In defense of Progressive Taxation Rates

I’ll need to do a write on what I’d change about taxes in general at some point. I think I’d probably surprise both lib’s and con’s with what I’d do if the world recognized my infinite wisdom and granted me absolute power. But after THIS BIT on MMFA yesterday and today, I feel that a brief write about the progressive taxation system and some basic accounting principals might be in order. And yet I still want to get back to health care! I had this awesome graph that I made! I really want to use it! Oh well. This is good food for thought as well and important stuff, so I’ll hit this first. And I may need to break it up into two posts; we’ll see how it goes.

So… first things last, let’s have a little refresher on how progressive taxation actually works. Let’s use the 2010 Brackets for “Single” as an example.

These are the brackets:
10.0% up to $8,375 in income,
15.0% from $8,375 to $34,000,
25.0% from $34,000 to $82,400,
28.0% from $82,400 to $171,850,
33.0% from $171,850 to $373,650 and
35.0% above $373,650

So… what does that mean? Does someone making $375,000 really pay $131,250 (35%) in taxes? No. If they did then that extra $1,350 in income would end up costing them $7,645.50 in extra taxes! That hardly seems fair. And although that’s what the Rush Limbaugh’s of the world would have you believe happens, it’s utter BULLSHIT. It’s a lie. Here’s how it actually works:

This person would pay 10% on their first $8,375, just like that part-time high-school student earning that much does. ($873) They will them pay 15% on the income between $8,375 and $34,000 (15% x [34,000-8,375] = 3,843.75) the same as every school teacher does. They would then pay 25% of every dollar after $34K up to $82,400 (25% x [82,400 – 34,000] = $12,100) just like every engineer does. After that they pay 28.0% on every dollar from $82,400 to $171,850 (25% x [171,850 – 82,400] = $25,046) just like every Mid-level Manager does. Then it’s 33.0% of every dollar from $171,850 to $373,650 (33% x 373,650 – 171,850 = $66,594) just like every other company Vice-President does. And they’d only pay that top rate (35%) on just that last $1,350. That last bit of income ($1,350) only costs them another $445.50 in taxes. You might think that’s a lot, but the point remains: They still took home more. There is no disincentive to work harder, assuming that you’re working hard so you can take home more money.

Bottom line? The guy making $373,600 paid 66,908.75 in taxes (an effective rate of about 17.9%) and took home $306, 691.25. The guy who put in that one extra weekend, and kissed slightly more ass, who got $375,000? He paid $67,354.25 in taxes: an effective rate of (wait for it…) about 17.9%. And he took home $307,645.75. Was that extra $954.50 worth it? Only he can answer that. But you can’t call it a disincentive, due to the higher rate of taxation. That’s just plain wrong. It’s incorrect. It’s demonstrably false. So if you hear someone talking like this, their either lying or ignorant.

Or… to put the way I usually do: Conservatives only come in two flavors: Evil and Stupid. One’s lying and the other’s buying.

So, now that we all understand how it WORKS, let me explain why this is a GOOD way to structure an income tax, and how I might do it differently. As to why it makes sense: It comes down to a hierarchy of needs.

Let’s say you make median income. In this country that’s just under $50,000/year for individuals. We’ll round up to 50K to keep the math easy, and let’s just talk about individuals for now, again just to keep things simple. (Note: The actual numbers aren’t really important. We can all quibble over where to draw the various lines and what % tax to levee on them. That’s a good area for debate. But regardless of what you conclude the principle still holds.) So take someone who makes $50,000 per year. What are the spending their money on?

Food, Rent & Utilities, Clothing, and Transportation.

After they’ve dressed for and driven to work, paid the bills and eaten, there’s basically nothing left. And this is why, if I had my druthers, I’d make the first $50K tax-free, for EVERYONE. Because everyone needs every penny of their first $50K just to survive.  (I live on about 50K per year myself, AFTER TAXES, and not including what I put away for retirement, so I can assure you: if you reduce that at all, you will not only impact my lifestyle, but my spending decisions substantially.  Do that to EVERYONE and you WILL destroy the economy.

Now let’s double it. If you’re making $100,000 per year, after you’ve covered the necessities, your next $50K is paying to improve your standard of living. We’re not into luxury yet, to be sure, but we’re probably talking about owning your home rather than renting, maybe a new car instead of a used one, the occasional night-out with your significant other, maybe some travel and, of course, saving for retirement and/or your kids’ education. (Disclosure: I'm somewhere between $50K and $100K right now, so I know this bracket pretty well! LOL) Now, all these things are still important, and I don’t begrudge anyone a comfortable, middle-class lifestyle. HOWEVER… it’s pretty clear that you don’t need your second $50,000 as much as you needed your first. (Anyone can live on $50K/year, but no one can live on $0!) So this is an income block that I’d start taxing. Let’s say at… 30%. That might sound HUGE, but actually, but it actually ends up a net reduction for anyone making $100,000 or less. If you make $100,000, right now you’d owe $21,709. But under my proposal, you’d only owe $15,000.  At every level below that the savings is greater.

