Paul L. Caron

Thursday, August 16, 2007

The Two-Income Tax Trap

Interesting op-ed in the Wall Street Journal:  The Two-Income Tax Trap, by Todd J. Zywicki (George Mason):

Scholars on the left ... [argue] that rising bankruptcies will result from new stresses on American households, such as those posed by rising health-care costs and higher mortgage payments for increasingly expensive homes. These new expenses strain the family budget, leaving less discretionary income available to save and to meet other household expenses, and forcing mothers into the workforce. Despite the apparent prosperity of American families over the past several decades and the presence of two regular incomes, American households, on this view, are in a more precarious situation than ever before. The argument is developed in the book, The Two Income Trap: Why Middle Class Mothers and Fathers are Going Broke, by Harvard Law School Professor Elizabeth Warren and her daughter Amelia Tyagi. In fact, using their own numbers, it is evident that they have overlooked the most important contributor to the purported household budget crunch -- taxes.

Ms. Warren and Ms. Tyagi compare two middle-class families: an average family in the 1970s versus the 2000s (all dollar values are inflation-adjusted).

The typical 1970s family is headed by a working father and a stay-at-home mother with two children. The father's income is $38,700, out of which came $5,310 in mortgage payments, $5,140 a year on car expenses, $1,030 on health insurance, and income taxes "which claim 24% of [the father's] income," leaving $17,834, or about $1,500 per month in "discretionary income" for all other expenses, such as food, clothing, utilities and savings.

The typical 2000s family has two working parents and a higher income of $67,800, an increase of 75% over the 1970s family. But their expenses have also risen: The mortgage payment increases to $9,000, the additional car raises the family obligation to $8,000, and more expensive health insurance premiums cost $1,650. A new expense of full-time daycare so the mother can work is estimated at $9,670. Mother's income bumps the family into a higher tax bracket, so that "the government takes 33% of the family's money." In the end, despite the dramatic increase in family income, the family is left with $17,045 in "discretionary income," less than the earlier generation.

The authors present no explanation for why they present only the tax data in their two examples as percentages instead of dollars. Nor do they ever present the actual dollar value for taxes anywhere in the book. So to conduct an "apples to apples" comparison of all expenses, I converted the tax obligations in the example from percentages to actual dollars. In fact, for the typical 1970s family, paying 24% of its income in taxes works out to be $9,288. And for the 2000s family, paying 33% of its income is $22,374. Although income only rose 75%, and expenditures for the mortgage, car and health insurance rose by even less than that, the tax bill increased by $13,086 -- a whopping 140% increase. The percentage of family income dedicated to health insurance, mortgage and automobiles actually declined between the two periods.

During this period, the figures used by Ms. Warren and Ms. Tyagi indicate that annual mortgage obligations increased by $3,690, automobile obligations by $2,860 and health insurance payments by $620 (a total increase of $7,170). Those increases are not trivial -- but they are swamped by the increase in tax obligations. To put this in perspective, the increase in tax obligations is over three times as large as the increase in the mortgage payments and almost double the increase in the mortgage and automobile payments combined. Even the new expenditure on child care is about a quarter less than the increase in taxes.

Overall, the typical family in the 2000s pays substantially more in taxes than the combined expenses of their mortgage, automobile and health insurance. And the change in the tax obligation between the two periods is substantially greater than the change in mortgage, automobile expenses and health-insurance costs combined.

This suggests that the most important change in the balance sheets of middle-class households over the past three decades is a dramatically higher tax burden caused by the progressive nature of the American tax system. In turn it follows that the most effective way of alleviating the household budget crunch would be to adopt lower and flatter tax rates that would reduce the government's take. Another possibility, advocated by Prof. Edward J. McCaffery of the University of Southern California Law School, would eliminate the "secondary earner bias" in the tax system, which causes all of the wife's income to effectively be taxed at a much higher marginal tax rate than the husband's. Any of these reforms seem sensible.

Lower and flatter marginal tax rates generally are not advocated by those who dominate the American legal academy today. But for those who want to consider serious strategies for preventing bankruptcies, less money in Uncle Sam's pockets may mean more money in ours.

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"Typical WSJ, obscuring the effect of increases in social security taxes by pretending it's the fault of the 'progressive' income tax."

WORSE. Even including FICA withheld (and the child care credit for both kids but NOT the child credit), the couple in question pay no more than about $9,925 in federal income, Social Security, and Medicare taxes total. In other words, the total federal tax bite is, at most, 14.6% of total income.

These people aren't even in the 33% income tax bracket, much less paying 33% of their income in federal taxes.

I don't know if the author if the cited piece was being deliberately dishonest or is simply woefully incompetent. Maybe it's both.

Posted by: Bill | Aug 16, 2007 8:21:15 PM

That's exactly what I was going to say, Gwailo. The marginal rate for married filing jointly on $68k in income is only 25% in 2006 (though perhaps their counting state taxes as well).

Posted by: Ugh | Aug 16, 2007 1:29:20 PM

Typical WSJ, obscuring the effect of increases in social security taxes by pretending it's the fault of the "progressive" income tax.

Posted by: Gwailo | Aug 16, 2007 1:07:56 PM