Federal Tax Burden

The Occupy protests sparked my curiosity yesterday with their "99%" slogan.  Specifically, it got me thinking about tax burden in the United States as it relates to income. I did some digging around this morning and came up with some data from the Congressional Budget Office and put together a chart that confirmed by suspicions.

The above chart splits the US population into fifths and shows the percentage of total federal tax dollars each group would be paying under two different taxation systems: a simple flat tax (outer ring) and the 2006 tax structure (inner ring).  Again, this is all about actual federal tax dollars, not about marginal tax rates.

The data on the 2006 tax structure comes directly from the CBO.  To calculate the (highly) theoretical flat tax revenues, I used the CBO numbers for average income for each income bracket  and population for each income bracket.  I chose to compare the actual 2006 data to a theoretical flat tax not because I am necessarily a proponent of such a system but because a flat tax is probably the simplest tax structure. Everybody pays a certain percentage of their income, no matter where the money comes from or how much they make. (Because of this fact, in doing my tax revenue calculations, the proportion each income bracket pays is unaffected by the flat tax rate.  The total number of tax dollars would be, though.)

Items of note:

1. Even under a flat tax, the richest 20% of tax-payers will provide over half the tax dollars the federal government collects.  The obvious reason for this is that the richest 20% make a lot more money; 10% (for example) of $1,000,000 dollars is a lot more than 10% of $10,000.
2. In 2006, the richest 20% paid ~70% of all the federal tax dollars.
3. The poorest 20% hardly paid any of the federal tax dollars in 2006 (~0.8%).  Under a flat tax they would pay ~4%; this would be a five-fold increase in their tax rate.
4. If we moved to a flat tax, everybody's tax rate would go up (each group would be expected to pay for a larger portion of the total tax revenue) except for the richest 20%; their's would do down.

I'll leave it to you to draw your own conclusions.

Just the Simple Truth (Mostly)

Check out this little article I stumbled upon in my blogger reading today: Just the Simple Truth. For those of you who are a little bit more lazy here's a pertinent part where the author is quoting President Obama: "But after the Democrats and Republicans committed to fiscal discipline during the 1990s, we lost our way in the decade that followed. We increased spending dramatically for two wars and an expensive prescription drug program-but we didn't pay for any of this new spending. Instead, we made the problem worse with trillions of dollars in upaid-for tax cuts-tax cuts that went to every millionaire and billionaire in the country; tax cuts that will force us to borrow an average of $500 billion every year over the next decade." Let's parse this paragraph and look at the basic assertions the President is making in this speech, stripped of their rhetorical ornamentation.

1. Both parties were involved in "fiscal discipline" during the 1990s. (I believe this is a reference to balanced budget we had for a few years in the late 90s.)


2. Spending increased significantly during the 2000s thanks to two wars and Medicare part D.


3. Tax cuts during the 2000s prevented a lot of revenue from being collected from those in the highest tax bracket.

Assuming my interpretation of item one is correct, all of these assertions can be shown to be true.
I don't want to get into the policy angle of whether the extra spending on wars and Medicare was a good idea or the decision to reduce tax income as a whole. Clearly, though, we can say that this combination did not end up working out well in terms of balancing the budget. I know there are plenty of people out there that are philosophically committed to trickle-down economics but in this case the lower taxes rates didn't generate more tax dollars and the budget got way out of balance. Its worth noting that Wisconsin Representative Paul Ryan's assertion that "the more you tax something, the less of it you get" may be true; our budget wasn't balanced through the 2000s, though. It didn't seem to work for that decade.
Here's my main point: assuming the above three facts are true, their validity is a red herring in the larger problem of our national debt. Here's one of many graphs you can find online showing our annual federal deficit over the years, this one in terms of GDP rather than just dollars (to try to level out effects of economic growth).


