Romney and the 47 Percent

We have all heard about the now-infamous video where Governor Romney talks about the 47 percent of Americans who supposedly support Obama as dependent on government. The video made quite a splash in the duck pond that is the GOP establishment. Panic erupted. Republican cocktail-party goers on the Tenderfoot Coast between Times Square and Tyson’s Corner whipped themselves for having even pondered voting for Romney. Jonah Goldberg and his buddies over at National Review are all up in arms. Media “conservatives” like Megyn Kelly at Fox News are trembling with fear. Shoot-from-the-hip columnist Josh Barro over at Bloomberg just can’t jump ship fast enough, declaring to the world that the election is now over.

Leading the scramble away from Romney is of course Bill Kristol, editor of the allegedly conservative Weekly Standard. It is not surprising that Kristol’s coat is turning left: like most people in the mainstream media, Kristol is an ardent Obama supporter (see, e.g., herehere and here).

Unlike these Cocktailers, Mainstreamers and Beltwayers, we at the Liberty Bullhorn don’t have tender feet. We are not addicted to schmoozing with liberals and we are certainly not afraid of either principles or good analysis. Therefore, we don’t panic when Governor Romney says something that is deemed politically incorrect by thin-skinned news pundits and campaign consultants.

What Romney meant is very easy to understand for anyone who cares to spend more time on the issue than it takes to read a tweet. But to make sure that even those with a short political attention span can follow the reasoning, let us sum up what the issue is all about in five easy steps:

1. The federal budget is in deep deficit.

2. About four in ten Americans are net takers of government services and entitlements.

3. About four in ten Americans are net givers of government services and entitlements.

I know these two points can be difficult to grasp for cocktail conservatives, but bear with me. I will explain in a moment.

4. To close the deficit we need to move people from being net takers from government to being net givers to government.

5. (This is the last point – hang in there, tenderfooters!) If you depend on government, you get addicted to the easy money.

From these five points, Romney concludes that:

a) it is likely that those who depend on government will vote to perpetuate their own dependency; and

b) this presents us with a formidable challenge – provided of course that we want to close the budget deficit without killing the American economy.

The best road forward, Romney says, is again to move people from the column of net takers from government to the column of net payers to government. However, the longer people depend on government, the more institutionalized they become (my term, not Romney’s). Even though you can convince people rationally that self determination is better than dependency on government, experience from Europe shows that most of the net takers of government services and entitlements aren’t going to listen to that rational argument. Comfort appeals to a lower level of the human mind than self determination, and therefore has a tendency of prevailing.

Anyone who wants to study the effects of this kind of dependency can look at how Europeans respond when austerity-minded governments try to take away their allowance. They protest wide and loud even though the unsustainability of their welfare state is staring them in the face.

This is the short version of what Romney said – hopefully it is short enough for the cocktail conservatives on the tenderfoot coast to understand. (If you still don’t grasp Romney’s point, and if the following analysis is too complex for you, do feel free to e-mail me and ask for clarifications. I have successfully educated people with little or no high school background on more complex issues than this.) Now, let’s take a more comprehensive look at the problem.

There is a very good way to illustrate the difference between a net taker from government and a net giver to government. It is called the Earned Income Tax Credit (EITC). This welfare program is one of the most obvious candidates for turning people from net taxpayers to net government takers. In fact, it is the single largest welfare program in the country: in 2009, 27.4 million families received a total of $55.1 billion in Earned Income Tax Credit, averaging $2,206 per family.

The EITC is nothing more than a low-income trap. It gives a substantial infusion of cash to eligible taxpayers but combines that infusion with effective marginal tax rates that exceed what people pay who make ten times more.

As for the cash, a taxpayer who qualifies can get up to $5,030 per year. Since the “credit” is refundable, and thus de facto a welfare program, it cancels out and in many instances exceeds what eligible taxpayers pay in federal income taxes. Three out of four EITC recipients got at least as much from the government as they paid in federal income taxes, making them net consumers of government. This is not counting any other government entitlement program; if we add all other cash that government hands out or provides in the form of services, we find – as demonstrated by the Heritage Foundation - that the upper half of all income earners pay virtually all federal income taxes.

It is a big moral problem when people are net takers from government. They are not contributing their fair share – which obviously would be a fixed, equal percent for everyone, as in the Herman Cain 9-9-9 plan – and since they are not paying their fair share it is ethically questionable whether or not they should have the same influence over government as those who actually bankroll government.

