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Joint Effort To Solve National Dilemma Necessary

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By Lowell L. Kalapa

(Released on 11/2/08)

Last week we looked at the growing problem with federal spending and just how much of the spending pie is “locked up” and on autopilot as far as annual increases. This week, let’s take a look at the revenue side and some possible issues that need to be addressed by Congress.

First of all we need to understand where the federal government currently gets its income or revenues. About 80% of its total receipts come from the individual income tax (45%) and from social insurance payroll taxes such as Social Security, Medicare and unemployment taxes (34%).

Individual income taxes are what is known as progressive, that is higher income individuals are taxed at higher marginal rates. Contrary to popular belief, if not political rhetoric, the top 20% of individual income taxpayers paid 86% of the income taxes collected in 2005 (latest year for which data is available). On the other hand, the bottom 20% of income earners actually get back tax credits – sort of a negative income tax – equal, in the aggregate, to 3% of total individual income taxes due from all taxpayers.

Unlike the individual income tax, payroll taxes which go for Social Security, Medicare, and unemployment insurance are regressive because the same rate applies to all wage income. And because there is an annual adjusted cap on taxable wages for Social Security, high wage earners pay a lesser percentage of their earnings than do low-income wage earners. As a result, households in the bottom 80% of the income distribution picture pay more in payroll taxes than they do in income taxes where the rates are graduated.

Corporate income tax that is levied on corporate profits and excise taxes which are imposed on specific products such as tobacco, liquor, and motor fuels have shrunk as a share of total revenue because of the very design of these taxes. Regardless, individuals end up paying these taxes because the businesses paying these taxes merely pass on the cost of the tax to their customers.

The obstacle to finding a solution for the pending fiscal crisis is a result of decisions made long ago to address past priorities. Even though setting the federal spending plan is an annual ritual, the decisions made each year by Congress and the President determine the federal spending plan for years to come. For example, a decision made to run a deficit in any one year contributes to larger interest payments in the future. A decision to add benefits or create new entitlements under programs like Social Security and Medicare become embedded in the federal budget until a proactive decision is made in the future to curtail or reduce those benefits. Providing for automatic annual increases ensures that these programs are on autopilot unless Congress chooses to terminate or reduce them.

So what should be done to get the federal fiscal house in order? As we outlined last week, there are three options, cut spending, increase revenue or incur more debt. Since debt is a part of the problem, incurring more debt is not a viable option. That leaves Congress with cutting spending, for which their track record has been poor; and/or increasing revenue otherwise known as raising taxes, a politically unpalatable option.

On the spending side, as we saw earlier, entitlement programs like Social Security and Medicare are spiraling out of control. So one of the options is to reform these entitlement programs. One idea put forward is to adjust the age of retirement or index retirement according to longevity. With improvements in health care, people are living longer and in many cases choose to remain in the workforce. In fact, another option is to encourage people to work longer.

Another option that probably will not go over very well is to reduce future benefits for those who are better off in retirement while maintaining the level of benefits for the less well off.

On the revenue side, one proposal would raise the current Social Security cap on earnings so that those earning substantial amounts pay more into the system so that more of their future benefits are funded by their earnings. Finally, some policymakers have suggested that perhaps workers should be mandated to put additional funds away for retirement into personal accounts that they could manage or choose other investment options so the portfolio of retirement income sources is more diversified, i.e., a sort of mandatory 401K.

Next week we will look at other expenditures including health care reform and Medicare coverage, subsidies for health care, needs-based benefits and guaranteed access. Again, all of these options to correct the systemic problems in the federal budget will not be easy, but they must all be explored.

Lowell L. Kalapa is the president of the Tax Foundation of Hawaii. Mr. Kalapa’s commentary is printed each week in the Maui News, West Hawaii Today, Garden Isle News, and the HawaiiReporter.com.

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