Wednesday, October 24, 2012

The Wealthy Pay the Exact Same in Federal Income Taxes as Everyone Else

I'd like to propose a change in an argument I've seen online a great deal.  I've been seeing this argument in one form or another for the past 15 years (at least since Steve Forbes ran for President in 2000).  The idea is that a flat tax would be a fairer system of taxation because currently the rich pay a higher percentage of their income than the poor or middle class.

What this argument totally ignores is the fact that the rich actually pay a higher marginal tax rate.  However, they pay exactly the same rate as a poor or middle class person for the same income.  For example, a single person with no dependents, up to the first $8700 in income has a tax rate of 10%, no matter how much subsequent income they earn, for income between $8700 and $35k everyone has an income tax rate of 15%, and so on, until you reach the top tax bracket and currently pay a 35% federal income tax rate.  One of the big issues is that most citizens truly do not understand marginal tax rates.  They believe, incorrectly, that if you are in the top tax bracket you pay 35% on all of your income.

Also, I'd argue that the lower income is more important to the taxpayer, that it makes sense the rates go up.  One way to look at this is to calculate the opposite of one's Return on Investment for these different groups of individuals or families.  A rich family will clearly save more and spend a lower percentage of their income than a poor one (note:  there are always exceptions).  Therefore, the money at higher income levels is not as valued as the money at lower levels, and to match the value, should be taxed at a higher rate.  BTW, yes, I know I'm reaching here; but that's the beauty of having one's own blog to write down your thoughts.

Caveat: This totally ignores looking at standard deductions as well as other deductions for which people are eligible.  This will be a big issue if Romney is elected, because he has stated publicly that he will eliminate many of these deductions in order to reduce overall rates; however, I did not include deductions for simplicity.  However, since the deductions are taken off the top level income, if you have enough you can drop your marginal tax rate below the $85k pretty easily depending on your income.

The other point that is missed in whether the rich are overtaxed, is the fact that we are currently near historical lows for the rich in terms of their marginal tax rates.  In fact, this guy ran the numbers and determined that:
 if you want to maximize growth, the top rate should be raised to about 64% and the tax burden on folks at the lower end of the income scale should be lowered.
Now before you say, but 50% of people pay no income taxes, the lower end rates in the analysis also included other taxes like Social Security and Medicare which are regressive taxes taken out of your paychecks as FICA.  Why is this important, because one of the main taxes the GOP has tried to raise is the FICA tax rate which was reduced as part of the stimulus package that Obama in the beginning of his first term.

So, when someone tells you that the rich already pay their fare share of taxes, you can tell them, they paid the exact same amount as everyone else.

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