However, there as also economic problems that are at least as important as the moral ones. Established economic theory says that steep marginal income taxes discourage increases in labor supply and labor effort. Since the EITC suffers from precisely that – steep marginal tax rates – it discourages self determination and pursuit of prosperity.

To make this point, let us perform a little experiment. Suppose that Jack and Jill are married, have no children and no other deductibles file their taxes jointly. They qualify for the EITC, with an amount determined by the EITC eligibility calculator provided by the Internal Revenue Service. (Federal income tax amounts are taken directly out of the IRS 1040 tax table.) Suppose, also, that their income increases by $10,000 per year, starting at $10,000. Their net between the federal income tax and the EITC will be as follows:

Taxable Income Federal Income Tax EITC Net Effective Rate
 $          10,000  $                  1,003  $    5,030  $    (4,027) -40.3%
 $          20,000  $                  2,166  $    5,030  $    (2,864) -14.3%
 $          30,000  $                  3,666  $    2,700  $        966 3.2%
 $          40,000  $                  5,166  $    1,120  $     4,046 10.1%

The marginal rates are even more startling than the effective rates reported above. Suppose Jack and Jill make a combined $30,000 per year. Jack is offered a better job which would increase his income by $5,000. Their combined federal income taxes would increase by $750, indicating a 15-percent marginal tax on the new income. But their higher income also reduces their EITC eligibility from $2,700 to $1,640. This loss is now equivalent to a tax on the last $5,000 they make. The actual tax on that income increase is therefore $1,810 – a 36-percent effective marginal tax rate.

This effective marginal rate prevails through a wide income bracket: from $22,500 to $40,000. These numbers are, again, calculated under the assumptions outlined above, which makes them somewhat artificial. Nevertheless, they do highlight the fact that taxpayers who qualify for the EITC are taxed more heavily on the margin than high-income earners.

There is plenty of anecdotal evidence of what happenes to families who go from a low-paying part-time job to full-time employment. I know a family where the breadwinner had endured the recession earning just over $20,000 and was happy to accept a full-time job paying $50,000. He and his wife were amazed to discover that once they had made the transition, they saw no noticeable change in their disposable cash every month. They were penalized by the welfare state who kicked them off income-dependent welfare programs, including but not limited to the EITC. In addition, of course, they had to pay a much higher federal income tax on the last earned dollar.

You work more every day, take on a lot more responsibilities – but you are not better off. Romney’s point is that when faced with this kind of choice, too many people fall for the temptation to remain on welfare.

And just to put another angle on his comment, consider the fact that in 2009 almost 68 million tax returns declared an income of less than $30,000. That was 48 percent of all personal income tax returns. The vast majority of these filers qualify for one tax-funded entitlement or another, transforming them from net taxpayers to net takers of government services and entitlements.

To make this point yet another way: according to individual income tax return data from the IRS, tax filers with an income between zero and $30,000 earned 3.8 percent of the total adjusted gross income – but they paid only 0.1 percent of all federal income taxes.

Put bluntly: their income share is 38 times higher than their share of the taxes.

This imbalance between income and tax payments remains strong as we move up the income ladder. A full 64 percent of all tax filers make less than $50,000 per year. They earn 10.5 percent of all income but pay only 3.9 percent of the federal income taxes. This makes their income share 2.7 times bigger than their share of the total tax burden.

Do you think these people want to increase their share of the taxes? Thought so. And that’s precisely Romney’s point: now that we have placed half of the American people in a tax-and-entitlement comfort zone, how do we get everyone onboard when we try to close the federal budget gap?

3 comments

  1. Pingback: Romney and the 47 Percent « The Liberty Bullhorn
  2. Paul Gessing

    So, tell me specifically: how will our hero Mitt reduce government dependency during his term in office? I have seen zero in terms of substantive plans. He’s not endorsing Ryan’s all-too-weak-tea Medicare reforms.

    • S R Larson

      Paul,

      Romney has backed Paul Ryan’s Path to Prosperity which is the first important step toward doing away with the welfare state. Ryan’s block grant model will do more for reducing government dependency than the ’90s welfare reform. It’s not a perfect model but good enough to get us up on the right track. I see it as a first necessary step of five major reform steps, all of which will probably not be completed this side of 2020, but at least Romney-Ryan give us a chance to turn this country around.