). There is a state tax of 4.5% levied on all of these premiums.
8. In the Tri-Met district (most of the three county area around Portland), employers pay a payroll tax of 0.6176% of payroll to the district. There is also a mass transit district in Lane County (the Eugene-Springfield area).
9. Payroll processing including handling payroll taxes can be outsourced to companies such as ADP for $10 per month per employee or less (with prices depending on exact services and number of employees). Other accounting costs related to payroll taxes are assumed to add another $10 per month. For an excellent argument that the government-imposed costs of complying with taxes are themselves a tax, see Costly Returns: The Burdens of the U.S. Tax System by James L. Payne, ICS Press, 1993. Payne s methods would likely indicate a significantly higher compliance cost for payroll taxes for those companies that handle payroll taxes in-house.
10. Nominal gross income is the person s official wages and salaries, after employer-paid payroll taxes and before withholding employee-paid taxes.
11. Social Security Manual: 1995 Edition, The National Underwriter Company. The Social Security wage base for 1994 is $60,600 (page 44). The Social Security tax rate is 6.2% on employers and 6.2% on employees (page 187).
12. Social Security Manual: 1995 Edition, The National Underwriter Company. All wages and salaries are subject to the Medicare tax. The Medicare tax rate is 1.45% on employers and 1.45% on employees (page 188).
13. See footnote (6) for a description of this tax.
14. 1994 1040 Forms and Instructions, Department of the Treasury, Internal Revenue Service.
15. 1994 1040 Forms and Instructions, Department of the Treasury, Internal Revenue Service. Marginal rate information for the earned income credit comes from Guide to Income Tax 1995 Edition, Consumer Report Books.
16. 1994 Oregon Full-Year Resident Income Tax Booklet, Oregon Department of Revenue. Oregon income tax has a nominal 9% rate. For taxpayers with a federal tax liability (federal personal income tax minus EIC) in the range of $0 to $2,999, the nominal rate should be multiplied by 0.85 because increasing federal tax (at a 15% nominal rate) reduces Oregon taxable income. However, none of the three example families is in this situation.
17. Total direct taxes on income are all taxes withheld from employee income: federal and state income taxes, employee-paid Social Security, Medicare, and workers compensation taxes. The federal earned income tax credit (EIC), a negative income tax (the government pays you instead of vice versa) is also included as a direct tax.
18. Nominal net income is the actual net wages and salaries received, after payroll taxes and withheld taxes.
19. Assumes $20, $30, and $40 respectively of long distance calls per month for the three households. For marginal rates, assumes that 4% of additional net earnings are spent for long distance telephone calls.
20. Assumes that the single man drives 8,000 miles per year, the married couple with no children drives 12,000 miles per year, and the married couple with two children drives 16,000 miles per year. All three households are assumed to get 25 miles per gallon, producing annual use of 320, 480, and 640 gallons of gas respectively. Note that miles driven is not normally a linear function of income; increasing number of persons in the three households is the reason for these estimates. The marginal tax rate of 0 shown assumes no increased propensity to drive with increased income, almost certainly an understatement.
21. 50% of corporate income taxes, 0% of gift and inheritance taxes (not paid by the poor), plus all excise taxes except gas and telephone, all customs duties and fees, and all miscellaneous federal receipts, totaling $137.5 billion for FY 94, per the Budget of the United States Government Fiscal Year 1994, divided by estimated 1994 GDP of 6,594 billion, yielding a 2.1% burden on the general economy.
22. Assumes basic telephone service cost is $15 per month per household.
23. See endnote 20 for explanation of gas tax estimates.
24. Assumes one vehicle per household, all adults are drivers. DEQ inspection is $10 per year. Auto registration is $30 every two years ($15 per year). Drivers license is $16.25 every four years ($4 per adult per year). Plate fees, out-of-state VIN inspection fees, and transfer of title fees are not included.
25. The numerator for other indirect Oregon taxes is obtained by summing 50% of corporate income taxes; 0% of gift/inheritance taxes (no impact on the poor) and replacement tire taxes (repealed); and 100% of other state taxes not already accounted for, Summary of Oregon Taxes table, page A1, Basic Tax Packet, Research Report #1-95, State of Oregon Legislative Revenue Office. That total is 587.8 million dollars for the period 7/1/93 to 6/30/94. There are 17 different taxes or groups of taxes included. Added to that total is $70 million in business licenses and fees (page R-19, Governor s Budget, 1993-1995) for an overall total of $657.8 million. These taxes and fees are viewed as a burden on Oregon s general economy, as measured by state GDP. State GDP for 1994 is estimated as $68.3 billion. The $68.3 billion etimate is obtained by taking actual 1991 state GDP of $58.8 billion and assuming that our state GDP grew at the same rate as estimated national GDP grew according to the Budget of the United States Government Fiscal Year 1994, page 6. Thus, 0.96% of each dollar spent goes for indirect state taxes and fees.
