Redistributing Upwards

Most people think of social welfare policies as ones that aim to help people with low or moderate incomes, but the largest entitlements in what I call the Submerged State conglomeration of policies channeled through the tax code and subsidies to private organizations—benefit especially high income households. The three submerged policies that are most costly to the United States are the tax subsidies for employer-provided health and retirement benefits and the home mortgage interest deduction. Each of these three policies favors more affluent Americans, as seen in the figure below. In 2004, families with incomes of $100,000 or above—the top 15 percent of the income distribution—claimed 69 percent of the benefits of the home mortgage interest deduction, and 55 and 30 percent of the tax benefits associated with employer-provided retirement benefits and health benefits, respectively.

On the rare occasions when policymakers discuss these policies, they usually imply that they help middle class Americans, for example, to afford to buy a home and to save for retirement. But the actual amount the average family gains pales compared to the benefits for affluent households. This happens in part because the wealthy are in higher tax brackets, so their deductions are calculated at a higher rate. For example, if a middle-income family had a mortgage of $230,000, around the value of the median-priced home nationwide, they would owe $3,619 less in taxes, but a family in the top 2 percent of the income distribution with the very same mortgage would see savings of $6,673.   In reality, of course, these high income families are likely to spend far more on the activities that are tax-advantaged than are families with moderate incomes. If they take on a mortgage of $500,000, their savings jumps to $14,506; if they borrow $1 million, they will keep $29,012!

In an age of rising economic inequality, our nation has permitted the continuation of these submerged policies that aid primarily the most advantaged Americans and sharply reduce federal revenues, making programs that could assist low to moderate income people far more difficult to afford. The design of these policies obscures them from view, and neither policymakers nor the media do much to reveal them to the public. They are also shrouded by the fact that they are not part of the regular budget process: they face fewer hurdles in being enacted in Congress than regular spending programs, and once in place, they operate essentially on “autopilot.”  Even if they grow into large entitlements, like the ones mentioned above, policymakers are never obligated to revisit the question of their value or costs.

As the supercommittee looks for how to proceed, reducing tax breaks—at the very least, curtailing their bias toward the wealthy—could go far to improve the nation’s balance sheet and to reduce inequality. If done through an open conversation with the public, it could also help Americans to see government for what it is and to better understand how it affects their lives. The result would be to reduce the deficit and in the process, to strengthen democracy.



4 Responses to Redistributing Upwards

  1. Sam Gardner October 31, 2011 at 1:50 pm #

    In Europe, this is sometimes referred to as the Mathew effect (25:29) “For to everyone who has will more be given, and he will have an abundance. But from the one who has not, even what he has will be taken away.

    The reason is simple: once the principle of sharing accepted, the details of the lawmaking are started. As we all know, the rich are so much better at negotiating their due than the poor or middle class. Indeed, one of the definitions of poverty is exactly the lack of power.

  2. Mark October 31, 2011 at 4:36 pm #

    The rational thing would be to replace the subsidy for health and retirement benefits with socialized medicine and a federally guaranteed pension system (either a new program or Social Security with much higher payments). But it’s not likely either of those things will actually happen in the United States. All the political oxygen goes to finding ways to make things harder and more unjust, not more efficient and fair. As a result, as a practical matter, challenging these subsidies creates an opening for them to be eliminated and replaced with nothing. The result will be that many people spend more on health care and have harder retirements while people who are not receiving these subsidies now will be in the same situation they are in now. Meanwhile any money the government saves by eliminating the subsidies will be used to blow things up.

    As for the mortgage deduction, I agree. It promotes an unsustainable way of life. Getting health care and retiring are not optional. Buying a house instead of renting is optional.

  3. Alan T November 1, 2011 at 12:04 pm #

    I learned a great deal from your paper on the Submerged State, and I’m glad you’re posting here. I’d like to mention a few additional points that support your arguments.

    You point out that federal income taxes are less progressive than they appear because of tax deductions that benefit the wealthy. Furthermore, most other taxes we pay, such as payroll, state, and sales taxes, are regressive. As Paul Krugman ( says, “the overall [tax] system is barely progressive at all.”

    A few haircuts ago, my barber asked me if I believe in redistribution of wealth. My barber understands that the distribution of wealth matters more than the distribution of income. The very wealthy increase their wealth mainly through unrealized capital gains, which are not taxed. Therefore, a progressive income tax redistributes income downwards, but wealth upwards. Warren Buffet’s wealth increased by $3 billion in one year, according to Forbes, but only 1.3% of that (see was taxable income.

  4. jaske November 1, 2011 at 1:15 pm #

    I would like to see the math behind those numbers.

    The max loan for MID is 1 million. At 5% loan rate, at the max payment (since principal declines), the interest is 50,000.

    So at what tax rates does anyone get a benefit of $29,012 on a 1 million loan?
    That works out to be 29/50 = 58% tax rate. Which is bunk.