STIM 2: The Tax Deal

on December 17, 2010

As I write, it appears that the negotiated tax deal will go through.  Among its components are an extension of the tax brackets and rates that were set to expire (for all income levels), a generous estate tax treatment, yet another extension of unemployment benefits, and a one-year reduction in Social Security taxes on workers.  But let’s keep it simple…this is another large scale Federal stimulus program.  Move over QE2, STIM 2 is here.

Will it work?  The bond market seems to think so—yields are up 45% since October when it became clear that Republicans would get enough clout to ensure an extension of the Bush tax policy.  Not to be outdone, stocks are up almost 10% in that period, too.

So beyond the obvious, why write about this?  To clarify the truths about the taxation at the highest income level, and to the lampoon the estate tax debate.

The other day I heard a class warfare guerrilla on the radio proclaim, “This is a tax cut for billionaires!” Well played, friend!  Only true in the loosest sense…yet nicely inflammatory.  Of course, he didn’t really mean that the highest bracket of earners are all billionaires—they only make up a fraction of the joint filers earning more than $250,000 a year.

So what’s a more accurate term for this “upper class?”  Here’s one:  “Small Business Owners”.  Many small business owners are in this tax group (but clearly not all in this group are small business owners).

Here’s a fact that gets overlooked.  Small businesses in this country account for 90% or more of the jobs created.  Nearly all small businesses are structured such that their income flows through to the owner.  They’re S-Corps, LLCs, LLPs or Sole Proprietors.  That means that the income statement (or Profit and Loss) of the business and that of the owner are essentially two parts of a whole.  Tax the individual and you’re taxing the business.  And conversely, the less you tax the business owner, the more capital they have to invest in their businesses.  And the more they have available to hire.

People who aren’t in the top tax bracket, or have ever studied those folks, often make the erroneous assumption that higher taxes on that group lower their consumption.  One less yacht, trip to the South of France, or piece of art work.  I’ve been working with this group my entire career—and that characterization couldn’t be farther from reality.

Consumption planes out and does not rise (in most cases) in lockstep with income.  People take care of themselves personally, and the rest of their income is either saved/invested or given away to charity.  This is what gets hit when taxes go up.

The prevention of a tax increase on the upper incomes is good for small business, hiring, charity, and the overall economy.

On a different note, it’s time to once again pick on the estate tax.

What percentage of taxes the Federal government collects comes from Estate & Gift taxes?

A.      8%
B.    16%
C.    32%
D.    40%

I’ll give you the answer in a moment.

The current estate tax dates back to 1916 and the need to raise funds to finance US involvement in World War I.  For all the talk of income inequality today, it was actually about the same back then. The top 1% of incomes earned between 18-20% of the money then, as it is now.  The estate tax was secondarily an attempt to narrow the income gap.

Today, an estate tax exists for only one reason: to provide income to certain lawyers, insurance salesmen, and CPAs.  It’s an inconsequential form of tax receipts, but you’d never know that to read the papers or listen to politicians.  The estate tax is a favorite piñata of Federal politics, and both parties whack it with a stick whilst proclaiming their view.

“Death should not be a taxable event!”  “Here, here!” (…the crowd roars).
“The rich should pay their fair share!” “Here, here!” (…the other crowd roars).

So, getting back to the question.  How much of our Federal tax receipts come from the estate (and gift) taxes?  About 1%.  And only 1% of families were affected by the tax in the most recent year.  When you factor in the Federal costs of regulating and collecting these funds, the Federal government nets less than 1% of its receipts from this tax!

Source: OMB

click to enlarge

Which brings me back to my point.  This is a silly, antiquated, counterproductive form of taxation and should be ended.  Yet the reality is that it serves its purpose with partisans, and provides lawyers, insurance men, and accountants a lot of income from client trying to avoid or minimize it.

UPDATE: The bill was just passed.  Families can now pass up to $10 million between generations without tax, and the rate begins at 35%.  So now, we have a law that applies to only 0.1% of our citizens.  Given that it’s going to produce even less tax revenue, kill this wounded old pig–for fairness, if nothing else.

Bill ValentineSTIM 2: The Tax Deal