26. Per Basic Tax Packet, Research Report #1-95, State of Oregon Legislative Revenue Office, average levies in Multnomah County are $21.40 per $1,000 of assessed value in 1993-94. However, 1990 s Measure 5 mandates that in the two years after 1993-95, maximum assessments within the Measure 5 limits will fall by another $5.00 per $1,000, thus the levy rate is estimated at $16.40 per $1,000 as of 7/1/1995. The single man is assumed to share one half of a rental property assessed at $60,000 (his share is $30,000). The couple with no children is assumed to rent a unit assessed at $45,000. The couple with two children is assumed to rent a home assessed at $60,000. Marginal tax rates are based on spending half the proportion of additional dollars on housing as are spent from present income.
27. The typical City of Portland storm water drainage fee is $4.51 per month per residential unit, according to Ms. Linda Dobson in Commissioner Mike Lindberg s office, telephone conversation 4/18/1995. This fee appears on sewer bills. As described in endnote 26, the single man is assumed to share a residence with one other person.
28. Property taxes on business are passed on to consumers as higher prices, @ 1.26% of nominal net income. Per Jim Scherzinger of the Legislative Revenue Office, commercial property accounts for 35% of assessed value in Oregon, (telephone conversation 4/18/1995). Applying that (current) ratio to 1993-94 property tax collections of $2.466 billion (per Basic Tax Packet, Ibid) produces business property taxes of 863.1 million dollars in that year. These taxes are viewed as a burden on Oregon s general economy, as measured by state GDP. State GDP for 1994 is estimated as 68.3 billion dollars (described in a previous endnote). Thus, the burden is 1.26% of the state s economic output. 29. Local telephone companies pay the City of Portland a 7% franchise tax which includes the normal business license tax (which is much lower for other companies) on local exchange service. Local telephone companies pay a Multnomah County business income tax of 1.45% on local exchange service. Local exchange service for each of the three households is assumed to cost $15 per month, which is multiplied by (0.0845/1.0845) = 7.8% to obtain the tax amounts. Thanks to Mr. Dennis Tooley, policy manager of U.S. West, for this information.
30. In the LRO Basic Tax Packet, local taxes -- excluding hotel-motel (largely paid by non-Oregonians) taxes, property taxes, and mass transit district taxes -- total 246.4 million dollars. These taxes are viewed as a burden on Oregon s general economy, as measured by state GDP. State GDP for 1994 is estimated as 68.3 billion dollars (described in a previous endnote). Thus, the burden is 0.36% of the state s economic output. In the listed totals, local telephone taxes are subtracted to avoid double-counting.
31. Cited by Stephen J. Entin in Report of the Task Force On Social Security , page 10, August 1994, from Citizens Against Government Waste.
32. My research has not produced much evidence of this effect, so the following hypothesis is largely speculation at this point. Our extensive federal and state anti-discrimination and employee protection laws may be doing some harm to the very groups of employees they are intended to help. Consider: For those companies that are not government contractors or otherwise subject to special scrutiny, the safest employee may be an Asian or Caucasian, able-bodied, heterosexual, age 20 to 39 male. This employee may be the least likely to sue their employer for job discrimination, wrongful discharge, family leave issues, or sexual harassment. I do not suggest that companies consciously follow such policies; as organizations may engage in self-preserving behaviors without intent. Searching for safe employees would have similar advantages in natural selection to searching for safe sex. In Foridden Grounds: The Case Against Employment Discrimination Laws, Richard Epstein cites a finding by Richard Posner (see pp. 262-263) that firms sometimes seek suburban locations because the lower proportion of minority workers in the local area makes it easier to meet affirmative action goals and to resist disparate impact lawsuits.
33. Cited in Forbidden Grounds, Ibid., page 261.
34. While reduced numbers of children, home automation, and moving production outside the home to the external economy have all reduced the need for domestic labor, the great increase in families where both spouses work outside the home has simultaneously increased the need for domestic labor.
35. More than 40 occupational licensing boards are listed in the 1993-1994 Oregon Blue Book, pages 11 to 110.
36. A Better Deal for Oregon s Drivers by David Reinhard, Associate Editor, The Oregonian, May 7, 1994. Also, Let Drivers Opt Out of Auto Tort System by Michael Horowitz, The Wall Street Journal, September 23, 1992.
37. Social Security: Prospects for Real Reform, Peter J. Ferrara, Cato, 1985, page 27.
38. An employer of a roofer in the assigned risk pool (likely if the company has less than $80,000 annual payroll in that job classification) pays a premium of $39.75 per $100 of payroll if SAIF Corporation is the insurer, plus a 4.5% tax charged on the premium. Thus, raising the roofer s salary $1.00 will mean paying an additional 41.5 cents for workers compensation insurance and about 8.5 cents more in other payroll taxes, for an additional 50 cents. The workers compensation premium is 27.7% of total marginal compensation (and about the same percentage of total compensation).
39. America s Unfairest Taxes: Tariffs and Quotas by James Bovard, the National Center for Policy Analysis, June 1992, page 5.
40. The Politics of Plunder: Misgovernment in Washington by Doug Bandow, 1990, Transaction Publishers, pp. 183-185.
41. Monopoly Mail: Privatizing the U.S. Postal Service by Douglas K. Adie, 1989, Transaction Publishers, page 148.
42. Personal interview by the author with a family that wants to remain anonymous.
43. See Resolving the Housing Crisis: Government Policy, Decontrol, and the Public Interest, edited by M. Bruce Johnson, 1982, Pacific Institute for Public Policy Research, for good coverage of these issues.