Taxes and Generational Equity in 2008: The Latest Annual Analysis of the Issue No One (Else) Seems to Want to Talk About
It’s tax time again, and time to take stock of how the events of the past year have affected two fictional couples, the Young Hopefuls, now both age 29 with a three-year-old child, and the Senior Voters, now both age 69. You may recall from last year’s post on this subject that in 2007 each couple had an income of $100,000. The Young Hopefuls, with no savings or health insurance or pension, and living in a rented one-bedroom apartment, paid $22,214, or 22.2% of their income, in federal taxes that year based on a TurboTax analysis, while the Senior Voters, who owned their home, had a pension, and benefited from Medicare, paid $11,791 on the very same level of income, or 11.8% of it. The Young Hopefuls paid $10,814 in state and local income taxes and (indirectly as part of their rent) property taxes, or 10.8% of their income. The Senior Voters paid just $2,378, or 2.4% of their identical income, in state and local income and property taxes, one quarter of what the younger couple paid. That is $33,028 in taxes for the Young Hopefuls and $14,169 for the Senior Voters on the very same cash income, even though the senior citizen couple in this example had far more wealth and non-cash benefits. After paying for taxes and housing the Senior Voters had $83,405 left to spend, the Young Hopefuls $46,980. So what happened to these couples in 2008?
Like many of their generation, Mr. Hopeful has been forced to work as a freelancer or independent contractor, so his non-employer could avoid providing him with health insurance and pensions while continuing to provide these to other employees hired earlier. With business down in the recession, his self-employment income was cut from $75,000 in 2007 to $50,000 in 2008. While this sort of income loss is more common among the self employed, the current recession has seen wage cuts and furloughs become common for wage and salary employees as well, particularly in recent months, with both wage rates and hours falling.
Mrs. Hopeful held a part-time retail job without benefits in 2007, at which she earned $25,000 while paying $5,000 in child care. She lost that job after Christmas 2007, and was unable to get another one. Unemployment insurance payments in New York are set by the following formula -- “your original benefit rate is calculated on your actual high calendar quarter wages. Your weekly benefit rate is one twenty-sixth (1/26) of the high quarter wages paid to you in your base period.” Mrs. Hopeful’s high quarter was $7,000; her weekly benefit is $269, which she received for six months before exhausting eligibility, for a total of $7,000 in taxable unemployment insurance income. (The federal government later extended eligibility, and New York State unemployment later rose, so she may become eligible to collect again in 2009).
Since the inflation of the early 1970s, before the automatic inflation adjustment for Social Security was enacted in 1975, no elected official has been able to say the words “senior citizens” without also saying the words “on fixed incomes,” the fixity of those incomes being part of the presumed need and entitlement of the retired, regardless of how high those fixed incomes are. As a result of the New York State pension enhancement passed in 2000, however, the first $18,000 of the Senior Voters’ New York City pension income is automatically increased by an amount equal to one-half the inflation rate, which was 3.8% for 2008. That pushed their pension income up by $306, from $35,385 in 2007 to $35,691 in 2008. In 2009, moreover, even if (as is likely) we have deflation, that pension income will rise by another $180, as a result of a guaranteed minimum 1.0% “inflation adjustment” increase. The city will have to raise taxes on wage earners’ deflating income to pay for that adjustment for non-existent inflation. The Social Security inflation adjustment was 2.3% for 2008, adding $712.77 to the Senior Voters’ 2007 total of $30,990, raising it to $31,702.77. The Social Security adjustment for 2009 has been set at 5.8%, and will increase their benefit payment by another $1,838.76.
The Senior Voters also cashed in $35,000 from their 401K-equivalent 457 plan in 2008, bringing their total income for the year to $102,592, up 2.6% from 2007. The Young Hopefuls’ income, meanwhile, fell 43% to $57,000.
So what about taxes? Let’s crank up the Turbo Tax and find out.
The $102,593 in income the Senior Voters received translates into $76,839 in federal taxable income once the partial exclusion of Social Security income, personal exemptions, and the standard deduction are factored in. Their federal income tax bill would have been $11,894 for the year, but they received a refund check for $1,200 in May as part of the first federal “stimulus” giveaway, reducing their net federal tax to $10,698, or 10.4% of their income.
The $57,000 the Young Hopefuls received, including $7,000 in unemployment assistance and $50,000 in independent contractor income, falls to just $32,067 in federal taxable income after personal exemptions and the standard deduction. Their federal income tax would have been $4,009, but they received a $1,500 “rebate” in May, more than the Senior Voters according to TurboTax presumably as a result of their lower income. Mr. Hopeful, however, has to pay both the employer and employee share of the payroll tax as part of the “self employment tax,” which comes to $7,065 according to Turbo Tax (why it isn’t $7,650 I don’t know, but I’ll trust Turbo Tax on this one despite what happened to Tim Geithner). The total federal tax bill for the Young Hopefuls, therefore, is $9,574, or almost as much as the Senior Voters, who had far higher income in 2008. That amounts to 19.1% of the Young Hopefuls’ reduced income, or nearly double the Senior Voters’ share.
