Why should people be allowed to shield income from taxation?

Heather Long discusses the (supposedly) final version of the Republican tax bill in The Washington Post, and I came upon this part:

Andrew Devendorf has contacted Sen. Marco Rubio’s office every other day for the past month to beg the Florida Republican to make sure Congress’s final tax bill doesn’t make graduate school unaffordable for him and 179,000 other PhD students in the United States. Rubio has emerged as a potential swing vote on the tax bill, giving him possible leverage as Republicans finalize their plan with the goal of getting legislation to President Trump’s desk by Christmas.

It looks like Devendorf’s efforts paid off. Tuition waivers for graduate students are expected to remain tax-free. The medical deduction, which helps 8.8 million Americans with severe conditions like Alzheimer’s, is also expected to remain.

“Nothing’s final of any of this stuff, but we’re trying to make sure that the provisions in law that are available to students for education continue to be available,” Sen. John Thune (R-S.D.), a member of the conference committee, said Wednesday.  .  .  .

Devendorf is in the first year of a PhD program in clinical psychology at the University of South Florida in Tampa. His older brother committed suicide. Since then, Devendorf said, he has dedicated his life to studying psychology in the hope that he can help others with mental health issues. (Suicide is the second leading cause of death among Americans ages 15 to 34, according to the National Institute of Mental Health.)

At the university, he receives a $14,000 a year stipend and pays taxes on that income. But under the bill that passed the House, he would have to pay taxes on that stipend plus the $30,000 tuition waiver he gets from his university, even though he never actually receives any money from the waiver. Taxing the waiver would bump up his tax bill substantially, making it difficult for him to continue his studies.

“Our stipend is already super hard to live on . . . how am I going to fund myself it this passes?” he said this week. “I come from a middle-class family. This isn’t a lucrative field.”

There’s more in the original article, but this one jumped out at me: is Mr Devendorf not receiving (roughly, I suppose) $30,000 in value from the waiver? In effect, USF is paying him $44,000, but is helping him to hide $30,000 of income.

This is just another version of hiding income in kind. The biggest income hiding comes in the form of employer-sponsored health insurance plans. According to the Henry J Kaiser Foundation:

This annual survey of employers provides a detailed look at trends in employer-sponsored health coverage including premiums, employee contributions, cost-sharing provisions, and employer opinions. The 2016 survey included more than 1,900 interviews with non-federal public and private firms. Annual premiums for employer-sponsored family health coverage reached $18,142 this year, up 3 percent from last year, with workers on average paying $5,277 towards the cost of their coverage, according to the Kaiser Family Foundation/Health Research & Education Trust 2016 Employer Health Benefits Survey. The 2016 survey includes information on the use of incentives for employer wellness programs, plan cost-sharing as well as firm offer rate. Survey results are released here in a variety of ways, including a full report with downloadable tables on a variety of topics, summary of findings, and an article published in the journal Health Affairs.

In other words, people in employer-sponsored health insurance plans are receiving an average of $12,865 per year in untaxed compensation. Of course, some employers have more, or less, generous health insurance plans, so some people are receiving more untaxed income than others, both for health insurance. And those who do not have employer-sponsored health insurance, but are relying on the Affordable Care Act insurance exchanges, are having to spend income that is subject to taxation for their insurance. Of course, those using the Obamacare exchanges for their insurance, but get a government subsidy to pay for it, or help pay for it, aren’t paying taxes on the subsidies. Basically, it’s only the middle-class self-employed who are being taxed on the full amount of what they pay for health insurance.

In a system in which we tax people based on their income, we should at least treat everybody the same. Instead, we allow Mr Devendorf to hide 68% of his real income from taxation, and the remainder is mostly shielded by the personal exemption and standard deduction.1 Applying the 2017 personal exemption of $4,050 and standard deduction of $6,350,2 Mr Devendorf’s total federal income taxes would be only $360, or 10% of the $3,600 unshielded income after the personal exemption and standard deduction. $360, on an effective annual income of $44,000.

Yet, if a single person earned $44,000 in payroll, his taxes would be $3360!

But, naturally, there’s more! Social Security and Medicare taxes (6.20% and 1.45%, respectively) are applied to all salary and wage income, so the personal exemption and standard deduction do not apply. Mr Devendorf would pay, on $14,000, $868 in Social Security tax, plus another $203 for Medicate. Yet the single worker earning $21.15 per hour, or $44,000 per year, would pay $2,728 plus $638 in Social Security and Medicare taxes.

Why, I have to ask, should a regular worker would owe $6,726 in total federal income-based taxes, while Mr Devendorf’s liability is only $1,431? Why should the man lucky enough to have an employer-based health care plan receive a tax-free benefit of $12,865 — that’s over $1,000 a month — while the man who isn’t so fortunate have to pay taxes on all the money he must spend on health insurance?

The obvious answer is that, in an income-based tax system, we should treat everybody the same, and tax all income, not allowing people to ‘hide’ compensation through such means. It would require a lowering of tax rates, to make up for this, but it should be done.
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  1. The tax bill, if it passes, will eliminate the personal exemption, in favor of a larger standard deduction. I mentioned the personal exemption as well, because the tax bill has not yet passed.
  2. Calculation assumes that the taxpayer is unmarried and has no dependent children.

3 Comments

  1. This is a good argument to get rid of the income tax entirely and replace it with a national sales tax. Because this whole article raises the question of: “What is income?” Is income money you actually receive? Or is it something you get without having to pay for, like an expensive tuition charge that has been waived, as in the case of this grad student? Or is it a “Free” benefit, like employer supplied health insurance?

    • In my mind, the 16th Amendment was the greatest violence ever foisted on a free people. The original Constitution required that direct taxation by the federal government be levied on a population basis, that the taxes for Donald Trump and Bill Gates and me would all be the same.

      European nations have a form of the national sales tax, with the ‘value added tax’ at each point in the production process. American politicians don’t like having individuals seeing how much they are taxed, so they impose very heavy corporate income taxes, but corporations do not pay any taxes; they simply collect those taxes from their customers, throughout the production chain, and all taxes are eventually paid by the end consumer of their products.

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