Saturday, July 30, 2011

Taxes explained -- "effective" tax rates create different picture

"Tax brackets" don't indicate true level of taxation on Americans

One of my favorite articles on the subject of effective tax rates -- the rates people actually pay on ALL taxes, not just income taxes -- is by Ezra Klein, a columnist with the Washington Post. Written in April 2010, the article is a little dated but still provides a clear picture of just what we're arguing about when we talk about raising taxes on the top 1 percent. We'll come back to that in a minute though.

First, a little background. People argue that the rich don't deserve a tax hike because they already have a tax rate of 35 percent, well above other rates available. Firstly, that tax rate is a bit deceiving -- only the richest of the rich actually pay that amount. The tax system is designed so that you are taxed a certain amount of dollars for the income you earn, and THEN all income earned after a certain amount is taxed at your respective rate. For instance, a person earning $300,000 isn't taxed at 33 percent (their supposed tax bracket), but rather 28 percent. See the brackets below for how that's computed:
Individual tax brackets for 2010
10% on income between $0 and $8,375
15% on the income between $8,375 and $34,000; plus $837.50
25% on the income between $34,000 and $82,400; plus $4,681.25
28% on the income between $82,400 and $171,850; plus $16,781.25
33% on the income between $171,850 and $373,650; plus $41,827.25
35% on the income over $373,650; plus $108,421.25
The tax rates don't represent the rates you pay if you're within a certain bracket, but rather what rate of tax you pay after a certain income is earned.

Here's another example, a more visual way of seeing how the income tax calculations are done:
400,000 - 373,650 = 26,350
26,350 x .35 = 9,222.50
9,222.50 + 108,421.25 = 117,643.75
117,643.75 / 400,000 = 0.294 or 29.4 percent
The income tax of a person earning $400,000 is 29.4 percent, much lower than the perceived 35 percent that people always cite. (The $250,000 income earners, often a point of contention for politicians, are taxed at the rate of 27 percent, not the 33 percent their bracket would suggest they be at and certainly nowhere near what millionaires would be taxed.)

Beyond that fact, however, distribution of taxes overall is significantly closer than people believe it to be. Income taxes are paid predominantly by the rich -- but the middle class and poor pay most of the payroll taxes. Since Social Security taxes are capped at $106,000 (that is, no income above that amount is taxed), those earning less than that amount pay the full tax rate, while those earning above that amount pay a significantly lower rate. For instance, a person earning $400,000 still only pays 4.2 percent (the current Social Security rate) on $106,000. So their Social Security tax rate is:
106,000 x .042 = 4,452
4,452 / 400,000 = 0.01113 or 1.113 percent
So taken together, the taxes that a person earning $400,000 per year pays is 29.4 plus 1.1, or about 30.5 percent. Again, that is almost 5 percent lower than people believe it to be (35 percent being the perceived tax rate for that income group).

Now, back to the Ezra Klein article. The argument made by many conservatives is that the rich pay all of the taxes in this country, that some people don't even pay any taxes at all. That myth is based upon the premise of income taxes, and that some people in the lower brackets are able to claim enough tax credits to offset what they owe to the government.

However, taken together, the gap between who pays taxes and who doesn't isn't as deep as you may think it is. As a proportion of the income earned, for example, the top 1 percent pays a fair share. In 2008, that group earned about 1 in every 4 dollars earned -- and similarly, they were responsible for paying about a quarter of all the taxes the U.S. took in. But that's true of nearly every income group in the country as well:



The effective tax rates reveal an even more startling picture (click the image for a larger view):

It's clear to see that the rich aren't facing as big a tax burden as conservatives portray. A large chunk of their income is going towards taxes -- but that's also true of other income levels, even those at the lowest quintiles. The top 1 percent of income earners have nearly identical effective tax rates as the next 39 percent of income earners, and the next quintile below that is barely taxed any lower. The lowest 40 percent of income earners see lower tax rates, but that's understandable seeing as they're earning less than ten percent of all income in the country.

We should keep these things in mind when we consider raising taxes on the richest Americans. They aren't paying 35 percent of all income, and raising their taxes back to pre-Bush levels won't make them pay those old "rates" either, since those rates were calculated in similar ways. Indeed, raising taxes on the wealthiest of Americans would cut the deficit by trillions of dollars in the long-run.

2 comments:

  1. what about the idea that most of the wealthiest earn most of their income from capital gains, which for most equities held for over 1 year are taxed at a meager 15%?

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  2. Please correct your ignorance.Your 15% tax that they pay is ater earned income tax has been paid.So,use the above equation: 400,000 - 373,650 = 26,350
    26,350 x .35 = 9,222.50
    9,222.50 + 108,421.25 = 117,643.75
    117,643.75 / 400,000 = 0.294 or 29.4 percent.

    Now you have the dollars that "the rich" place in investments,which goes for loans to others to get "rich" and they pay 15% on that.If you don't get this simple example,you,well there is no explanation for you.I didn't want to be mean.

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