Monday, February 2, 2015

F.I.C.A., Inflation and the Middle Class Squeeze

“What’s this F.I.C.A.?” said my son.  He was home from college (in 1992) and was deconstructing his first pay stub from his summer work at a local nursery.  F.I.C.A., which everyone knows is the payroll tax that feeds the Social Security and Medicare trust funds, was larger than any deduction on the stub.  Such are the travails of a 19-year-old working for minimum wage.

The tax is very regressive.  It penalizes low wage earners more than high wage earners as it takes 7.5% of every dollar earned up to $117,000 each year.   It’s only one of the ways in which middle class taxpayers are hurt more than those at the top and bottom.

The poor receive government benefits in the form of the Earned Income Tax Credit, Medicaid, Section 8 housing and food stamps to keep them afloat.  By the time your earnings get to around $35,000 annually, most of that is phased out.

At the top, the wealthy can lower their tax bill though a variety of credits and deductions associated with owning assets, like stocks and real estate.  Those factors typically don’t help the middle class as much.

The middle class squeeze is about more than just taxes though.  It’s about inflation.

We keep hearing that inflation is under control.  And, the numbers don’t lie.  Overall inflation has been running well below the Federal Reserve’s target of 2% for years now.  However, as the cost of manufactured goods has been going down, the cost of essential services has gone up a lot!  Here’s a chart from the liberal think tank Center for American Progress (CAP) that illustrates the problem very well:

Which of these services can you forgo?

Meanwhile incomes are dropping in real terms.  This chart compiled by Mother Jones using data from the US Census Bureau shows the trend going back to 1967 and indicates that 2012 median income is about the same as it was in 1989.

Politicians on the left and right are now talking about the middle class and I suppose that’s good. But, what are the solutions they propose?  It may be too soon to tell how the President and his Republican opponents in Congress will define the battleground.  However, it’s easy to predict that it will be more of the same standoff.

CAP proposes a long list of solutions reminiscent of the 1960’s before globalization and automation stripped good paying factory jobs out of the US economy. These include raising the minimum wage, strengthening unions, improving education, reforming healthcare and realigning factors leading to more equitable home ownership.  

Will a return to the policies of the Great Society work in the 21st Century?

For their part, Republicans haven’t come up with a viable alternative – or any alternative other than lowering taxes and reducing the deficit.  Both are attractive but unlikely to trickle down to the middle class. 

But, if these policies won’ t work, what will?

It’s hard to know for sure.  However, I would favor those that provide opportunity through programs that would likely defy the dogma of both the left and the right. We can encourage the growth of high paying, blue-collar jobs in industries like energy and manufacturing through deregulation and subsidies. We can reform the tax code so that the burden falls less on employers and employees than on those who profit from asset appreciation.  And, rather than imposing huge tuition costs on those who might graduate without needed skills, we could provide support for technical skills demanded by the market. 

Moreover, capitalists – those who believe in a society built on opportunity rather than welfare – must find a way to ensure that the middle class can share in the benefits of our system.



  1. When are you announcing you are running for president? J

    The only real cure is simplicity to the point that the people we put in congress, and the also Mr./MS. President, have the capacity (knowledge and time and commitment) to understand the impact of the decisions that are being made on the people they serve. Not holding my breath that this will happen in my life time.

  2. Ralph Michalske, MBA
    Semiconductor Product Marketing Professional

    Hi John,

    I'm inclined to agree with you when you say, "capitalists - those who believe in a society built on opportunity rather than welfare - must find a way to ensure that the middle class can share in the benefits of our system". However, no one has proven that capitalism was meant for mature economies, but rather for developing economies. The US is a good example of capitalism growing an economy from nothing to what it is today. Virtually all economic classes benefitted from this growth. The upper economic class is still growing. This leaves the middle class merging with the lower class. I don't think we can ask capitalists to fix anything it wasn't meant to do.

    If the middle class in the US wants "to ensure that they can share in the benefits of our system", then they will need government's help. This will likely involve some re-distribution of wealth in our system. Keeping in mind that the middle class is a major benefactor of our current tax system with tax shelters in housing, student loans, and retirement savings, your son's economic group will have to ask the upper class to pull more of the weight of the middle class.

