Oct. 22 (Bloomberg) -- We don’t want to think about it, let alone read about it, but higher taxes are on the way.
Two tax hikes were passed this year and another is likely. These new taxes are supposedly being levied just on the rich. But over time, they will hit most of our kids. And they are just the beginning of our children’s and grandchildren’s tax trauma, given Congress’s inability to curb spending.
The two increases are for Medicare. They were buried inside the 2,000-page health-care bill and take effect in 2013. Earn more than $250,000 ($200,000 if single) and you’ll face an extra 0.9 percentage-point FICA tax for Social Security. And once your income passes this level, you’ll pay a 3.4 percent tax on your asset income.
These thresholds aren’t indexed for inflation, let alone growth in real incomes. So these taxes on “the rich” will eventually hit everyone as nominal incomes rise with inflation and productivity. Within 20 years most earners will be paying these new Medicare taxes.
The Alternative Minimum Tax also has thresholds that aren’t indexed for inflation. Congress has raised these levels to keep the share of taxpayers affected constant. But there is no guarantee it will continue to do so.
There are two other income-tax thresholds that haven’t changed since 1984. These are the income levels at which the first 50 percent and then 85 percent of our Social Security benefits are subject to taxation. In 2000, only 22 percent of recipients were above one of these thresholds. Now it’s 39 percent. When today’s children retire, virtually all will pay taxes on 85 percent of their benefits.
Bye-Bye Tax Cuts
Take a current 10-year-old who reaches the 25 percent tax bracket. She’ll hand back 21 percent (0.25 times 0.85) of her Social Security benefit in income taxes. To add injury to injury, President Barack Obama’s National Commission on Fiscal Responsibility and Reform likely will recommend a 20 percent benefit cut through a three-year increase in Social Security’s full retirement age.
Congress will, surely, also repeal George W. Bush’s income-tax cuts for the rich by raising rates in the top two brackets to 36 percent from 33 percent and to 39.6 percent from 35 percent. Over time, many of our kids who are middle income and even low income will face these higher rates because of real bracket creep.
Based on these assumptions, many young, low earners, now in the 15 percent bracket, will land in the 25 percent bracket by 2020. And many young workers with moderate earnings, now in the 28 percent bracket, will move into the 36 percent bracket.
What’s the total impact on young and future Americans of these tax time-bombs?
Kids and Grandkids
Consider two couples -- the kids, who are 30, and the grandkids, who will be 30 in 2040. The kids earn $70,000 a year per spouse, own a $400,000 house with a $1,718 monthly mortgage payment, will spend $30,000 on each of their two children’s four years of college, and earn 6 percent (3 percent after inflation) on their assets.
The grandkids are just like the kids except all their numbers are 3.68 times larger because of inflation and productivity growth.
Let’s reference by 100 each couple’s sustainable living standard absent any federal taxes. To compare the kids and the grandkids, we’ve adjusted the grandkids’ living standard down for their increased productivity.
Under the current tax system, the kids’ living standard is 83, meaning they face a 17 percent lifetime tax rate. Add in the new Medicare taxes, and the increase in top tax rates over the next decade, and their living standard drops to 80 -- a 20 percent tax rate.
The grandkids face a bigger hit. Their living standard is 74 -- a 26 percent tax. So, compared with the current tax system, the grandkids have to pay 9 cents more per dollar earned to Uncle Sam.
If things continue as we adults have planned, our nation’s debt, measured as a share of gross domestic product, will reach Greek levels just when the grandkids start heading to work. At that point, simply stabilizing the debt-to-GDP ratio will require raising taxes by 50 percent, thereby lowering the grandkids’ living standard from 74 to 61.
This is a 39 percent bite, more than twice the lifetime tax rate that baby boomers have experienced. Bear in mind, this is an average, not a marginal tax rate; it’s like taxing every dollar the grandkids earn at 39 percent.
Deficits Keep Soaring
A 50 percent tax hike will work for a while. But, given projected federal spending, it won’t keep deficits from soaring down the road. So the great-grandkids can expect even higher lifetime tax rates than their parents.
We’ve spent six decades passing the generational buck -- taking ever-larger sums from the young and giving them to the old, while promising the young their turn, when old, to expropriate their own offspring.
This massive Ponzi scheme is turning the American Dream into the American Nightmare. Stopping it means dramatically limiting the growth of federal spending. Here’s how:
-- Scrap our health-care system and provide all citizens with a voucher based on pre-existing conditions to buy a basic health plan, and limit coverages so that the total cost of the vouchers is fixed each year at 10 percent of GDP -- what Germany now spends on care.
-- Freeze Social Security in place, pay off its accrued benefits and replace the system with mandatory saving in personal accounts whose assets are jointly invested, by computer, not Wall Street, at minimal cost, in a fully diversified global index fund. The government would match contributions of the poor to make the system progressive and annuitize account balances at retirement. This Personal Security System would take much of Social Security’s unfunded liability off our kids’ backs.
-- Finally, stop spending more than the next 15 countries combined on defense. Declare victory in our unwinnable wars and bring the troops home.
And what about revenue? Scrap the current tax system and tax the elderly as well as the young through a levy on consumption. Also, provide a fixed monthly payment to each household to make the consumption tax progressive.
This all may sound radical. It’s not. Our progeny only have 100 cents out of every dollar they earn to surrender to Uncle Sam. And if their tax rates get too high, they will have a simple response: “Hasta la vista, baby.”
(Laurence J. Kotlikoff is a professor of economics at Boston University and president of Economic Security Planning Inc., and Richard Munroe is a senior software engineer at the firm.)
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