Do You Know How Our Tax System Works?
By Justin Gardner | Related entries in Taxes
Yes, I’m genuinely asking.
Because after reading stories like this, I think a lot of people believe that tax brackets are things that you fall into and then ALL of your income is taxed at that rate.
This is obviously not true because that system wouldn’t make ANY sense, but ABC apparently found some wealthy people who think it does.
Here’s one such case…
A 63-year-old attorney based in Lafayette, La., who asked not to be named, told ABCNews.com that she plans to cut back on her business to get her annual income under the quarter million mark should the Obama tax plan be passed by Congress and become law. …“We are going to try to figure out how to make our income $249,999.00,” she said.
“We have to find a way out where we can make just what we need to just under the line so we can benefit from Obama’s tax plan,” she added. “Why kill yourself working if you’re going to give it all away to people who aren’t working as hard?”
The attorney says that in order to decrease her income she’ll have to let go of clients, some of whom she’s been counseling for more than a decade.
“This means I’ll have to tell some of my clients we can’t help them and being more selective in general about who we help,” she said. “I hate to do it.”
First, let’s just state the obvious…if this woman actually turns clients away she is remarkably dumb. Because all she’d be paying is another 3 cents on the dollar for the income she earns over $250K.
The math on this is easy. Let’s just say she makes an additional $250K and her total income is $500K. Do you know what she’s paying right now on that $250K? $90,000. Do you know what she’d be paying with the 3% hike? $97,500. So she’d have to pay another $7,500.
My challenge to you…ask the people you know if they understand how the progressive taxation system works. Seriously. Please ask folks. Because after asking a lot of people I know (and these are smart people) I found that at least 50% of them thought that tax brackets were things that ALL of your income fell into.
Long story short, we can no longer afford for people to be so uninformed about our tax system. Everybody should know how this stuff works and I hope you do your part to make sure that happens.
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March 3rd, 2009 at 3:50 pm
What they understand is their marginal return on labor for next-hour-worked and the labor/leisure tradeoff, that their hourly reward for each additional hour of labor will decline with each additional bracket reached. By your reasoning they should strive 24/7 until that reaches zero, until their next hour of labor is taxed at 100% and they’re essentially working for free. Uh uh. At some point they decide not to work additional hours for a progressively reduced per-hour reward.
Nor do those in upper income brackets right now have any faith at all that this would be the least of their new taxation problems. Am I the only one who remembers the 800-lb gorilla in the room? Namely, Obama’s campaign pledges to remove the cap on SS taxation? The pledge he later modified to “only” strike at those making over 250K? For the self-employed (and many if not most of those in those upper-income brackets are self-employed in some fashion) that’s another 12.4% of GROSS earnings, taken off the top before deductions.
Yes, increasing the top marginal rate on next-dollar income from 37.7% to 53.1% would indeed have a lot of people working a lot less once they approached or hit the caps. Like overtime in reverse–the more time you put in, the less you get paid per hour. What wouldn’t they love about that, whether it’s a 10% extra nick or a 40% one?
You can say that Obama hasn’t openly proposed to implement that SS cap recission since he reached his new office, but he sure proposed it while running for said office, it’s an article of faith among his faction and the Krugmanites (an overlapping set), and at this point few people in the upper brackets have any reason at all to trust him. He’s been using them as his favorite class-warfare punching bag since he reached the White House, and they have zero reason to think he won’t continue to do so in a very real and expensive way.
Additionally, upping the bracket just a bit makes those near that cusp more likely to get zapped by everyone’s least favorite government gouging, the AMT. And as the first few paras of the article make clear, for some it’s sheer objection to paying a higher rate just to (as they see it) give it away to the undeserving–they object to where the money would go just as much as they do the amounts, and they object to being targeted and reviled for being succesful. They’re well-off enough that they’re willing to be slightly less well-off rather than pay extra to Washington for the privilege of being demonized.
So no, I don’t think the people in the article are all that dim.
