Friday, November 30, 2012

Reason #265: Further Reading

Given that the big news story for the next month is almost certainly going to be the Bush tax cuts and the oncoming "fiscal cliff"--and given that this blog is called "Why I Enjoy Paying Taxes"--I figured now would be a good time to dig a bit into how federal income taxes actually work, and how they're applied.

Tax brackets, the ranges of income that dictate the tax rate you pay, were a fairly well-known thing even before their current spotlight. But what I, at least, didn't know until recently was how those rates are actually applied.

Number one: the Bush tax cuts don't involve tax rate manipulation so much as bracket manipulation. Rather than take the existing bracket arrangement (known as the rate schedule) and lower the rates associated with each bracket, they created a new rate schedule--causing all the existing brackets to shift.

This is especially important because of point number two: any given tax rate only applies to the specific range of income in its own bracket. In other words, if the bottom bracket involves a 10% tax rate on income up to 25 thousand dollars, after which the rate goes up to 15%, and you make, say, thirty thousand, you don't pay 15% on the entire thirty thousand, only the five thousand you made past the cutoff. Your first 25 thousand is still taxed at the 10% rate, and would be whether your total income was thirty thousand or thirty million.

Going back to the Bush tax cuts, what this means is that the actual bottom bracket, 15% up to about $36 thousand, stayed the same, but a 10% bracket was added underneath it for people making about nine thousand or less. There probably aren't a lot of people making less than nine thousand dollars a year, but for those who make, say, twenty thousand, it means that only about half their income ix taxed at 15%, and their overall tax rate comes to around 12.5%. Great, right? This is why everything above that bottom 15% is called a marginal tax rate--they only apply to the margins.

The problem with the Bush cuts, and the reason the Democrats are seeking to change them, is that all the higher brackets then shifted downwards instead of upwards, and the top bracket, 39.6%, disappeared entirely. This was helpful for everyone, really, but because there were never any tax brackets higher than $400 thousand, taking the people who make more than that from a 39.6% rate down to a 35% rate meant losing untold millions of dollars of revenue from mega-ultra-millionaires who were now being taxed according to the rules that has previously existed for people in the $200-400 thousand range.

Take a good look at the chart above this post--the dotted line is what the poorest Americans have paid in income tax over the last century; the solid red line is what the richest have paid. If Obama gets his way, the dotted line will stay where it is, and the red line will nudge back up to about 40%. Not only is that the same place is was in the late nineties, but it's ten percent less than it was in the early eighties, which itself was twenty percent less than it was in the seventies, which itself was twenty percent less than it was in the fifties.

That 90% fifties tax rate seems fucking insane until you understand how marginal rates work--all it was really saying is, there's a limit on the amount of money one person can reasonably need, and while you're free to make a hundred or a million times that limit if you can, you're damn well gonna put a greater-than-usual chunk of that money into the service of your nation. As far as I can tell, at the time, no one seemed all that unhappy to do so.

What changed?

Further Reading

Wikipedia - Rate schedule (federal income tax)

History of Federal Individual Income Bottom and Top Bracket Rates

2013 Federal Income Tax Brackets And Marginal Rates

Congressional Proposal Could Create ‘Bubble’ in Tax Code

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