The Young Hopefuls’ state and local income taxes amounted to $1,797 and $899, respectively, for 2008. Had they been making a lot of money they might have regretted living in New York City, which unlike all but a few localities has a progressive local income tax that hits the better off harder. As it is, however, they are lucky to live in a place where property taxes are low, and local income taxes go down when incomes do. Their local income tax is down from $1,637 in 2007, when they had $100,000 in income rather than $57,000. The landlord of their 500-square-foot one-bedroom apartment, seeing other tenants move out for better deals, considered a rent reduction for the Young Hopefuls, but after the 7% property tax increase decided against it and left the rent unchanged. (According to the firm where I work, NYC market rate rents were virtually unchanged in 2008 and fell sharply in the fourth quarter). The property taxes passed on to the Young Hopefuls as part of their rent thus rose from $3,551 to $3,800. In 2007, when he had $75,000 in self-employment income, Mr. Hopeful owed $1,029 in additional Unincorporated Business Taxes; in 2008, with just $50,000, he owes nothing. Adding it up, the Young Hopefuls owed $6,496 in state and local income and property taxes, or 13.0% of their income.
And the Senior Voters? Retirement income is pretty much exempt from state and local income taxes in New York, so New York taxable income is zero, just like last year. Turbo Tax claims they are entitled to a $290 refund as part of the STAR local income tax break, even though they paid no local income taxes. The Senior Voters owed $3,581 in local property taxes on their 1,500-square-foot (plus semi-finished basement) rowhouse, but after the $400 Bloomberg (City Council?) check and the $132 Spitzer check, their net property tax was just $3,049. (Note to the IRS -- I remembered to deduct such checks from property taxes paid when itemizing deductions, did everybody else?). Factoring in the income tax refund, the Senior Voters paid $2,759 in state and local taxes, or 2.7% of their income.
If they are savvy the Senior Voters can get at least that much in benefits in services over at the senior center, since most senior citizen services are not means tested, since seniors are presumed to be needy because they are “on fixed incomes.” They can also ride mass transit for half price, and have similar deals at other publicly funded facilities. Regardless of what happens to other people’s taxes and services in the city’s fiscal crisis, it is likely that the Senior Voters pensions and other retiree benefits will be undiminished, and their state and local income tax of zero will not increase.
Adding it up, the Senior Voters paid $13,453 in income and property taxes on their income of $102,593, or 13.1% of it. The Young Hopefuls paid more taxes -- $16,070, on their far lower income of just $57,000, or 32.1% of it.
The Young Hopefuls paid $19,744 in rent in 2008, not including the portion that was passed on to the city in property taxes. Given their diminished income, that left $21,186 to pay for everything else -- food, electric bills, phone, diapers, health care (without insurance), transportation, everything. An income of $57,000 is not low for a young couple by U.S. standards, and the Hopefuls are not poor, but with New York’s high state and local taxes and, for those who don’t have one of the deals available (like a rent regulated unit occupied for a long time) housing costs, that income be a challenge to live on, even for a solidly middle class couple. The fact that the Hopefuls spend half their after-tax income on housing is not unusual here. If Mrs. Hopeful doesn’t find a job, and Mr. Hopeful’s earnings continue to drop, they’re going to have to move to a cheaper neighborhood. If not a different city.
The good news for the Young Hopefuls in 2008 was that the many free and near-free entertainment and recreation opportunities provided by living in New York City -- at the parks, the beaches, the libraries, the free Saturdays at the Brooklyn Museum and free Tuesdays at the Brooklyn Botanic Garden -- provided a fulfilling life despite more limited income. And they could get around on transit and with bicycles, meaning they didn’t need a car. No doubt these benefits are why so many young hopefuls have come to New York City in the past. We’ll see what’s left of them after the budget cuts in 2009 and 2010. We’ll see, moreover, what happens to the schools, which were gutted when your author was a young hopeful with a child approaching school age himself, sending his children to Catholic School and some of this friends out of the city. The taxes the Young Hopefuls pay, after all, are claimed first by pensions, retiree benefits and debts, with public services coming from whatever is left.
The Senior Voters took a bit of a hit on housing in 2008. In addition to paying an extra $381 in property taxes compared with 2007, their costs for insurance, water and sewer, and heating and cooking gas rose by $1,257, in large part due to the energy cost spike during the year. The total increase of $1,638 in these costs was a substantial share of their increase of $2,593 in income. But because our fictional couple didn’t foolishly refinance their house as its value rose and blow the proceeds on high living, as apparently many other senior citizens did, they have a paid-off house they can live in rent-free. The federal government is borrowing $billions, and will perhaps borrow $trillions, to offset the economic damaged caused by those, young and old, who were less responsible. The Young Hopefuls, and even little Baby Hopeful, will be paying for this in higher taxes and diminished public services and benefits the rest of their lives.