March 3rd, 2009 at 4:25 pm
First, nothing in the article implied that she didn’t understand the progressive tax system. It is as Tully described, the margin utility of labor that the progressive tax system comes with it. The last hour of the day is the hardest and the least profitable. So yes, the progressive tax system punishes productivity and this attorney is absolutely correct in weighing the cost-benefit of adding more clients.
March 3rd, 2009 at 5:37 pm
I somewhat see where Tully and J. Harden are coming from, but honestly when I read the story it sounds to me like those people are just trying to make a political point, not making a calculating cost vs. benefit decision. I can understand being a little less motivated to work hard, but being obsessed about getting under the 250 mark, to the last dollar, seems to be more politically motivated. But I do agree that it’s probably not due to ignorance of the tax system. Although I also agree with Justin that there are probably a lot of people who do misunderstand this.
However, the article mentioned that there is some legitimate confusion about how the reduced itemized deductions are going to work. I assume that will be worked out in a logical manner, but I can see some people being paranoid about how that might work.
March 3rd, 2009 at 8:11 pm
[...] people from all over to communicate. TBogg reveals a number of people who really need to talk to Justin Gardner (or anyone else who can explain, as Justin does, how the tax system really works). TBogg picks up [...]
March 3rd, 2009 at 8:28 pm
The article above isn’t the only case of people displaying this ignorance about how marginal tax rates work. I just wrote a post which quotes comments at Michelle Malkin’s blog and pointed out their need to read this post explaining the tax system. One of them even thinks they will lose everything over $250,000!
http://liberalvaluesblog.com/?p=7272
March 3rd, 2009 at 8:29 pm
I went and asked five college educated people and 2 of the 5 thought that all income was taxed at the higher rate or weren’t sure. I have to admit I was surprised by this and I think there needs to be some education on this.
However, I am not sure how many people really stop working or reduce hours just because they are being taxed an additional 3% on part of their income. Do we have people today who hit the the jump between 15% and 25% and say, well so much work working extra hours? Maybe we do, but I haven’t heard of them.
I would have loved if they had asked the attorney if she only added clients after to the Bush tax cuts.
March 3rd, 2009 at 10:07 pm
Tully, first off, please don’t pull this with me…
Wait, did I propose new tax brackets or did I explain how much these folk will be paying above $250K and question if they didn’t understand this given statements like “Why kill yourself working if you’re going to give it all away to people who aren’t working as hard?â€
And some part of you has to be a bit miffed by the notion that somebody thinks that just because they make more money means they’re working harder? How anybody can say that with a straight face after all of these CEOs have made millions by essentially running their companies into the ground baffles me. But hey, maybe that really is excruciatingly hard work.
Also Tully, talk about straw men. I count three in there (It could get to 100%! SS tax! AMT!), so all you’re doing is attempting to pour your own fears into people who said nothing about any of those things. Again, why even try to get away with this?
Listen, somebody who understands the tax brackets and is making $250K a year will not turn down a raise in their pay since it’s almost a 99% certainty that they’ll be working the exact same amount of hours. Because we both know what kinds of jobs pay that much. So that wonky labor/leisure, opportunity costs argument is bankrupt.
But I challenge you and Josh (and you too Mike) to ask 10 people the title of this post and see what their response is. And I trust you’ll all ask people who you don’t know if they know they answer or not. I predict 30% won’t know.
I leave you to it…
March 3rd, 2009 at 10:47 pm
I don’t disagree with you on general public ignorance of the tax code, I just don’t think this attoreny necessarily exhibited that.
As a general rule, yes, I believe that by working harder and being smarter one can and general does earn more in a free market. That has been my observation in business and the ethic that I was raised by. Sure, there are some bad apple executives, but you would toss the baby out with the bathwater.
March 3rd, 2009 at 11:19 pm
i remember public finance in grad school where explaining progressive tax took two class periods of repetition – so I can believe that most don’t understand…
March 3rd, 2009 at 11:23 pm
I see Justin beat me to it. The part of Tully’s post that he quoted represents why conservative economic arguments are so much crap in the body politic.
