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Bradley T. Borden

Bradley T. Borden

Posted: February 23, 2011 09:50 AM

Last fall the Tea Party flexed its muscles and helped send many new faces to Congress. Now the news is filled with talk of budget-cutting, and House Republicans threaten to shut down government. They propose cuts that reduce spending by $100 billion. This would be good news if our deficit were that small and the cuts didn't adversely affect those who support them.

Cutting $100 billion comes nowhere near to closing a budget gap that exceeds $1 trillion. If the actions do not include tax law fixes, public services such as transportation infrastructure, social security, Medicare, police and fire protection, and public education will be on the chopping block. Cutting those services primarily and negatively affect the middle class.

Real life examples illustrate who wins and loses from such actions.

Mr. Smith is a 45-year-old Wall Street banker who made $15M last year. He is married with two children; his wife doesn't work. They had $200M in investments, which increased by $30M, so their purchasing power increased by $45M last year. They paid $3M in taxes (much of their earnings were exempt from tax or subject to special low rates, so they paid just under $3M in income tax and about $10K in social security and Medicare taxes). Their tax was about 7% of their increased purchasing power.

The Smiths' children attend a private middle school. The annual tuition and expenses are $80K.

Mr. Jones, on the other hand, is a 45-year-old mid-level business manager whose wife is a part-time nurse. Together they made $105K. They are part of the majority of Americans who make between $25k and $200K each year. They had $85K in retirement savings, $30K in liquid savings, and $12K of equity in their home, which they bought in 2002. The value of their investments increased by $5K, so their total purchasing power increased by $110K last year. They paid $24K in taxes (including $16K in income tax and $8K in social security and Medicare taxes). Their tax was about 22% of their increased purchasing power.

The Joneses have two children who attend public middle school. In exchange for the $24K of taxes the Joneses pay, they will receive retirement benefits and retirement health care in the form of social security and Medicare, education for their children, police and fire protection, and other public services.

Consider how budget cuts and no tax fixes will affect the Smiths and the Joneses.

First, consider the estate tax. As children get older, the cost of living increases--children often need braces, transportation, food, clothes, the latest electronic devices, sports equipment, musical instruments, and eventually college expenses. The Joneses will have difficulty maintaining their current rate of savings as their living expenses increase. They will use all of their savings and home equity in retirement and will have very little when they die. Estate taxes won't affect them in any way. Lower estate taxes (or none, in the case of estate tax repeal) help the Smiths, who will pass millions to their children tax free. The revenue lost from the lower estate taxes takes money away from public services the Joneses consume.

Second, consider Medicare and social security cuts. These programs are for the middle class and comprise the most significant portion of the federal budget. The Joneses' savings won't be sufficient to cover retirement, so they will undoubtedly need both. The Smiths will live well without them.

Third, consider tax rates. The effort to prevent tax rate increases for the top 2% of the population may have helped the Smiths avoid hundreds of thousands of dollars of taxes, which they can add to their savings. The increased rate would have done a little to equalize tax rates (remember the Smiths' rate is 7%, while the Joneses' is 22%). The lost tax revenue puts pressure on the services the Joneses consume.

Finally, consider the education budget cuts. The Smiths use private schools, so education cuts don't affect them directly. Cuts to public education will result in larger class sizes for the Joneses' children, lesser-skilled teachers, more demands for parents to cover school costs, higher college tuition, and a watered-down curriculum. Private education comparable to what the Joneses had before the budget cuts will cost them tens of thousands of dollars a year. The Smiths paid $80K last year, but they were paying for the best education money can buy. Cheaper private schools (including K-12) may charge only $5K-$15K per child for one year's tuition; the more expensive ones approach $50K per year. Borrowing to attend expensive colleges will be more difficult because federal student loan programs will be subject to cuts.

The Tea Party's focus on budget and tax cuts appears to benefit the Smiths but will directly harm the Joneses. I somewhat understand why the Smiths support such cuts. The majority of the Tea Party members are, however, like the Joneses. That majority is fighting for changes that help others and hurt themselves. Why are they sacrificing their way of life on behalf of the Joneses? Budget cuts without changes to the tax law will destroy the middle class.