Tuesday, June 24, 2008

Taxes, Part 2-Federal Income Tax

I think it's also important to understand how the tax brackets work, which most of us don't. We hear that "the rich" are in the 35% tax bracket and assume that they pay over a third of their income in taxes, or say that I'm in the 25% bracket, so we assume that Uncle Sam gets a quarter of my pay. That's not entirely true. First of all, the first pretty good chunk of income is exempt from tax. There's a $3500 exemption for each person in your family (so that's $17,500 in my family), plus a standard deduction of nearly $9000. If you itemize deductions, it's even higher... especially if you tithe (one more little benefit of giving). So a family of 4 starts off with a $23,000+ head start (this doesn't apply to FICA tax, which is very regressive). So if that family makes $70,000 a year, which is technically in the 25% range, their taxable income is only $47k, which means they really only pay in the 15% bracket. And actually, the next $15,650 after their $23k tax-free is at the 10% level. So only about $31,350 is taxed at the 15% level. Doing the math, that means this family making $70k pays about $6268 in taxes, or only 9% of their gross income (plus the FICA, of course). And let's not forget, with two minor children, the family alos gets a $1000 per kid rebate (thanks, President Bush), so their actual federal income tax burden is only 6%, which is less than what they pay in Social Security tax. The combination of those two taxes is still less than 14%.

Now this changes a bit when you make serious money. Take that same family and make Dad a high-dollar radiologist pulling down $400k (and ignoring for a second that their itemized deductions would certainly be higher, if only for living in a bigger house). The first $23k is still tax free, then there's a chunk paid at 10%, at 15%, at 25%, at 28%, at 33%, and finally, the last $27,300 is taxed at the 35% level. Total tax is a little over $104,000. That $2000 in child tax credit seems a drop in the bucket to this guy (actually, it may phase out at his income level, but I'm too lazy to look it up). So he's paying $102,000 in tax, or about 26% effective tax rate (again, plus the FICA). So a quarter of his pay goes to Uncle Sam. He's also paying an additional 3% in medicare taxes on every dollar ($12,000) , and since he's self-employed, he's paying the max 12.2% (both sides of social security) on the max of $102,000 ($12,400). So the total hit on his wallet is 31%, BEFORE we eliminate the cap on social security earnings. If we eliminate that cap it jumps to almost 41%.

Even at the extreme (Bill Gates, Oprah) end, the effective rate never quite reaches 35%. It may be 34.9999, but some tiny portion is always taxed at the lower levels. And of course, right now these guys still cap out on the Social Security at $102k, which diminishes as a percentage as you add millions and millions of dollars to the equation. Again, if you eliminate the cap, they'll be at near 50%.

Okay, that's all the math. What's the point? I know this comes as a bit of conservative heresy, but I don't think we're really over-taxed, at least not most of us. I have no empirical data to back this up, but my heart and my gut tell me it's immoral for the government to take more than about a third of what anybody earns. But even for the guy in the top 1% of taxpayers at $400,000 income, that's not currently the case. Again, eliminating the FICA cap makes it so. But as it stands right now, our system is very progressive (the top half of taxpayers pay over 96% of the total income tax revenues, and the top 1% of earners pay 39% of the total take), but with even high-dollar people not getting the shaft at anything like the confiscatory rates of the 1970s and before. What's more, this is a much higher percentage of total tax revenues paid by the top 1% than when the top bracket was double what it is now. So, on the one hand, I don't think we really need a new round of tax cuts for "fairness" reasons, but on the other, I don't think we need a hike on the evil "rich," who are already paying plenty and are right on the edge of where my "fairness threshold" kicks in.

BTW--All the numbers about taxes in this post came from the tax tables at Wikipedia. That, and my TI-35+ pocket calculator.

Okay, I promise, just one more nerdy post about tax rates and I'll try to come to a point.

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