Tully, I’ve known you for years and I like you. But Justin is right about the field of strawmen that your post represents.
March 4th, 2009 at 7:01 am
Flat tax FTW. The current direction is leading us into a fiscal tailspin. And let the Obama apologists begin in 3…2…1…go!
March 4th, 2009 at 8:58 am
Tully, where ya been? Brian.
I agree with Tully that the costs for upper income folk could be substantial and that that there is no evidence that the person cited by Justin misunderstands how taxes.
But I also agree with whoever suggested that this has as much to do with political petulance as actual behavior. Sure, people might choose to be slightly less well off as a matter of principle, in order to avoid accruing income to the point where they tip into a new bracket. But will they really make that choice? Maybe a little.
The outright red herring is the sad “I’ll have to turn away people and they won’t be able to benefit from my help” line. With unemployment threatening to reach 1 in 10, I am confident that there are others around who can help them out. This person knows well that if they turn away work, the market will respond. If fact, those who turn away work might even foster an environment where their client base discovers that someone else can help them just as well for less money. Wouldn’t that be an oopsie.
And if in fact that person has skills so singular that no one else can help, then the market solution is to simply charge more for your services to preserve your income.
March 4th, 2009 at 10:13 am
Agreed it would be silly to try to manage your income to that level. The larger point of course is it’s not the time to take money out of the economy, whoever earns it. We also have to look at the impact overall on this. Sure they’re just raising the incremental rate over $250K, but they’re also raising the FICA tax limit, adding another 8% is it to all income over the current cap which is around $110K or so. They’re also reducing deductions. So the total tax impact can be somewhat significant.
The other question that this raises is what happens when this isn’t enough? Do we then do down to $200K, then $150K? I know all of this sounds like a lot of money to people who don’t make that much, but a lot of people in that range are simply not “rich”, they’re the suburban dwelling professionals, business owners and executives and as much as people don’t seem to like such successful people anymore, we have to remember who creates these jobs. I always chuckle when “bankers” or others get blamed for job or wealth losses – who created those jobs and that wealth in the first place?
I really hope we can move off this class warfare and us vs. them mentality. When more than half the people don’t pay taxes, the balance will tip irreversibly and it will become easier to legislatively extort money from the few remaining earners.
March 4th, 2009 at 11:23 am
Anyone who actually pushes a flat tax is either an elitist who wants to soak low-income workers, or an ignorant rube who has no idea how badly a flat tax would soak low-income workers.
Either way, the flat tax is merely another part of the conservative culture war strategy of redistributing wealth from the poor and middle class up to the wealthy.
March 4th, 2009 at 12:15 pm
I find it hard to believe anyone can debate that the attorney in the story *doesn’t* know how a progressive tax system works. How the heck do you explain this?!
“We are going to try to figure out how to make our income $249,999.00,”
It makes absolutely no sense in any other context. The individual is clearly clueless or is being deliberately so to make an inane political point.
March 4th, 2009 at 1:35 pm
The woman in the article sounds like she has been listening to Limbaugh and his ilk. She says “Why kill yourself working if you’re going to give it all away to people who aren’t working as hard?†A lawyer, working in air conditioned offices and probably going to 2 hour lunches. I am a blue collar worker who makes a fraction of her amount, and I can say with 100% certainty that she doesnt work harder than I do. This entitlement mentality is typical amongst the wealthy.
But hey, if higher taxes means fewer lawyers, then bring them on.
March 4th, 2009 at 2:56 pm
> As a general rule, yes, I believe that by working harder and being smarter
> one can and general does earn more in a free market.
The latter, possibly. Which is to say, I do believe that people who are naturally endowed with an IQ of 160 probably on average do do better than people who have an IQ of 100. (And no, I am not laying claim to an IQ of 160).