The simple truth that isn't acknowledged by the President or stated in the article I linked to is that the "fiscal discipline" that resulted in a budget surplus for a few years at the end of the 90s was an aberration. From 2011 all the way back to the 1960s it is clear that this period of time is the only one where we had a balanced budget for any significant length of time. It appears there are a few toe-dips into balanced-budget territory over the last half-century but they are minor and are in no way equivalent to the massive overspending that happened in all the remaining years.
We have a systemic problem. For many years now, our country has not been living within its means and this is a trend that we cannot afford any longer. We need to get serious about our problem and make some hard choices. We can not continue to borrow money for government programs and somehow expect to never have to pay it back. There are good programs that are working well that we will need to cut; there are tax breaks that seem fair and good that will have to be removed. We are so far in debt and it is unreasonable to expect that we can get back to living within our means without making significant sacrifices. Our expectations and lifestyles covertly subsidized through our government in the form of low taxes and expensive government programs are unsustainable.
I'll end with the political finger-pointing. Republicans, you have abandoned any claim of being fiscally responsible based on your performance this past decade. I know you believe in lower taxes but you have to also believe in lower spending as well. In fact, during times of national crisis like the launch of our war on terror, you might even need to increase taxes to pay for the military activity or cut other programs so that our budget can stay balanced. Wars don't pay for themselves and emergency overspending for a few years needs to be followed with determined underspending to pay all that debt back.
Democrats, specifically President Obama, its hard for us to take you seriously as a man determined to balance the budget. You inherited a difficult situation in 2008 and choose to try to spend your way out of it. You and your allies are the ones responsible for the spike in the national deficit at the far right-hand end of the graph. You too need to find a way to generate huge budget surpluses to counter-act the huge spending we just went through.
To both parties I say this: I have a house that is always falling apart, a car that needs repair even more regularly and family members who get sick. I understand that there are months that we need to spend more than we make because of these emergencies that pop up. But you know what happens next month? We spend less to make up for it and replenish any emergency savings that has been depleted. Nobody would let me overspend for 35 out of the last 40 years of my life and call me fiscally responsible. They wouldn't lend me a dime.

National Budget Visualized

Here's a great visual depiction of the budget President Obama has proposed, put together by the NY Times. Items of notes:

• According this this USA today graph, this budget is still larger than the federal income. We are still spending more than we make, like we have for several decades now. Under Obama's budget, we are going to add $1.1 trillion to our debt.
• Our interest on the existing national debt is s$474 billion this year, up 14% from last year.
• It is clear that the biggest spending is, as I have often asserted, in Social Security, Medicare, Medicaid, and Defense (ignoring the interest on the national debt since we really can't do anything about that except pay it).
• Most of the money in this budget is considered "mandatory" spending, meaning that previously enacted legislation (such as the Social Security Act) requires a certain level of spending. New legislation could be passed to overturn these mandatory spending requirements (such as a End Social Security Act, to make up an example) but the money funding the programs created by previous legislation is not up for grabs as a part of the regular budgeting process.
• The big spender not in the mandatory spending pool (called "discretionary" spending) is defense spending. Defense spending is the only one of the Big Three that can be changed without passing additional legislation.
• During the Bush years it was common for the normal budget to be augmented by "emergency" spending bills to fund the wars. This money is outside of the normal budget process and thus does not show up in the kind of graph the NY Times has put together. I don't know whether President Obama has any emergency spending legislation he is going to propose or not.
• Finally, just to be clear, the President doesn't officially get to set the budget for the year; he can only sign or veto a spending bill that Congress passes. Obama's budget is an opening bid in what will be probably a long negotiation before a final bill is arrived at that all parties can live with.

You Balance the Budget

In terms of posts to this blog, I've written a lot about the Federal deficit and balancing the budget. This is one more item on that list.

The New York Times has an interactive feature on their website that allows everyday normal people like us to take a stab at balancing the budget and getting our national debt under control. The interface is simple: there are a list of options that each make a dent in the budget problem and you go through and check the ones that get you to a balanced budget. Its easy to use and gives you a very tangible handle on what it will take to make our federal government fiscally responsible.

Go ahead and give it a try. Spread the word. Start thinking seriously about what it will take for our government to start acting like grown-ups when it comes to money.

The word is spreading!

David Leonhardt must have been reading my blog because, on a nationally syndicated radio program (Marketplace), echoed nearly exactly (almost verbatim) what I've been saying about what it will take to balance the budget. We've got the make big cuts in one of the following: Medicare, Social Security, or defense and/or raise taxes. The most politically fleasible option will probably involve modest changes to many or most of these.

The message is getting out! You heard it here first (maybe)!

Before Congress gets back to balancing the budget...

