Middle Class Tax Churning And The Risk Of Riots

Presently everybody is talking about variants of austerity measures regarding public expenditures imposed on us by the financial crisis. Most Western governments are running huge debts and there is no relieve in sight unless we cut spending and - if we follow free marketers - thoroughly de-regulate the economy. But it is entitlement reform that has been long ago established as the pivotal tool for mending unsustainable economics in most Western governments. Growing resources needed to serve entitlements according to some are even to blame for the loss of confidence with many investors. The projected future runaway train of entitlement costs refers to the whole range of social security, including such things as food stamps, income support, rent assistance, health care and state pensions, the bulk of which is absorbed by the middle class. 

Thus it comes as a surprise that in a recent Republican plan the middle and upper class, where certainly the most sizable savings might be achieved, should be exempted from cuts of government transfer payments or tax benefits. This is what emerged from blogger Alan D. Viard of the American Enterprise Institute in a post at Real Clear Markets. The point is that the ambitious Republican plan for slowing the increase in entitlement spending that was adopted by the House two months ago will target the lower income population in the US and spare the middle and upper class. This of course gives ammunition to the occupy movement and rightly so. However it would be a huge mistake to trigger riots with clearly wrongheaded policies. 

“The Congressional Budget Office's latest long-run projection of current budget policy does show rapid growth for one low-income entitlement. Medicaid, together with related health subsidies, is slated to grow from 1.9 percent of GDP in 2011 to 3.7 percent in 2035. But, that 1.8-percent-of-GDP expansion is overshadowed by the 4.3-percent-of-GDP expansion - from 8.5 to 12.8 percent - slated for Medicare and Social Security. Meanwhile, all other federal programs are slated to shrink from 12.3 percent of GDP to 8.5 percent. Any viable strategy to control federal spending must slow the growth of the two large middle-class entitlements, Medicare and Social Security.” 

It seems easier to cut lower-income entitlements like food stamps than targeting the bulk of middle class benefits that could stir up more opposition. However clearly here arises the issue not only of mathematical logic but moral justice. After all the middle and upper class are far more capable of stomaching some cuts than the poor. Moreover this problem reflects a long history of big government and wrong allocation of tax payer’s money - or more precisely the self-serving vote-buying tactics of the political class aiming for getting re-elected at the expense of the tax payer. We can see this probably in all Western countries and not only there. It was called tax churning by Peter Saunders, independent sociologist formerly based in Sydney with the libertarian Centre for Independent Studies. He explored this problem in depth in Australia which can serve as a good example for the rest of the West. Why is tax churning a problem? Saunders warns of 

“politicization of civil society: Something for nothing from anonymous and remote state agencies breeds instrumentalist ‘rights mentality’; At least half of welfare state spending (AU$85bn) is churned rather than redistributed. So most people could afford to buy what they need (using income smoothing instruments like insurance, savings or loans)… … if only they were not being taxed so much to pay for the government to provide these things for them. Producer group ‘rent-seeking’and bureaucratic empire building; Vote-buying by politicians”.

Also on his list of worries:

“Social disintegration crowds out bottom-up private initiatives (e.g. charities, neighborhood self-help), Creates perverse incentives (e.g. high transfer payments make it not worth working); Encourages dishonesty (500,000+ payments canceled or reduced by Centrelink last year); Suggests the fallacy that welfare state buys social cohesion (crime statistics prove otherwise). Personal disempowerment Undermines ethic of personal responsibility, promotes “learned helplessness,” Escalates expectations (e.g. current child care debates) Government “takes the life out of life” by eradicating problems for people to resolve (Charles Murray); Leaves “only sex and shopping” (Theodore Dalrymple); Enables self-destructive behavior that would not otherwise have arisen (e.g. growth in single parent numbers); Economic disincentives Deadweight costs of personal taxation = $60 billion (Robson) Every extra $1 raised costs $1.20 in lost output (take fewer risks, work fewer hours); Problem of high transfers due to progressive income tax plus means-tested benefits; Pressure on government age pension that will increase by1.9% points of GDP in 40 years Pressure on government health and aged care budgets Federal health expenditure up from 3.8% to 7.3% GDP in 40 years (PBS 0.6% to 2.5%) Spending on aged care up from 0.8% to 2% GDP”.

Saunders provides supporting data from Melbourne:

  • Income support is pay to 1 in 6 adults of working age, making him rely almost wholly on welfare for an income;
  • Family support payments are taken on by 9 out of 10 families with children (plus child care benefits, allowances and baby bonus etc);
  • Age pensions receive 8 out of 10 over 65 year olds (54% retirees get full and 28% partial pension);
  • Health care, 6 out of 10 citizens rely exclusively on Medicare,
  • Annual ‘subsistence’ income levels for different household types (based on welfare minimum payments). For example a single earner gets AU$13,328; a single parent + 1 child gets $21,824 (13,328 - 8,496); a single parent + 2 children gets $25,398 (13,328 - 8,496 - 3,584); a couple gets $21,796 (13,328 - 8,468); a couple + 1 child ($27,308 13,328- 8,468- 5,512); a couple + 2 children $30,881 (13,328- 8,468- 5,512- 3,573). These numbers are based on Melbourne Institute, “Poverty Lines Australia June 2006”, counting allowances, which are lower than pensions, and including rent assistance. The full data set here: http://www.slideshare.net/saunderspeter/taxwelfare-churning.

Saunders recommended apt interventions to stop this malfeasance by strengthening personal responsibility. For instance people should be allow to opt out of state health care and pensions in exchange for equivalent amounts in tax free earning which they can put in personal savings accounts. With this tool they get control over their health care expenditures. This is just one example. 

When I lived in London a couple of years ago, working as a German locum doctor for multiple NHS health care providers, I had already passed my sixtieth birthday for several years before I was made aware that I had missed out with the “freedom pass” for all UK pensioners or people over sixty. It gives you a free ride on all “London Transport”, including the tube, the famous red buses and even suburban train services. This transport network covers roughly a range of nearly 50 miles in diameter. Of course this is a major boon worth several thousand pounds a year and I enjoyed using it. 

However being a doctor I could afford paying my travel on public transport myself - even more so since it saved me the considerable costs of a car. Benefits for the middle class like this are also part of  tax churning. Of course child support payments for all by the government are another such superfluous perk. Politicians might calculate if they return some of the heavy tax burden back to the citizen they may be able to raise taxes even further and so the political election racket can go on and on. But this has to be stopped and the financial crisis gives us the opportunity to do it. However if we scrap all entitlements for people earning more than, say, 20.000 € a year there is one logical step more to take: a flat tax for all somewhere close to 25%.