But work harder? Bullshit. I am an IT professional right now. I work 60 hour weeks, sometimes more. I am paid pretty well, all things considered. But I’ll tell you what, I would rather work 60 hour weeks at IT, as awful and grueling as that sometimes is, than work 40 hour weeks doing janitorial work in a factory, as I did way back when. Even if the pay was identical.
Janitorial work (and that’s just one example) is back-breaking, brain-numbing labor, labor which leaves you no energy left at the end of the day to do anything but have dinner, lie down for a while and watch TV, and then go to sleep. If you don’t get rest breaks and meal breaks and sick leave and so forth (which I didn’t… they were well out of compliance with regs even then) it’s a job which will ultimately destroy you, and then leave you jobless and homeless with no money, no pension, and no options.
Whenever I hear someone talking about how people who work harder make more money, I know that person has never worked any harder than I do right now, and probably not even that.
-fred
March 4th, 2009 at 3:14 pm
David G. — Every year, I and millions more like me, try to get our taxable adjusted income as low as we can possibily get it without red-flagging the IRS or doing anything illegal. That is all she is saying and I don’t blame her. Earnings and taxable adjusted income are not the same thing. I have never reduced earnings for tax purposes — although I can perfectly understand someone on the cusp of a higher tax bracket analyzing the economics of only marginally higher earnings. However, I have made capital expenditures and allocations (new computers, deposits in HSA, ect.)that were not necessary so that I could reduce my taxable adjusted income.
This is what people in business do…try to keep as much of their income as possible. Otherwise, it isn’t really called “business”– it is called “volunteering”. I guess you can call that an entitlement mentality — an entitlement to their own money.
March 4th, 2009 at 4:33 pm
Volunteering.
Wow.
*sighs*
March 4th, 2009 at 5:22 pm
One other thing, I now realize why many detractors think that these plans add up to socialism. Because anybody who would claim that a business is “volunteering” if they don’t do everything in their power to avoid paying taxes simply isn’t coming to the table with a workable economic point of view. And yet fiscal policy has been so distorted and twisted by the free market folks that this is where we’re at right now.
Case in point, I debated with Leslie Carbone on Twitter the other day when she agreed that Obama’s economic policies were “genocide of anyone who creates wealth.” She obviously defended it as an apt metaphor, but I think it demonstrates how bankrupt the rhetoric and logic of the right-wing is these days. A 3% tax increase is not akin to genocide, not even metaphorically. But there you have two conservatives tweeting away and patting each other on the back for making what they think is a good point about a miniscule tax increase.
Meanwhile, they take absolutely no responsibility for how their philosophy stripped away necessary market regulations and thus brought about a reality where banks that could overleverage themselves 30 to 1.
And yet these are the times we’re living in and so a course correction is needed. Because selfishness and greed aren’t the kinds of things you build a lasting prosperity on. Enter Obama, who argues that there can be a balance between capitalism and the public good. I hope he succeeds because we’ll all be better off for it if he does.
March 4th, 2009 at 5:38 pm
J. Harden,
I would agree with you except for the following statement from the article: “This means I’ll have to tell some of my clients we can’t help them…”
Turning away clients with money is not a typical tactic to reduce taxable adjusted income. Rather extreme. I agree with previous posts that the client’s comments are more political than financial.
Also, there are many instances where a manufacturer (or service provider) will reduce sale prices to gain more market share, ship more volume and increase overall revenue. It’s done all the time in consumer products. Higher volumes at less profit, but higher revenue. You can look at the client’s case as being similar. She can accept the business with a slightly reduced profit margin but increase her revenue. She chooses not to. By your definition, this standard product pricing method would be labeled volunteering simply because the profit margins have been reduced.
March 4th, 2009 at 6:58 pm
I agree with Mike A, and my previous comment (of course). The lawyers actions go way beyond just trying to lessen taxable income. She wants to reduce her real income, which is absurd unless she doesn’t understand the tax code as Justin said, or else, as I think is more likely, is trying to make a Limbaughesque political point. While it is possible that she is making a calculated cost vs. benefit decision, it sounds highly unlikely to me.
