Common Myths about Taxation

Random Banter:
Taxes suck, but aircraft carriers are expensive, so are police officers and roads.  Also, Team America: World Police is really expensive (To hire a guy like Gary--that's high 6 figures).  I know a lot gets mentioned about the poor "stealing"...yadda, blah, yadda, blah, but that is not that as big of a part of government budgets given the 4 decade run away from Keynesian economics, government intervention, and welfare.  Our safety net in the U.S. has consistently gotten worse through these 4 decades (1970-present).  You hear a lot from conservative politicians about how we need to make our safety net even crappier, with the implied notion that the welfare system is for blacks and hispanics.  In fact, my Civil Procedure professor likes to constantly complain that people think that welfare is a "black and brown problem".  However, its not, there are a lot of poor white people too who receive a lot of government benefits as Bill O'Reilly (the conservative talk show host who has sold out to the left) states, see here.

Here are two myths about taxes:
I know a lot of smart people and a lot of elitists and the vast majority of these people get these mistaken. 



1. The Estate Tax is paid by most people: The estate tax only effects rich people, very rich people.  It does not affect average people.  The GOP likes to frame this as a tax that everyone pays as a death tax -- but this is "hiding the ball" politics and not true.  There is a $5 million exemption from the tax.  That means you can pass off $5 million to your kids without incurring any federal tax burden, FIVE MILLION!!!!  Now, I'm not a sociologist but I bet that the vast majority of people don't have $5 million to pass on to their children.  Even in excess of this $5 million, the tax rate is not super high, it is a progressive, marginal rate between 18%-35%.  Remember that if you pass off $6 million to the kids, $5 million is not taxed, only the excess $1 million is taxed. 

Interesting note: There was a estate tax holiday in 2010 (meaning no federal estate tax at all).  George Steinbrenner, the owner of the Yankees, died in 2010 and his kids got really lucky.

How good the is GOP messaging on misguiding the public on the estate tax?  There was an episode of Raising Hope in which a neighbor of the main family, The Chances, of this story says to the family that if "MiMa" (the grandmother) died this year (referring to 2010), there would be no estate tax-implying a financial gain for the family.  The Chances are a working class family and not to be mean, but there is no way that MiMa has over $5 million to pass on to her kin.  The GOP has done such a good job tricking the public and Hollywood writers on the estate/"death" tax -- Good Job.  If I ever need favorable public relations, I'm hiring the firm in charge of this success.
 
2.  The Difference between Marginal and Average Tax Rates:  Lets say you make $500,000 dollars a year based on compensation from your labor (not capital gains).  Congratulations, you are super successful! You have an average accountant and average charitable donations.  Lets say you have $80,000 in deductions.  That means you have $420,000 in taxable income.  Let's say you are happily married (and your spouse is caring, patient, and hot).  Again, Congratulations!   Here are the tax brackets for 2011 for a Married couple.

Tax Brackets 2011            Married Filing Jointly     
10% Bracket                     $0 – $17,000                    
15% Bracket                     $17,000 – $69,000            
25% Bracket                     $69,000 – $139,350          
28% Bracket                     $139,350 – $212,300        
33% Bracket                     $212,300 – $379,150        
35% Bracket                     $379,150+

Here is your income tax liability: (10% x (17,000-0)) + (15% x (69,000-17,000)) + (25% x (139,350-69,000)) + (28% x (212,300-139,350)) + (33% x (379,150-212,300) + (35% x (420,000-379,150)) = 1,700 + 7,800 + 17,587.50 + 20,426 + 55,060.50 + 14,297.50 = $116,871.50

Here is what the GOP wants you to think:  you pay -- $500,000 x 35% = $175,000.  (1) one tax rate applied to all income, (2) no deductions when you think conceptually about income tax.

Notice the differences ($175,000-GOP propaganda vs. $116,871.50-actual).  You don't pay your marginal tax rate on all of your income, only on the income made in that bracket.  So when you reach a higher tax bracket, only the excess gets taxed at the higher rate.  Also, deductions help a lot.

How do I know that GOP is that effective at messaging?:  Let me refer you to that famous 2008 interaction between Barack Obama and Joe the Plumber.  They were discussing over Obama's proposal to increase the rate for the highest bracket from 35% to 39.6% (what it was in the 1990s-early 2000s), with the assumption that the highest bracket was $250k vs. $379k so that there would be a slightly higher tax on taxable income in excess of $250k (after deductions).  Joe the Plumber was concerned that if he bought a $250k-$275 revenue business it would not be profitable.  Please note that many small businesses file as individuals (sole proprietors and LLCs).  As soon as this was brought up in the debate between Obama and McCain, one of my conservative friends texted me: "why does the American Dream end at $250k?"

Here are a list of reasons why everyone involved misunderstood the tax code. 
1.  The federal income tax is on profits, not revenue.
2.  A $250k-$275k plumbing business has lots of business expenses that can be deducted (equipment, trucks, employee costs).  All of these costs are not included in taxable income.
3.  Only the excess of $250k in taxable income is taxed at a higher rate.  So in the fact pattern Joe the Plumber described, he would pay no additional tax under the Obama plan.
4.  Obama didn't know enough about the tax code to correct this series of reasoning errors and fumbled through an answer at the debate.
5.  As to my conservative friend's remark about the American Dream, I would say your dream would be pretty fickle if an additional 4.6% tax on all taxable income in excess of $250k affected your dream of making money in anyway.  There are so many people who make way more than $250,000 in taxable income, even when the top bracket rate was 39.6% and even higher in the past.  The American Dream isn't going anywhere.  I still want to be a part of the 1% and that won't change if the top tax bracket increased by 4.6%.

Needless to say, Joe the Plumber, my conservative friend, and Obama all misunderstood the tax code in the exact manner that the GOP wanted.  Again, I think the GOP media consultants are so good and if I ever got caught clubbing baby seals, I would want them to frame it as saving the seal population from mass starvation and saving the jobs of local fishermen.

It is also important to note that your tax liability is higher than this because of social security, medicare, and state and local income tax.

I've picked on (and complimented in a backhanded way) the GOP a lot on this post, so let me say some critical things about the Democrats.  These Democrats want to pick on the rich for everything and all of societies ills.  News flash, the rich are helping a lot more than they are hurting.  The Democrats also want to nickle and dime the rich at every taxable level.  There are so many millionaire's surtaxes that are proposed by Democrats on the rich.  What if the city, state, and federal government all have millionaire surtaxes?  That would not be cool.  I'm ok with one level of millionaire surtaxes, but not three or even two.

Let me emphasize that I am not necessarily pro-tax (cause they suck like Mitt Romney), I'm just pro-truth.