The Senior Voters took another hit, too. At the end of 2007 they had $835,625 in a 401K-like retirement savings account (a 457, since they had been public employees). They were invested according to the standard formula, with 30% in stock (100 minus their age approximately) and the rest in bonds. But the stock portion of their savings lost 40% of its value, a decrease of $100,275, and the bond portion lost 20% of its value, with another $87,740, in the market turmoil of late 2008. Given the distribution of $35,000 during the year, their wealth (aside from their house and pension) is down from $835,625 to $616,610. (The similar hit to the funds that support their pension will be absorbed by taxpayers, including the Young Hopefuls, in higher taxes and diminished public services and benefits, for years to come. Most of those entering the labor force after 1982 do not get pensions, and the similar losses to their retirement savings are not cushioned by them).
Understandably, therefore, the Senior Voters are feeling a little needy. In fact, lots of senior voters are feeling needy. And like many of their generation, they aren’t really thinking about the situation the Young Hopefuls find themselves in, particularly since -- as is common -- their children have moved away. They want to know what elected officials -- those running for Mayor of New York City this year for example -- are going to do for them.
In fact, many senior voters may be interested in a proposal by a think tank to have the federal government reset their 401Ks back to what they were in August, making up the difference with taxpayer funds, to undo the “failed experiment” of the 401K and protect their retirement income. Other proposals circulating in Congress would exempt even more retirement income from federal taxes, as in New York; the amount could presumably be made up by borrowing and, eventually, higher taxes on wages. President Obama, in his campaign, also promised to exempt a substantial amount of retirement income (but not wage income and certainly not self employment income) from taxes, the only thing he said that ticked me off. And Comptroller Thompson, in the first proposal I ever heard him make, proposed additional STAR relief to senior citizens, and not others with the same income. It was that proposal, nearly three years ago, that induced me to produce this series of “taxes and generational equity” posts.
But I digress.
There is nothing inherently immoral about a set of public policies that makes it hard on young people, particularly those without the burden of caring for young children, while making it easy on old people. The young, after all, have many other advantages. But such a system is only moral if it is sustainable. Can the Young Hopefuls expect similar benefits when they are senior citizens in 40 years? May I call your attention to the national, state and local debts, and the sudden interest -- while the federal government is borrowing $trillions -- in “reform” for Social Security and Medicare, with presumably no impact on those who were “age 55 and over” when former President Bush said the words? The Young Hopefuls had better plan on working until their health fails, and then living on less. (I certainly do on general principles, and I’m much better off than they are).
There is one other concern the Senior Voters have. In recent years, some other modest rowhouses on their block have sold for $1 million. So that is what they believe their house is worth, and what they would be entitled to if they sold. The were considering selling, moving to Florida, buying something cheaper, and banking most of the $1 million, ending up in a place where they wouldn’t have to pay for a plane ride to take their annual cruise. Suddenly, however, houses aren’t selling.
And no wonder. Because for all the senior voters to be able to sell, lots of young hopefuls have to be able to buy. Even in 2007, when the economy was better and the Young Hopefuls were prospering, the $1 million selling price would have been ten times their $100,000 income, whereas the general rule of thumb is that one can afford to pay only three times their income. Lots of young hopefuls paid too much in the bubble, abetted by toxic mortgages in which they lied about their incomes (often with coaching) and paid low initial payments they could barely cope with, to be followed by exploding payments they couldn’t possibly afford. Losses on bonds backed by those toxic mortgages are one factor that has diminished the Senior Voters’ savings. Now, however, those types of mortgages are no longer available.
Even if you assume the most a middle class couple like the Young Hopefuls could aspire to in Brooklyn is a two-bedroom apartment, and even if their income was to recover to its 2007 level, the most they could pay for a housing unit on $100,000 in income would be $300,000, and during the bubble two-bedroom apartments in much of Brooklyn were going for twice that. Which means that all over the United States, senior voters are faced with the prospect of settling for half.
No wonder that when listening to Bloomberg Radio while riding my bike to work, I’m treated to a parade of guest experts saying the Obama Administration needs to borrow as much money as necessary to stop housing and stock prices from falling, in order to turn the economy around. How? By passing a law requiring everyone under age 40 to pay 50% of their income for housing, whether in rent or mortgage, in addition to one-third in tax? The idea that younger generations could be paid less (real wages have been falling for most since 1973), taxed more (particularly since the increases in the regressive payroll tax to “save Social Security in 1983), and still buy houses (or for that matter stocks) at inflated prices is laughable. Only Congress can make it possible, by taking away people’s choices. Because what I tell young hopefuls who are thinking of buying a house is don’t do it. Not until the price is so low that they could claw back, in the form of lower housing costs, all the public debts and obligations this generation of senior voters is leaving to them.
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