Even though the 2012 Presidential election is still months away it will be on top of us before we know it. So far I haven’t seen a candidate that I would vote for and it looks like I will be writing in Mickey Mouse and Donald Duck. Lately I have become cynical of today’s career politicians and the one issue that I wish they would just drop is taxes, because it is a dead issue. Neither side of the issue seems to have a clue about how taxes work. While it is true that some wealthy Americans actually pay less taxes than some middle class Americans, simply raising taxes on the rich will do very little to change this fact.
How it really works
To understand how the rich end up paying less taxes than the middle class you must understand how taxes are calculated. Probably the first thing that needs to be understood is that a person’s income has very little to due with what they owe in taxes. You see income taxes are calculated not from gross income but from a much lower amount called taxable income. This is the strategy the rich employ to bring their taxable income as low as possible. Every possible deduction is taken with the ultimate goal of bringing one’s taxable income to zero.
Kind of makes you angry doesn’t it? Well rest assured that this strategy is available to the common folk and is not reserved exclusively for the rich. But how to do this is beyond the scope of this article, suffice it to say though, it isn’t rocket science.
Once the first strategy has been employed the next step is to calculate the tax owed. For a taxable income of 100 thousand dollars or less we simply refer to the tax table provided by the instructions for the 1040 form. You might think that just because one’s taxable income is higher that their tax rate is higher than those with a lower taxable income.
While this is true in principle the amount of taxes owed is not a much as you might think. Just because a taxpayer’s tax rate is say 30 percent they won’t pay a flat 30 percent of their taxable income. Let me explain.
The scenario
For simplicity we will have only three tax brackets and only one filing status with three taxpayers each in a different bracket. Taxpayer one, has a taxable income of 20 thousand dollars and is in the 10 percent bracket. Taxpayer two, has a taxable income of 50 thousand dollars and is in the 20 percent bracket. Finally taxpayer three has a taxable income of 250 thousand dollars and is in the highest bracket of 30 percent.
In a perfect world the tax for each tax payer are as follows, 2 thousand, 10 thousand and 75 thousand dollars respectively. But in reality it is closer to 2 thousand, 7 thousand and 62 thousand dollars respectively.
Doing the math
Believe it or not I didn’t just pull those numbers out of thin air so here is how the math works. Since taxpayer one is in the first tax bracket he/she pays a flat rate of 10 percent on his/her taxable income. Taxpayer two is in the next bracket at 20 percent, and for purposes of this example the cut off for the next bracket is 30 thousand dollars.
The difference between 50 thousand and 30 thousand is 20 thousand dollars so taxpayer two will pay 10 percent of 30 thousand dollars which is 3 thousand dollars plus 20 percent of 20 thousand dollars which is 4 thousand dollars, 3 thousand plus 4 thousand is 7 thousand.
I set the cutoff for the last bracket at 100 thousand dollars so we take 30 thousand from 100 thousand to get 70 thousand. 20 percent of 70 thousand is 14 thousand add the 3 thousand from before (10 percent of 30 thousand) and you get 17 thousand.
Subtracting 100 thousand from 250 thousand we arrive at 150 thousand taxed at 30 percent which is 45 thousand. Now add 17 thousand to 45 thousand to get to 62 thousand dollars. If you are fairly good at math you might have deduced that the percentages if done at a flat rate works out to be 10, 14 and 24.8 percent respectively.
Conclusion
Once you understand how the income tax system works it is not hard to realize how useless it is to talk about taxing the rich. Even if the top bracket is 100 percent they still would pay less taxes than some middle class taxpayers. So unless and until the US tax code is literally burned and then rewritten, which by the way isn’t going to happen, all this hoopla about taxes is meaningless.
Oh, and here’s a news flash, the president has no power to levy or change any tax whatsoever. That power is specifically reserved for Congress.