I know I just wrote about this a few posts ago but one of my favorite podcasts (Planet Money) mentioned a report that effectively gave a receipt showing how are federal tax dollars are spent. The categories they chose to track seem a bit arbitrary but its worth taking a look at. And the top 3: Defense, Social Security, Health Insurance.

The report also referenced a few other great websites that try to get a handle on the same data. WhatWePayFor.com lets you plug in your salary and generate a dollar-amount break-down for your tax bill and the National Priorities Project has a Tax Day page that does a similar thing in less detail.

More on Federal Spending

I recently found an interesting report outlining how the income and expenditures of the federal government broken out by state. In partcular, the report highlighted the fact that there are some states in the union that historically consume more tax dollars than they generate; they are subsidized by the country as a whole. Conversely, there are states that generate more in taxes than they receive from the government.

Take a look at the report here and see where your favorite state (or maybe the states you love to hate) stack up. The most important columns are the last two showing the received-to-spending ratio (values over $1.00 mean the state was subsidized, values less than $1.00 mean the state did the subsidizing) and the ranking of the state in terms of dollars received.

I'll leave it as an exercise to the reader to decide whether citizens should be proud or not of their states' abilities to attract federal spending. Some call it "bringing home the bacon" and they vote based on who they think can bring the most money to the state. When it comes to tax dollars, though, its a zero-sum game; federal dollars flowing into the state have to come from somewhere and it will largley be taxes collected from another state. This is another way to look at federal taxes as wealth redistribution: money moving from "rich" states to "poor" states (or something like that).

Defense, Social Security, Health Care

I was in a discussion with a friend recently about the national debt, a topic that we are both concerned about. I was trying to point out that most of the federal budget is being spent on just a few things but didn't have the numbers in front of me to confirm this. Now I do.

The chart comes from Wikipedia; they used publicly available data.

There are three general areas of federal spending that make up a significant portion of the federal budget: defense, Social Security, and health care (Medicare and Medicaid). (Since this is 2008 data, there is no mention of the new health insurance reform and it will several years before we have data on how much that is actually costing us). The total of these three is 58% of our budget. If you throw in welfare and other "non-discretionary" spending the total comes in at 67%.

If we are serious about being fiscally responsible we need to look at cutting spending and when cutting costs, you don't look at the small things first. Completely eliminating, say, the funding for the Department of Justice will not make much of a difference in terms of limiting spending. Killing NASA won't help out much either. The federal government is involved in many, many, programs but when you get look at the data, most of these spend very little in the scope of the entire federal budget.

Here's my point: if you get in a discussion about balancing the federal budget just remember the big three. Make it a mantra. Defense, Social Security, Medicare & Medicaid. Don't let anybody get you off topic with talks of killing NASA or ending the Department of Education. Everybody has a part of the federal government that they love to hate and often political motivations can hide behind the mask of fiscal responsibility. (This is the reason I don't like including the "welfare and other non-discretionary" spending in the total; everybody has an opinion about welfare.) These programs are small fry's and killing them won't really help us out any.

To balance the budget we have to choose to confront the reality that most of our spending is in programs and that most people see as non-negotiable. Even my wife's very conservative mother, a woman who wants a smaller federal government, lower taxes, and a balanced budget, does not want to see significant cuts to the entitlement programs of Social Security and Medicare. Reality is unforgiving in this regard, though. The big three need be smaller. Defense, Social Security, Medicare & Medicaid.

How are we going to get from there to here? What sacrifices will you make to bring the help bring the country back into financial balance? The federal government has for some time now been balancing its budget by borrowing and we all know that this can't go on forever. The sooner that we get serious about a legitimately balanced budget, the sooner we can start paying down the debt. In 2008, we spent 9% of our federal dollars just on interest for the debt.

Defense, Social Security, Medicare & Medicaid.

We are the federal government. Don't simply blame the politicians for making politically expedient choices and avoiding unpopular ideas like cutting Social Security benefits. These ideas are untenable only because we, the people who elect them, don't want to make the choice for ourselves. If cutting Social Security benefits had our strong support then there is no doubt elected officials would openly advocate for it. We, the electorate, have to be willing to sacrifice if we expect our representatives to make the changes in law that will be required to balance the budget. Don't blame them; we gave them the job.

