Whether education or equity, treat their returns equally
A few years ago a colleague told me how his son was interested in going to medical school. He tried to dissuade his son citing many years of school followed by long hours, an unpredictable schedule, and costly malpractice insurance. So this father told his son: "Let me buy you a 7-Eleven instead."
Investing in training, education, a franchise, or a business is just that: an investment with an expected positive return. So why is return on human capital – wages – taxed at a different rate than return on business capital?
The American Taxpayer Relief Act of 2012 made a distinction among three income sources: ordinary income; ordinary dividends and short-term capital gains; and qualified dividends and long-term capital gains. Ordinary income is taxed via the income tax code as well as the 15.3% FICA payroll tax (6.2% of employee wages and 6.2% of employer payroll apportioned to Social Security as well as 1.45% of employee wages and 1.45% of employer payroll going to Medicare). Ordinary dividends and short-term capital gains are taxed as ordinary income but escape FICA taxes. Qualified dividends and long-term capital gains also escape FICA and are taxed at about half the income tax rate.
By the way, FICA – the Federal Insurance Contributions Act – is applied to today's wages to pay for today's beneficiaries of Social Security and Medicare. Don't be fooled: you aren't paying into the system for some future benefit; you're paying through the system to a current beneficiary with a promise that you'll receive some future benefit from some future wage earner. The Social Security and Medicare trust funds only provide a buffer should outlays exceed tax intake, and that 's currently what's happening. The Social Security and Medicare Boards of Trustees refer to this as "cash-flow deficit".
Sorry, I got a little off topic.
In the end, the tax code must be colorblind as to the source of income. Teddy Roosevelt said, “I stand for the square deal ... I mean not merely that I stand for fair play under the present rules of the game, but that I stand for having those rules changed so as to work for a more substantial equality of opportunity and of reward for equally good service."
Right now there are so many exceptions and exemptions that people in similar circumstances save for their source of income are taxed at different rates. If we expect our government to treat and serve us equally and if FICA is, in fact, "insurance" (that is, a hedge against the risk of low income or poor health) then the tax code fails us miserably.
The right response to inequity is not income redistribution but, instead, building a tax code where the sweat of one's brow is on a par with the heft of one's wallet. That way the color of money is always green.
