The Middle Class and Taxes

It’s apparently common wisdom in the US that strengthening the middle class involves cutting its tax burden. At least, that’s what John Edwards keeps saying over and over. However, as with many things John Edwards is saying, the truth is on the other side.

The middle class is fundamentally based on security, whereas the upper class is based on risk. Most middle class people would rather earn $45,000 a year to $60,000 (+/-) $40,000; most upper class people would rather earn $600,000 (+/-) $400,000 to $450,000.

This is important because a lot of government programs can be understood as middle class compacts to spread risk around. Right now, an American middle class family can expect to have to fork over $10,000-15,000 a year for four years each time one of its children goes to college, which reduces its earnings by about a quarter. Since middle class people live paycheck to paycheck (especially in the US, where people don’t save), this is often too crushing.

Instead, those families can agree to a compact wherein they pay on an annual basis, in the form of voting for a liberal government that will raise taxes and use them to subsidize higher education. Even if the average cost doesn’t change, it’s easier for someone making $50,000 a year to pay an additional $1,000 a year in taxes than to have to worry about paying for his kids’ college education.

Or, take unemployment insurance, the classic middle class welfare program. A middle class household can hope to have two working parents all the time and have nothing but meager savings and a broken social safety net to fall on if either is laid off. Or it can pay an additional $2,000 a year in taxes for unemployment benefits until the laid off employee can find another job.

It’s for the same reason that people get health insurance. If its average utility were positive or even zero, Aetna would fold. But despite the negative utility, the risk is worth mitigating for anyone who doesn’t have several hundred grand on hand to pay for an emergency.

But in fact, the utility of those forms of social insurance is positive. As a whole, it’s better for the economy to have an education system that can admit people based on merit rather than on the ability to pay, and to have professionals who, when laid off, can afford taking the time to find a job in their respective fields.

The same reasoning can be applied to government programs that help primarily the poor, like a social safety net, worker retraining, public housing, and national funding of education. It’s in everyone’s benefit that talented people can rise to the top regardless of where they’re born. It’s also in everyone’s benefit that the poor have the spending power to buy consumer goods; think of it as the public version of Henry Ford’s wage hike.

In addition, there are a lot of things the government just does better than the free market. The US health care system is so inefficient that Medicare and Medicaid cost per capita more than France’s health care system or even Germany’s, even though they cover barely a quarter of the population. The meteoric rise in college tuition in the US is traceable to the same spending problems that govern its health insurance system. Unemployment insurance likely pays for itself in the form of higher future earnings.

As some hardcore unionists will tell you, the problem isn’t high taxes, but low paychecks. This doesn’t really apply to the true middle class or to the upper middle class, but firmly governs the lower middle class. That’s mostly an issue of revoking anti-union regulations, but cash benefits to the poor exert the same upward pressure on wages as a minimum wage hike.

If the extra $3,000 a year in taxes I mentioned sound too high still, then consider the actual numbers. Each 1% of flat tax on all above-poverty income (and there I’m including interest income, capital gains, and corporate profits) generates $60-65 billion dollars in the US.

Now, the lushest higher education funding – that on everyone including room and board – will cost $140 billion per year; restricting to four years, and limiting subsidies to tuition, fees, and books, will cut it to maybe $50. Unemployment insurance costs $100. Full daycare funding at 5 grand per kid is $100. Together that’s about 4% of above-poverty income, which works out to $1,600 for a family of four making $60,000 a year, which is almost an order of magnitude less than what that family will save on health care under a decent system.

There’s no way around viewing those forms of social spending as a middle class compact. It’s impossible to saddle the rich with the entire bill, even with Swedish tax levels. For sure, some middle class families will pay more for this than others – typically, those that are richer, smaller, healthier, and with children who go to cheaper universities – but overall it’s still an intra-middle class insurance scheme.

It’s telling that the US, where the government coddles the middle class with low taxes and a mortgage deduction, the middle class is feeling the squeeze more acutely than elsewhere. The American middle class is relatively well off only by the risk-based standards of the upper class. By its own security-based standards, it’s in deep trouble due to soaring health and education costs and labor market uncertainties. What the middle class needs isn’t lower taxes, but the greater security derived from higher taxes.