Defense, Social Security, Medicare & Medicaid.

Happy Tax Day

Hopefully all you US residents have your taxes done and mailed in. I happen to live in Kansas right now and the state has figured out that they can save money if they allow people to fill out electronic forms online. To encourage people to do so, they make filing through their website free. Once your federal returns are done, completing the forms online is fast, maybe twenty minutes. All the forms are completed and submitted electronically and any refund you may get is direct deposited in a week or so. I'm a big believer in this idea and am glad to see the federal government is slowly coming around to the idea and realizing manually processing paper returns is expensive and error-prone compared to electronic forms.

This is all beside the point, though. The uplifting topic for today is national fiscal responsibility, the national debt, and what we are going to do about it. First, some data:

• 47% of US households won't pay any income tax at all this year.
• Most tax revenue comes from a small percentage of people with the highest income.
• (Or here, presented graphically.)
• The National Debt clock (and links to related stories).
• Holders of the national debt and how it has grown over time.
• National debt over recent past.

I don't put this data up to simply give people something to worry about. I truly believe this is a very serious problem that has been effectively ignored for several decades. We are on an unsustainable course that needs to be corrected. Sadly (but fairly) I think that the solution will involve increasing taxes (sorry Tea Party) and decreasing spending (sorry social welfare and defense people). In other words, we've dug ourselves into this hole and the path out is going to be painful.

To help keep me honest and the conversations on-track as I bring this up with friends, I'm starting to think of the solutions to this problem in terms of the sacrifices that I need to be willing to make. Rather than looking at the problem as a whole (which needs to be done), I'm trying to think of it very personally. What government benefits do I need to give up to get our country back on track financially? How much more taxes will I need to be willing to pay to make this happen? What tax credits and deductions that I enjoy now should I surrender so that our country can be fiscally responsible? Being an academic, which research and development programs that I care about should lose their federal funding?

For each of us, the answers to these kinds of questions are different. There are some that are going to have to give up federal subsidies (Medicare, welfare, etc). Others will be paying a lot more in taxes. There will probably be federal employees who will lose their jobs in the government's attempt to control spending. Its not going to be pretty or fun.

It needs to be done, though. It may not seem like it to some, but these past few decades have been ones where we as a society have ignored the financial costs of the federal fiscal lifestyle (if you will) we have been enjoying. The time is coming when we will have to face these costs and the sooner the better. The first step is always admitting you have a problem.

I encourage you to write your federal Representatives and Senators. They will only be motivated to action if we make it clear that this is important to us. Vote accordingly. The attitude of the federal government is a reflection of the attitude of us, the people. We can't expect them to act responsibly until we take responsibility for our own actions and choices. Until we are upset enough with the situation to actually do something about it, we can't expect them to do any better. Doing something can start with a simple letter or email.

If you are a person of faith as I am, pray for our nation. I have been convicted lately of just how desperate a situation we are in (beyond but including our finances) and have begun to ask God to work in the hearts and minds of others and help save us from our own self-destructive desires. For the USA, a nation that has enjoyed tremendous financial wealth, to be willing to accept a lower standard of living for the sake of our country as a whole will take a miracle.

Taxes 2008

Katie and I just finished doing our taxes for 2008 and once again, I was quite impressed with Kansas' online FREE electronic filing.  After the muted pain of our Federal returns ("muted" by the use of TurboTax) the Kansas electronic filing was five minutes.  Copy a few values from the federal return, enter bank information for electronic deposit and we were done.  

One of these days very soon the Federal government will have free electronic filing for all simply because it will save a large pile of money/work by not having to deal with enter information on paper returns into a database.  Every year they inch closer and closer to this by allowing more and more "low-income" earners to file for free. (I think if your total income was less than $55,000 this year you could file for free.)  Right now, probably over half of the tax-payers could file for free.  My prediction: in less than 5 years over 90% filings will be electronic.  You heard it hear first.

(Oh, as a bonus side-note, TurboTax thinks the likelihood of an audit is "low" this year.  We haven't been audited yet for our 2007 return so we may have slipped of their radar for now.  I do have a friend, though, who is being audited for his 2007 return and due to my past experiences he has come to me for a bit a preparation guidance.  Once the word gets out that I'm fought the IRS behemoth twice and have been victorious, their going to be beating down my door for help.  I might have to start charging.)