    Interestingly enough, the middle class grew the fastest when taxes were highest for the wealthiest Americans. You've probably seen this chart before =>

    I could make the argument that President Reagan caused the demise of what was then the growing middle class by slashing the highest marginal tax rates to what they are today. He nicknamed his tax policies "trickle down economics". Well, it was a great idea that didn't work. The good news is that all bad policies that don't work can be reversed. When government takes ownership for the economy good things happen for the majority. Send your son a copy of the chart. I'm confident he'll figure something out.

    1. @Ralph. I would take a wider view and suggest that we are no longer an example of a true capitalist economy. What is euphemistically called "crony capitalism" is really at the core of your quite accurate observations. Faced with a political environment that won't tolerate lower corporate tax rates, big companies in big industries have bent Congress and many administrations to their will. The rates may be high but big companies get big tax breaks. The small companies -- the job creators -- can't catch a break.

      Successful small business owners often go beyond what the government requires to the benefit of their employees. One of my clients has told me that he works until October before he is making money for himself. His taxes (federal, state, local, FICA and other) consume half his income. He provides health benefits (and has since before Obamacare required it) plus pension and profit sharing not required by any government program. That's how a capitalist can share with the middle class.

      I am not naive enough to believe that all will act according to that example. And, further I would say that capitalist enterprises exist for the benefit of shareholders not customers and employees. However, taking care of customers and employees is good business as we all know. That said, I believe that capitalist enterprises should be regulated (within reason).

      It is popular for those who lean left politically to blame Reagan for the problems of the middle class. However, I can show you a graph that shows the divergence of economic productivity and real income that goes back to 1973. I believe (I haven't done the research yet) that the causes go back to the creation of the Eurodollar, a fiat currency created for the benefit of Post War Europe. The volume of Eurodollars in circulation was so great that it caused Nixon to close the gold window in 1971.

      Our economic growth since then has been driven in no small part by growth in debt. Increasing leverage improves return on capital until the house of cards collapses of its own weight as it did in 08/09. That, I believe, is why return on capital has so far outpaced return on labor.

      Blame Reagan if you like. But, nothing is ever that simple.

    2. David Brown
      Senior Principal Analyst at Innovative Decisions, Inc.

      I would like to point out the problem with many of the suggestions that treat our economic system as a "simple system", rather than the complex adaptive system it is. The idea of wealth distribution would work if the economic system was simple in that it would not change as a result of changes in government policy. Nothing could be further from the truth. Witness the exodus of large companies moving out of our country. Increasing taxes further on companies that already pay one of the highest corporate rates in the world is only going to increase this flow. This does not benefit middle or lower classes as jobs move offshore. Ask the former middle class in countries like Venezuela how wealth redistribution is going for them. It would be far preferable to pay for the suggested programs through higher revenue from increased economic activity than through higher tax rates.

  3. The short answer is 'Yes, of course' — it is why we even have a group that Marx called the "middle class." (He wasn't the first, but his usage popularized the term as he himself became tremendously popular in academia.) For Marx, the middle class were too content: They interfered with his plans.

    Most responders here will be inclined the other way, I'd wager, and have a dim view of free enterprise — or "capitalism" in Marx's terminology. Like "middle class," both Marxist terms have been widely adopted.

    I suspect that Americans and Brits will read your headline in slightly different ways, as the term "middle class" is used differently in the two nations. In the UK, they seem to be a step up from "working class," whereas in the US the two phrases are closer to synonymous.

    We are evidently we're evolving terminology in another way as well: Anyone who is part of a declining minority of adults with a job in the US is now becoming part of "the rich" when considering the practical effect of "tax the rich" policies.

    But those same policies seem unlikely to support the free enterprise concept in a way that would accomplish what your headline postulates; instead, we're cranking out about a tenth of a million new regulations every year, mostly aimed at constraining and limiting free enterprise.

    So, can free enterprise broadly boost prosperity of people and nations? Absolutely.

    Will it be allowed to? Probably not; the incentives are aimed the opposite direction.

    ==============/ D. Keith Howington

    1. Kenneth Alan Gass
      Vice President at Wunderlich Securities

      Capitalism and democracy in the US have both been diluted by well-meaning social reforms and gerrymandering/lobbying, respectively. The former, capitalism/social consciousness chemistry, is something which has been hard-won despite the efforts of the latter ~ gerrymandered Congressional districts and lavishly funded lobbying on behalf of the wealthy.

