Since the White House finally got around to announcing the outlines of their tax reform plan today, I want to briefly address an issue that’s generally ignored in discussions of income tax rates and brackets.
Marginal tax rates mean you pay taxes at lots of different rates
You often hear as shorthand that “the wealthy pay a 40% income tax.” That’s exactly wrong: the wealthiest Americans pay a 39.6% marginal income tax rate. If a single person reports a taxable income of $418,401 in earned income, they pay a 39.6% income tax…on exactly one dollar.
On the first $470,700 in taxable income, the person pays 10% on $9,325, 15% on $28,625, 25% on $53,950, 28% on $99,750, 33% on $225,050, and 35% on $1,700. Only after paying all those tax rates does our single taxpayer begin to pay 39.6% on additional dollars of income.
Tax cuts disproportionately benefit people who fill up each tax bracket
Let’s say that we decide the middle class is working longer hours for less pay and that the solution is a tax cut for hardworking middle class families (insert gagging sound effect here). $50,000 in taxable income seems like a good place to target our middle class tax cut, since that would imply about $60,400 in earned income, a solidly middle-class income. $50,000 in taxable income falls in the 25% tax bracket, so what happens when we cut the 25% marginal tax rate all the way down to 15%?
Our solidly middle-class taxpayer saves $1,205 in federal income taxes: 10% of the amount of taxable income in excess of $37,950.
Meanwhile, how much would someone making $100 million in earned income save? They’d pay $5,395 less in federal income taxes, 10% of the entire $53,950 bucket of earned income.
And remember, this is the outcome of a federal income tax cut narrowly focused on middle-class taxpayers.
But in this day and age, who can survive on $50,000 in taxable income? Let’s raise the threshold for our narrowly focused middle-class tax cut all the way to $100,000, which puts our single middle-class taxpayer in the 28% tax bracket, and we’ll cut the 28% tax bracket down to 15% as well.
Now our solidly middle-class taxpayer gets to save the entire $5,395 in federal taxes our titan of industry saves, plus an extra $1,053: 13% of her taxable income in excess of $91,900.
But sure enough, our hedge fund manager wins again, saving $12,967 (13% of $99,750) plus the $5,395 saved in the lower bracket.
So much for narrow focus.
The only way to narrowly focus a middle-class tax cut is to raise marginal tax rates on higher incomes
This is a mechanical outcome of the nature of a system of progressive marginal income tax rates, and there’s nothing that can be “done” about the savings the wealthy get from cuts to marginal tax rates in the lower income tax brackets.
On the other hand, there’s no secret to “narrowly focusing” a tax cut on the working or middle classes: you recoup the money saved by high earners through higher marginal income tax rates on the upper brackets.
To recoup the $5,395 saved by high-income taxpayers by cutting the 25% rate to 15%, you can raise the 33% bracket by 2.4%. To recoup the $12,967 saved by lowering the 28% bracket to 15%, you could raise the 33% bracket by 5.8%.
Note that this would still constitute a net federal income tax cut on everyone with taxable income up to $416,700, since only at that point will the entire tax savings in the lower brackets be recouped.
The idiocy of an “across the board” tax cut
To be clear, I’m not in favor of any of the above proposals because I don’t think our middle class is suffering under the cruel yoke of an expropriating tax code. But even if you think taxes should be lower, even if it’s out of pure greed, you have to understand that the wealthy receive a federal income tax cut when tax rates on lower incomes are lowered, even if the marginal tax rate on higher incomes is unchanged.
You do not need an “across the board” in order to cut everyone’s taxes. Cuts exclusively to the marginal tax rates of lower tax brackets not only benefit high-income taxpayers, they disproportionately benefit high-income taxpayers.
You know, you’re really bright, if you would just put your talents toward earning money vs gaming the system, then the government would have 0.0001% more to offset lower income folks with… have you considered putting your talents toward making more money in the name of all those who may lack such talents and need that extra little help? (Note this is said tongue in cheek).
Examining the distribution of a levy on people is certainly made more challenging by the crude approaches we take in applying the taxes. A fine analysis, and glad to have you point this out — it is worth observing that tax cuts on the lower classes still benefit the rich.
As usual, I’m more suspect of your conclusions and the “what do we do about it” factor, and it is also unfortunate that you’ve ignored the significance of the marginal tax rate, which does transcend the net or effective tax collected in terms of incentives and time investments made – albeit, not immediately connected to the total collection by the government.
In any case, is there still not some progressive version of a tiered flat tax, wherein all the gaming, deductions, and loopholes can be removed, and the rich can be taxed at a higher net rate — and wherein the disincentives the poor have are removed?
ed,
To your last point, I hope and pray that we get to the point someday when everybody just adds up their income for the year from all sources and pays a progressive income tax on it. I oppose every proposal that gets us farther from that point and support every proposal that gets us closer to it (for example, I’ve said nice things about Paul Ryan’s “tax postcard”, even though it leaves in two of the worst deductions, for mortgage interest and charitable contributions).
—Indy
So weird that tax cuts go to people who pay the most in taxes? Is this an Onion article or something? I love all the do gooders always wanna raise taxes on the people with higher income than they have.
SumOfAll,
This article is about the “do-gooders” that want to cut taxes on the middle class without realizing that such cuts overwhelmingly benefit the wealthy.
—Indy
Most in the middle class pay little in Federal Income Taxes. Most of the cuts to taxes will go to those who actually pay them which happen to be the wealthy. You know the ones paying most of the taxes.
SumOfAll,
You’ve hit the nail squarely on the head, that is the precise point of this post: don’t trust politicians bearing “middle class tax cuts” since they will overwhelmingly benefit the wealthy, not the middle class. You’re free to think the wealthy should pay lower taxes (I don’t) but policy shouldn’t be sold to the American people with lies.
—Indy
hey, we agree on something. I never thought I’d jive up with a lefty.
This is why I support a flat tax. If we taxed everyone the same % rate then it would be fair. Well except that those evil rich people would pay a bigger amount at the same % of course.
DaninMCI,
The problem with a flat tax is that in order to raise enough revenue, the rate would would have to be so high that low-earning people were taxed into desperate poverty. If the tax were low enough that low-earning people could survive on what’s left, far too little revenue would be raised to finance the state. The solution, as we know, is to tax low-earning people at a lower tax rate than high-earning people, thereby raising enough revenue to finance the state but raising it from those who are able to pay it without being forced into poverty.
—Indy
You can’t do much for people who pay no taxes! Remember it is their money in the first place, just allowing people to keep more of their own money. Which hopefully they will spend to finally get the gdp above 2%. So sick of the financial success hatred on the left
I really wish Trump will follow up with ALL of his campaign promises even though I am a lifelong Democrat (even if Jesus comes and asks me to vote for a Republican against a dead Democrat, I will still vote for a Democrat). The reason is that then people will realize how they got a con-man impersonating a President in the WH who only wants to protect his “own” wealth with abolishing Estate tax and LLC passthrough rates and for his Hedge find friends! Those Middle Class and Lower Class people who voted, will get a rude awakening in few years when they look back!
you sound like a typical hateful angry leftist using scare tactics and fear mongering. Well done lifetime lefty. Make sure to pass on your hate of people with means to those kiddoes!