Audit #2 Wrap-Up

This second audit turned out to be MUCH simpler than the first. To prepare for this audit, I used the same procedure as last time:

-Assemble all tax related documents from last year.
-Redo the math and make sure the total claimed on the tax return matches the total from all charitable contribution receipts.
-For each charitable contribution, match the donation receipt with a withdrawal from an account (checking, credit card...)
-Compile all this data in a nice spreadsheet to make the job of the examiner easier.

This self-audit revealed a small error I had made in the return and after thinking it over a bit, I decided to highlight this on the spread-sheet rather than hope nobody would ask about it. Honesty with the IRS seemed the most trouble-free course of action. (It turns out that the examiner asked up-front if I had found any errors during my preparation. Unless I wanted to lie, this question pretty much made irrelevant and rationalization I might have had for not mentioning the error. )

I made my way through security and on my ride up the elevator with the examiner, our conversation revealed that I had just been here eight months ago for my 2004 audit. This surprised him and he made a point of mentioning this to his supervisor who was going to sit-in on the audit.

We went through the cursory is-there-any-income-you-are-forgetting-to-tell-us-about questions (Any income from gambling? Trusts? Bartering? Garage sales?) and then proceeded to dig into the issue at hand: charitable contributions. I handed the examiner my spread-sheet and after unfolding it, he spent several seconds looking stunned. I don't know what he was expecting to see but the number of transactions he was going to have to check must have seemed daunting. He slowly turning around in his desk to grab a calculator and, with a sigh, started to ask me about the first item on my list.

At this point, his supervisor jumped in.

"What did you say your 2004 audit covered?"

Same as this one, charitable contributions.

"How did the 2004 audit turn out?"

No change to the filing was made.

"Tell us about the mistake that you found in your filing."

Due to the weird way my church reports my financial donations with them, I accidently counted $65 I paid for men's retreat as a charitable contribution. A closer examination of the receipt clearly shows that this was not a tax-deductable contribution.

"$65? That's it? If that's the extent of the error, I don't see any reason we need to continue with this. Do you have the 'case closed' letter they gave you at the end of the last audit?"

Now I was the one who was stunned. I slowly turned to my stack of folders to find my records from the 2004 audit. I handed the examiner the letter, he went to make photo-copies, and that was that.

As the supervisor explained, the IRS customarily does not examine the same person for the same item two years in a row. My impression was that this practice was not governed by law, but more by some internally-established procedures. If there had been other items of examination in the audit, they would have proceeded checking those and my charitable contributions. He said the computer that figures out who needs to get audited doesn't take into account any previous audits and when it saw my abnormally high charitable contributions, it flagged me and I got a letter. This also means that if I get flagged again in 2006, instead of scheduling an appointment I can simply call the examiner and let him know I've already been examined twice for this item.

With that, I was done. In and out in under an hour. Best of all, I don't have to file any kind of amendment to my return for that silly mistake I made. The fact that I don't have to do any extra paper-work is reward enough for me.

Audit #2

Our mail was on hold while we were out on Christmas break and, due to Gerald Ford's death, we didn't get our mail until Wednesday. Waiting in the stack on my desk was a little letter from our friendly neighborhood IRS office.

Yes, once again, I am being audited.

The last audit was for my charitable contributions during the 2004 tax year. This audit is for contributions during 2005. I guess the good news is that I haven't filed my 2006 return so I can't be audited for it. Yet.

I don't know what to make of this. Katie thinks that once you're audited, you stay on the IRS watch list. I'm skeptical but don't have a better guess at this point. I haven't started to assemble the documents yet but I'm not very worried. Additionally, since I've done this before, I have a pretty good idea what to expect.

Two audits, eight months.

Sheesh.

For the Love of Taxes

Yes, yes, this past Tuesday I was audited by the IRS. (Wow. "Audited." Never thought I would ever write that.)

The "invitation" I received to have my 2004 return "examined" was apparently chosen at random and my charitable contributions were singled out as the item of primary concern. (No suprise to me as I feel very responsible for how I spend my money and know that when all is said and done I will be held accountable for the financial choices I make; I like passing on the blessing God has given me and act accordingly.) Fortunately, I still had all my financial data from 2004 and it only took an hour or so to organize it and draw up a spreadsheet detailing the contributions I had made. Oddly, I was asked to bring my 2003 and 2005 returns as well even though it was very clear from the letter that it was my 2004 return that was under examination. Hmmmm.

