Comments on economics, mystery fiction, drama, and art.

Monday, November 20, 2006

The Devil in in the Details: Larry Lindsay on Taxes

Larry Lindsay made a reputation as someone who stuck to his guns, who was in touch with reality, by getting fired by the Bush administration because he told something near the truth about the likely cost of the war in Iraq. But sometimes reputation is only reputation. In a WSJ op-ed (available at the AEI website), he writes:

"Last year an entrepreneur similar to me would have paid federal taxes equal to 33.9 percent of total income. That is, income before any exemptions, exclusions, adjustments or deductions. By this measure all of the fringe benefits that an entrepreneur provides himself as a self-employed individual are included in income. His federal income taxes and the employer and employee shares of his Social Security taxes are all counted as "taxes."

"For comparison, consider a married worker earning a salary of $75,000, who like our entrepreneur, has three children. To compute his total income on the same basis, I gave him the same level of benefits as an average worker and the same level of capital income as others making his income. I also followed convention to impute to him both his own Social Security taxes and all of those paid by his employer. On that basis, his average tax rate was 14.5 percent."

Lindsay's data use an expanded version of total income, including the value of benefits, and also counts total income before any deductions, exemptions, or exclusions. Presumably, taxes are calculated on the basis of income excluding benefits and after taking all the deductions, exclusions, and benefits to which one is entitled. So let's see what we get if we do the math.

His employee family pays Social Security taxes of $11,475 (15.3%--the employee's share plus the employer's share of SSI--of $75,000. If we calculate benefits paid by the employer at an additional 20% of cash compensation, we get an expanded definition of income of $90,000. So, at a 14.5% total average tax rate, we get taxes paid of $13,050. This yields federal income taxes of $1,425, which seems unlikely.

How about his entrepreneur? The current taxes on earnings for SSI are 12.4% of earnings for retirement and disability, on your first $94,200 of earnings, and 2.9% for Medicare, on your total earnings. Earnings here include only wage and salary income, not other forms of income (interest, dividends, capital gains). For simplicity, let's assume that our entrepreneur has only salary income. Lindsay alleges that his average tax rate would be 33.9%. Again, let's do the math. Assume deductions equal to about 20% of gross income, and include benefits at ablut 20% of gross income, using the current tax table available at, I can't get to a tax rate above about 31.3% of gross income. And I think this is biased tooverstate taxable income.

My look at this suggests that there's something wrong with Lindsay's calculation of taxes, both for the employee and for the entrepreneur. And wrong in a way that understates taxes paib by working people, that overstates taxes paid by entrepreneurs.


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