      The cynical among the upper class will continue their accusations of 'class warfare' when it is proposed that the $117,000 ceiling on FICA should be discontinued(thereby eliminating the much ballyhooed Social Security shortfall that the Republicans foresee). Warren Buffett called them on this, saying , 'yes, there's class warfare, and we've won.'

      Nevertheless, these folks are all for what Steve Forbes touted as a 'more equitable flat tax.' Jesus of Nazareth pointed out the inaccuracy of that idea when he pointed to an impoverished woman giving a much greater percentage of her funds than someone in better circumstances.

      Finally, I might point out that Marx was at least partially right in his prediction that the workers would eventually own the means of production. There are more stockholders than ever before, mostly in the form of mutual funds and/or stocks in retirement accounts like 401Ks and IRAs. These company owners overwhelmingly vacate their corporate voting privileges, but do share in the wealth creation of publicly traded companies. This is apparently what the hapless Mitt Romney was trying to say when he blurted:
      'Corporations are people too!'

    2. @Kenneth,

      What Jesus reportedly observed in Luke 21 is certainly not the typical case in the United States today. Those of means give more in terms of dollars and percentage than those of modest circumstances. You mentioned Biden; he and poor, modest President Obama gave tiny amounts compared to Romney. At least an order of magnitude less; in Biden's case his donating of cast-off clothing was enough to be a significant impact on his total charitable giving. What a guy!

      Marx would not have been happy with high rates of stock ownership by the public, I think.

      But charitable giving has little enough to do with taxation, other than the fact that progressive governments seek to take over the roles of charitable organizations and push them out of the arena.

      To my surprise, you did not mention cronyism as a source of dilution/corruption of free enterprise. It seems to me a major factor.

      There is a whole well-developed thread here on taxation (entitled "Why not abolish..."), and you're welcome to join in. The flat tax is not a big feature of discussion there.

      ==============/ D. Keith Howington

    3. Ralph Michalske, MBA
      Semiconductor Product Marketing Professional

      Hi John,

      Linking the divergence of economic productivity and real income going back to 1973 and the Eurodollar, is a bit idiosyncratic. In your research of the Eurodollar you will find that it was a parallel currency (bank deposits outside US banks) devised by the Soviet Union to create disaster for the real USD currency here. Prior to President Nixon's brilliant move to take us off the gold standard or more correctly off the silver certificate, we were slowly being held hostage to Eurodollar debits being held in foreign banks and outside of the control of our central bank. The Soviet Union almost pulled it off. Lucky for us, Nixon caught it in time, and Fort Knox wasn't drained by the Soviets and other Europeans.

      I'm not sure what our upper boundary for national debt is. All debt requires debt service and I believe our upper boundary is related to this. In other words, we can't borrow any more than we can pay in debt service (periodic interest payments). With really low interest rates, we can take on more new debt service. Should the interest rate pendulum swing the other way, we could get ourselves in too deep. All this is watched closely by our central bank, the federal reserve. As a precaution, I am all for reducing our debt to a more manageable level. However, any way you do it will be painful for some economic segments in America. A VAT tax here would likely be the least intrusive to our economic segments and could be used solely for reduction of national debt.

      I like your altruistic ideas for businesses giving back to their employees in terms of health benefits, pension or retirement savings, and profit sharing. Personally, I'd like to see this codified into something like the Employee Retirement Income Security Act of 1974 (ERISA).

    4. Ralph Michalske, MBA
      Semiconductor Product Marketing Professional


      Can you cite any examples of the exodus of large companies moving out of our country? Many US companies are becoming more global and establishing foreign headquarters where business is brisk. President Obama recently proposed tax legislation to repatriate tax dollars back to the US. Wouldn't you be happy with this?

  4. James H. Dobbins, Ph.D., Esq.
    Engineer at MITRE

    Capitalism can save the middle class. By lowering taxes on small businesses and people, you encourage business growth, which encourages more employment, and when you take the 16% + who are not now in the work force and put them back to work, you increase their dignity and sense of worth, you increase government revenue by having more businesses and people contributing, and you have a huge increase in innovation. You free people to do what the Constitution says, to seek life, liberty and the pursuit of happiness. You remove the shackles that are now there preventing this.