Income Taxes, Payroll Taxes, and the 47%

Yesterday, Mike Bailey from Georgetown University (h/t Brendhan Nyhan) discussed results from a YouGov survey which finds that 78% of Americans believe they pay income taxes, even after they have been primed to consider the distinction between "income taxes" and "payroll taxes."

When Mitt Romney’s 47% comments came to light, many were surprised that Romney’s claim that only 47% of households pay income taxes is, in fact, true....

What’s going on, of course, is a disjuncture in the technical and ordinary usage of the term “income tax.”  Technically, the income tax is a progressive tax on income that does not include the “payroll taxes” paid to support Social Security and Medicare.  In ordinary usage, however, these payroll taxes are often considered federal income taxes – after all, on April 15, payroll and income taxes are rolled into the bottom line owed to the federal government....

The most recent YouGov/Economist poll asked, “Do you pay federal income taxes?”  Seventy-eight percent said they do. Given that about 54 percent of households pay federal income tax that suggests roughly 24 percent of respondents report that they pay federal income taxes, but do not.

The upshot, as the title of Bailey's post reports, is that only 22% of Americans know that they are part of the 47% that pays no income tax. The result is interesting and suggests that Mitt Romney has a bit of a rhetorical advantage on the issue of distributing the tax burden since more than half of the people indicted by Romney's 47% comment don't think he's talking about them. Bailey adds a bit of an editorial to this analysis, though, criticizing Mitt Romney for being disingenuous about the income tax/payroll tax distinction.

What this means is that there is important political slippage between the tax policy debate in Washington and the way it is heard by many Americans.  For Romney, this slippage is convenient as discussing income taxes as if they were all or even a majority of federal taxes paints the current tax system in a particularly unfavorable light.

Convenient is not correct, however.  Everyone who discusses taxes should report the full context on taxes so that Americans working with common sense views of income taxes are not misled.

I completely agree with Bailey that the American people deserve a full and fair reporting of the context of the national debate on taxes. Respectfully, though, I disagree with him about the source of the "slippage" in the way many many Americans understand their federal tax burdens.

In fact, most of the misunderstanding about "income taxes" versus "payroll taxes" arises directly from the existence of a "payroll tax" that is separate from the "income tax" in the first place. The problem is worse than that, though. The the federal government often refers to payroll taxes as "contributions" that individuals make to "earn" various "insurance" payments. Indeed, the federal that authorizes payroll taxes is called the Federal Insurance Contributions Act (FICA).

If the payroll tax is just an income tax by another name, why isn't it just called an "income tax" and included as part of the rest of workers federal income taxes?

It is no accident. The framers of the Social Security program intentionally separated the system of taxation that would support retirement insurance from the rest of the federal government's revenue collections. They didn't want workers to think of FICA payments as ordinary taxes. They wanted to create the illusion that working people were paying into a system to "earn" benefits that would be paid back to them later rather when they retired. Of course, Social Security does not work like that. It works like any other welfare program. People who are working now pay taxes to fund payments to people who are now retired. When those of us who are presently working retire in the future, our Social Security payments will be funded by taxes collected from people who are working then.

The separation of "federal insurance contributions" from income taxes was an intentional effort to obfuscate the nature of the Social Security program (and, later, Medicare) to insulate the programs fro subsequent political opposition. As President Franklin Roosevelt famously explained:

We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program.

Roosevelt knew exactly what he was he was doing. By "submerging" this part of the state, Roosevelt and the other parents of Social Security (and subsequently Medicare) successfully and fundamentally shaped the way that most people think about their payroll taxes and old age entitlements. A quick conservation with nearly anyone who is retired or near retiring will almost certainly show you that she thinks---no matter how conservative she may be otherwise---that she has a "right" to the Social Security and Medicare "benefits" that she "earned" by making her "contributions" over her whole working lifetime. This sentiment is not some abstract social contract business in her mind. It is a concrete, transactional and contractual reality.

The folks who are down on Mitt Romney for blurring the distinction between payroll taxes and income taxes and who also support continuing Social Security and Medicare in their present form as near universal, publicly financed entitlements through separate payroll taxes are trying to have their cake and eat it too. Mitt Romney's rhetoric about the 47% assumes a distinction in the contributions that people make to the federal government that was created by political liberals to manipulate public perceptions of massive transfers of income in order to insulate those programs from political attacks. Romney did not create that distinction and, to the extent that Republicans' desire to debate and reform old age entitlements are frustrated by the distinction, he and his party do not benefit from it.

So, by all means, let's have an open, fully contextualized debate about federal tax policies. But, the openness should start by recognizing that "federal insurance contributions" are just ordinary income taxes and that Social Security and Medicare are just ordinary income transfers. Unless and until the official and political vocabulary used to describe the nation's old age entitlements changes, we should not be surprised that many Americans misunderstand the nature of their tax obligations. Likewise, those who support the separation of income taxes and payroll taxes to protect old age entitlements from political opposition have little room to criticize politicians who try to capitalize on that separation for other purposes.