Let’s say you make $200,000. What is that second $100,000 paying for? An annual vacation? A four-bedroom house as opposed to a two or three bedroom? A NICE new car? A weekly night out with your significant other? Yes, yes, yes, yes, and more. Not to mention significant savings for retirement, your kid’s college funds, and even some long term asset and wealth building for your estate. Probably some significant charitable contributions as well. Now… we’re not into “rich bastards” territory by any stretch just yet, but we’re clearly beyond the middle-class lifestyle. We’re starting to get into luxury here, and that’s why I’d tax the last $100,000 at 35%. This is the top tier bracket now, and while it currently only applies to income over $373,000 currently, this proposal overall STILL results in a small net-savings for someone making $200,000. They’d owe $51,117 now and $50,000 under what I'm describing. Now, ABOVE that is where I’d start the actual increases.

And remember: At present, 35% is as high as we go. But I think we can justify go higher form here on out.

How about $400,000? What’s that last $200,000 paying for? In some case, just higher-end versions of was bought by the person in the next bracket down. But most of this is just being used (saved/invested) to generate more income. We’re way beyond necessity and well into wealth-building and luxury at this point. STILL not into “rich bastards” territory though! So, I’d tax that last $200,000 at 40%. We’re not revenue neutral anymore for this group but even at $400,000 their tax bill only goes from $117,644 to $130,000. That’s an increase in their effective tax rate of only 3%: from 29.4% to 32.5%. I’m sure they can weather this without it impacting their lifestyle. Remember: Most of this money is not even being spent. So it doesn’t even really support their lifestyle.

What about $800,000? Are people even SPEDNING that last $400,000? I can’t see on what. Mansions instead of houses? Limos instead of Cars? Screw these rich bastards. (LOL). 45% on these guys’ last $400,000. Even going this high, their effective tax rate is still only seeing a 6.5% increase, from 32.2% currently to 38.7% under mine. They’ll survive.

And from $800K to $1.6M? 50%. $1.6M to $3.2M? 55%, and so on… increasing the marginal rate by 5% for every doubling of the income bracket. You could max out at 50% for $3.2M on up rather than just $3.2M to $6.4M, but I don’t see why you have to. The people making this kind of money directly benefit from everyone else’s ability to spend (at their businesses) not the least of which includes the federal government. So if that’s what it takes to get rid of the National Debt? To tax Alex Rodriguez's last $13M at 75%? I don’t see what’s wrong with that. Everyone says that baseball players and CEO's make too much anyway.

In any case, everyone – liberals, conservative and everyone in between - can fight out where to place the brackets and what %’s to apply. That’s where the REAL debate should be. And I just threw out some numbers. To be honest I have NO IDEA if this would be revenue neutral, or a net increase or decrease overall. So whatever: fight it out.

BUT: The point remains that the more money you make, the less of it goes to actually support your standard of living. Thus the less you’ll miss it, and the less it will impact your spending decisions and thus the economy. Take 1% away from someone making $50K and they’ll reduce they’re spending by 1%. They’ll have to. And half of America doing that will hurt the economy even worse than that 1%, if you understand how the multiplier works. And worse yet, once the layoffs start, when companies don’t meet their revenue targets. OTOH, take 6% away from someone making $800,000? You’ll get a LOT more money per person, and they’ll never miss it. They weren’t going to spend it anyway! And it won’t affect their lives, or their children’s or their grandchildren’s one iota. And if you say otherwise, either they’re really being stupid with their money or they just have no appreciation of what they really have. (Think about this: the $490,000 they have left after taxes, assuming they don’t take a SINGLE deduction, which is ABSURD, still leaves them $40,833 per month - about what that median income earner currently makes in a YEAR, after taxes! It leaves them $9,423 per week, or $1,342 per DAY. You’d have a hard time spending THAT every day, even on a vacation in Paris. So, yeah: they can cope.

Two things to remember:

1) NO ONE wants to pay more in taxes.  This is meant as a fact-based, reality-based, principled argument not for taxing certain PEOPLE differently, but for taxing certain PORTIONS OF YOUR INCOME differently based on acknowledge that you need you first $50K more than you need you second, as so on...

2) ALL of the numbers I've quoted about assume that NO DEDUCTIONS are taken for Dependants, Mortgage Interests, Education and Medical Expenses, Retirement Savings, etc...  In reality NOBODY pays everything they would otherwise OWE and if they due they're either morons, or need to have someone else do their Tax Returns for them.  (Or buy TurboTax, like I do! LOL)   Nobody is in a situation in which they'll pay exactly what the owe according only to the brackets.  They'll pay less.  Every time.

Maybe I’ll put off health care another day or two to do a bit on CORPORATE taxation (to address “Abba the Cowpoke”) and maybe then talk about how else I’d change the tax code, if I had the absolute power to do so. This was fun. Thanks for reading.