High taxes hurt dyslexics

Taxes aren't really my thing, but I can't help passing along this anecdote about my mom:

My mom is 67 and ostensibly retired.  She taught elementary/middle school for several decades and specialized in teaching children with reading disabilities.  (She has a masters' degree in education.)  When she retired, she decided to supplement her income by teaching children with severe learning disabilities.  She took an intensive course in dyslexia and hung out out her shingle.

She now has 10 students.  Some are severely dyslexic, which means they will need years of therapy.  She's always been a great teacher and is evidently doing a good job now, because she's constantly getting asked to take on new kids.

She charges $25-$30 an hour or something like that, which is the going rate for this kind of therapy.  But each session takes a lot of preparation, so her effective rate of compensation is closer to $15/hour.

Still, that's pretty good money for a retired person, right?

But hold on.  Thanks to her social security benefits and a slightly better teacher's penson, she has just edged up into the 25% marginal tax bracket.  She also has to pay 15% self-employment tax -- to pay for her benefits when she retires.

A 40% marginal tax rate.

It's worse than that, though.  Because she makes more than the social security administration thinks is prudent, she must now pay taxes on $4,000 of her social security benefits.  Altogether, she has a 50% marginal tax rate on her teaching income.  Her effective rate of compensation is somewhere around $7/hour.

She was surprised by her tax bill.  She's done the calculation.  She doesn't want to work 15-20 hours per week for $7-$8/hour; after all, she's supposed to be retired.  So next year she plans to scale back to the five students with the most serious problems.  It's not worth it financially to do any of this, she said, but she feels like these five really need her. 

When economists talk about the deadweight loss from taxes, this is what they mean.  No one benefits when my mom scales back from 10 hours to 5 hours -- she loses out, five of her students lose out, and the government won't see one thin dime from the 5 sessions that would have been. 

There's always been a lot of handwringing from some about the distortionary effects of high marginal tax rates for the wealthy, but I've always thought the high marginal tax rates for the lower-income distort the market even worse.  (Not to mention the unfairness of it all -- I make a lot more than my mom, but my marginal tax rate is much lower.)  The 15% self-employment tax is crippling to those who want to go out on their own.  And I can't think of a more boneheaded retirement system than one that forces the retired to be even more reliant on meager social security payments.

Addendum.  I ought to say something about my idea of a fair tax system.  Here it is: 

(1) Eliminate the social security/employment tax.  Period.

(2) Eliminate taxation based on family income. 

(3) Give every taxpayer a standard $20,000 deduction, with progressive marginal tax rates after that. (Combined with (1), someone making $20,000 or less would pay no federal tax.)

(4) Eliminate the mortgage interest deduction.

(5) Impose a carbon tax, which would generate a huge amount of revenue, allowing reductions in income taxes, while pricing the externality generated by carbon use.

(6) Include employer-provided health care benefits in taxable income.

(7) Restrain the growth of social security somehow, perhaps by bumping up the retirement age by a year and reducing the COLA.  But don't count social security benefits when calculating income for the retired; i.e., soften the blow by letting them supplement their income without penalty.

Like I said at the beginning, I'm no tax wonk.  I don't know whether this would be feasible.  I'm sure it's not policitally feasible.  It certainly seems fairer to me, though.

Comments

[Tim]

I think the problem is that "self-employed" to the IRS means "I'm trying to deduct my car and home-office". Too many rich people exploit it. When my wife used to do paid acting she'd make about $1000/year. For which we'd end up paying about $500 in taxes. Completely ridiculous.

And now that I have a kid and can't go anywhere or do anything they're sending my money back to me by the barrel. Go figure.

[natrius]

How can we do (2) and (3) at the same time? Don't you need to take into account people's incomes to have a progressive tax code? Are you just suggesting that one family members income should affect the tax rate that the other member has to pay? That sounds like a good idea to me.

[M1EK]

I can't give much care on the "fairness" issue for social security recipients considering how much most get compared to what they paid in (yes, even current retirees); the sole reason I voted for Perot in 1992 is that he had the guts to tell a retiree making $50K that, yes, she ought to pay taxes on her social security benefits (for comparison, this was when I was making $35K as a new hire at I-freakin-BM; the minimum wage equated to something like $8K/year; and that minimum wage worker was paying 7% or so in payroll taxes to fund her social security for which her husband paid an average of 1.5%).