Thus Tuesday morning around 8:25am I walked into a/the federal building in downtown Wichita with a backpack filled with documents. A quick airport-style securty screening (complete with x-ray machines and metals dectectors) and I was up the elevator and seated at the desk of my examiner. As it turns out, she was a relatively new hire and her boss was there examing her ans she examined me. I found this quite humorous but decided to keep the joke to myself. This is, after all, the stern-faced IRS.

First question from the examiner: "Anything you want to tell us about now up-front? Any known omissions or errors on your return?" Yikes! That is quite a loaded question. Without much pause I decided to stick to my guns and declined to the opportunity to confess to cheating on my taxes. The examiner then deftly noted that I did my own return. Had I always done my own return? Yes, I always had, without the aid of any software. She was good, though, letting me know this wasn't a social visit in the least.

Still not getting to the item listed in the letter, she then went through the process of verfiying my source(s) of income. Do you have any interest-bearing accounts? Any investments that generate capital gains? Alimony? Child-support? Trusts? Estates? No, no, no, no..... Again, the purpose of these questions seemed more at getting me to confirm that my original income stated on my return was accurate and/or confess to any revenue that might have "slipped my mind" when I filed my returns. Towards the end my patience was wearing a wee bit thin; I felt like saying, "Just look at my return! That's my income!" Obviously, that wouldn't have helped. Its also worth noting that these questions literally had nothing to do with why they brought me in. They seemed to be standard questions that anybody being audited would have to answer.

While I'm thinking about it, the letter I received specifically mentioned that a lawyer or tax-preparer was allowed to join me for the examination. Considering that I lived in Boise in 2004 the odds of any relevant party in my tax preparation being available here in Wichita are virtually zero. If I hadn't done my own taxes, I wonder how I could have answered some of the questions posed. This is a point in favor of doing your own taxes or at least understanding every item on the tax return. You as an individual may be the one having to defend your return, not your tax-preparer or lawyer.

Finally, we jumped into the official item of examination, my charitable contributions. Having the spreadsheet delineating all the pertinent transactions helped TREMENDOUSLY. The spreadsheet showed the total for allof my contributions (which matched what I declard on my taxes) and was broken down by the individual organizations involved; these matched the statements I had received from each organization. The examiner didn't check every single donation (thankfully; that would have taken quite a bit of time) but sampled from each organization to which I had donated. She asked for not only a receipt verifying the donation but also proof from my accounts that I had actually made the donation (typically in the form of a
cleared check, credit card statement or bank statement). Its this latter part that caught me off-gaurd; if memory serves, the instructions on the tax return form only mention a receipt for each donation and not necessarily a corresponding cleared check or the like. I guess the assumption is you'll keep bank and credit-card statements; thankfully, I had.

There were a few minor hiccups in the process: I couldn't find my bank statement for the month of one of the transactions that was sampled for examination; a carbon copy of the original check was good enough. Also, there was a question whether one of the charities to which I had donated was officially registered as such. After a bit of digging with no conclusive answer the examiner got pragmatic. In light of the relatively small donation amount, the fact that this was a one-time donation and that I didn't intend to donate again she decided to give me the benefit of the doubt and assume the charity was registered.

This brings up another interesting point: over the course of the interview/examination she asked for a brief description of the kind of work each charity carried out. This was not only a great opportunity to talk to these (assumedly) non-Christians about the good that Christians are trying to bring to this world but also to remind me about each of these projects. It made me feel blessed that I could be a part of what God is doing, to be cut-in on the action.

A few more questions, checking a few more transactions, and we were done. The examiner was pleased that things went so quickly and when all was said and done, no adjustment was made to my return. Yeah! In-and-out in under an hour.

Lessons from the examination:
-Keep EVERYTHING. Official paper documentation for all financial matters makes any kind of audit much easier for you and the IRS
-Keep everything ORGANIZED. Again, having all these documents readily available made the whole process go very smoothly.
-UNDERSTAND your tax return and be comfortable justifying any item on the return. Having the above mentioned documentation makes this easier.