[DSK]

Imagine how many eyes would be open if every worker had to do something like Schedule SE, rather than so much of that tax being hidden as an "employer contribution." It is, of course, really your money; to the employer it is just part of the cost of employing you, and is money that could have gone to you directly if the tax did not exist.

[AC]

M1EK, where's the calculation showing that most retirees get out more than they paid in? I've always heard that the rate of return on social security taxes is zero or slightly negative. And anyway, you've ignored the efficiency part of my argument.

Natrius, I think if husband and wife both work, they should be taxed independently -- i.e., no aggregate family income. The so-called "marriage penalty" is really the higher-marginal tax rate on the second earner. For example, if husband and wife both earned $35,000 per year, then they'd both get to exempt $20,000, and they'd each pay the taxes on $15,000. Right now, their marginal dollar would be taxed at whatever the tax rate is for $70,000 - deductions.

This wouldn't help high-income earners as much, since the $20,000 exemption won't be a big deal to them, and they'll be paying much higher marginal rates anyway.

[natrius]

Oops, I meant that one family members' income *shouldn't* affect the other's tax rate. I agree with what you're saying completely.

[M1EK]

AC, those figures are for current workers under a certain age. Back during Perot's run in 1992, the NYT estimated that the typical person collecting social security at that time had taken 5 years or so to blow through all their contributions, plus interest.

I only have a sec here - but I did gather links a while back for a comment on one of the econ blogs I read; and the figures have obviously changed _some_ (the retiree in 1992 paid a lower overall rate than the retiree in 2007 due to intervening payroll tax changes) but they're still way on the positive side. The tipping point is arriving soon, though.

[M1EK]

Oh, and I fully acknowledged I was addressing only the fairness argument. The efficiency one is a lot harder -- part of it stems from the questionable position you and others have taken that the SS she gets is just "her money paid back to her", after all. If SS is just a wealth transfer from young working folk to middle-class elderly (as it is in my opinion), the efficiency argument also has to include the fact that we're more than likely paying her somebody else's money already.

BTW, the implicit assumption that it's "her own money" also rests on a _highly_ optimistic view of interest rates on that money if it were self-invested. The propaganda about privately invested SS accounts was all butterflies and sunshine about the stock market -- the type of stuff that ignores what happens if you retire in 1940 after having put money in through the 1910s-1930s.

[AC]

"part of it stems from the questionable position you and others have taken that the SS she gets is just "her money paid back to her"

No. I think the social security program is a social welfare program. That's why I advocate abolishing the payroll tax, which is a relic of the "it's just a retirement/pension system" thinking.

I raised the return-of-contributions point because you said retirees were getting out more than they paid in. I doubt that's true when you consider their opportunity cost. I certainly think I'd be better off socking my money into a retirement account. (Note: This is _not_ equivalent to arguing that Social Security should be abolished in favor of private retirement accounts; I admit that it is a social welfare system.)

You do make a good point on efficiency. Lowering one person's marginal tax rate means someone else's must go up, which raises new efficiency concerns. I'm now officially outside my area of competence. My "gut" feeling, though, is that imposing high marginal tax rates on low-income earners is worse -- both as a matter of fairness and equity -- than raising the marginal tax rates slightly for high earners.

[M1EK]

I've seen economists argue both sides of that marginal efficiency issue. Frankly, though, I don't care if a marginal increase causes a superstar to work a bit less -- I want to reward hard work over vanity work, in other words.

As for return on investment - again, yes, at our age we can beat SS, but that's strictly because we're paying such a high rate compared to our promised benefits to make up for earlier generations getting off so easy (they were charged too little). It's absolutely NOT because most of us could "beat it in the stock market", unless the "it" you're referring to is our _artificially_ low ROR. With the true ROR, some of us might; most of us wouldn't. (The market average does better than the median, in other words - and again most people discount the probability of another 1929 event coming someday).

In other words, don't listen to stock cheerleaders when figuring out if the stock market will always (not just usually, but always) beat a fixed rate. I can easily fashion cases where retiring at the wrong time would have resulted in social security "earning" far more than a private investment account.