But what I think is even more interesting in this thread is the work vs. pay argument. I disagree with Fred that pay has nothing to do with how hard you work. I think the point that is missed is that you are not paid necessarily by how hard you are working now, but how hard you have worked to get were you are. IT professionals, doctors, lawyers, etc. have to go to college, and sometimes way beyond. I have friends who are medical students, and I wouldn’t wish that on my worst enemy. Many of them say that they would have chosen differently if they knew how hard it would be on them and their families, but feel that it is too late to switch now. And anyone who believes most lawyers take 2 hour lunches I don’t think knows any real lawyers. Most lawyers are not even close to rich, but yes, they are better off than a janitor who does not need any formal education to his job. So I believe that it’s true that, in general the harder you work the better off you are financially (now and/or in the future).
But (and this is a big “but”), while this is true in general, it is not always true on an individual level. Certainly there are things beyond our control that also effect our economic condition, the most obvious one being the economic status of your parents, which has a great impact on what kind of education you can get. While the argument is always, “you can make it if you work hard”, the truth is that some people have to work a lot harder than others because of circumstances beyond their control. The free market is a great system, but is based on the simplistic general assumption that your success is based only on factors that you can control. I believe in a mixed system where we have a free market, but try to help level the playing field for people who have obstacles that are not of their own making. This comment is already long enough. I’ve written more here.
March 4th, 2009 at 10:36 pm
The Market is God, Justin. All-knowing. All-wise. Ask any good libertarian or libertarian/Republican. Just don’t mention that pesky Second Commandment to the professed Christians among them.
March 4th, 2009 at 11:33 pm
From my observations of a lot of Obama supporters — they should probably shy away from accusing others of worshippening false gods and graven images, you know what I mean. That is what they call irony.
March 5th, 2009 at 6:04 am
Harden:
Tired of references to Obama worship. I chose one candidate over another, as most Americans did, based on a mix of criteria. Some analytical, some emotional, again same as most Americans. By continuing your false god references, you demean and minimize this decision and place it into the category of “stupid Americans”. This allows you to easily dismiss Obama voter pov’s as rational or relevant. The “irony” here is that this country has witnessed the elevation of Reagan to god-like status for…what….the last 20 years?
March 5th, 2009 at 8:58 am
Mike, I think JH’s reference to worship is pretty pqlatable given that just above JS has made reference to “the market is god.”
Indeed. Just as most reasonable folks who favor certain policy approaches arrived at such conclusions after lengthy study and a mix of criteria, and by choosing among the available approaches. I’m not sure how widespread the deification of Reagan spreads. I do know that mileage varies, and that folks who count themselves liberal bear deep resentment to the whole thing.
I think he was an important figure and in many respects a good influence on our nation at a momentus time in history, but certainly nothing like a a god. For what it’s worth, my curent expectation is that Obama seems poised to be the democratic Reagan unless our nation collapses. This drives conservatives just as batshit crazy as Reagan did to 80s liberals. Oh well.
March 5th, 2009 at 9:15 am
KK
Agreed….I voted for Reagan twice…and proud of it.
My frustration is the use of labels to negatively categorize an entire group of people, thereby diminishing their points of view, and abdicating the responsibility of the post owner to engage in a thoughtful discussion. I’ve come to appreciate these posts as being, for the most part, well-thought out and intelligent. Name-calling (labels) adds little value.
March 5th, 2009 at 1:36 pm
Sorry, Harden, but most of your posts only prove to me that I have no reason to care what your observations are. There are definitely people who voted for Obama who are really emotionally vested in him for some reason. I’m not one of them so your comment is meaningless when applied to me. My comment is aimed towards those people who think that the “free market” as they think of it is incapable of error. That it will automatically balance fix anything that goes wrong in it and doesn’t need any government interference in its functions. And their definition of interference basically includes most (if not all) regulations of any kind. Costs to actual human beings? Immaterial.
March 6th, 2009 at 8:47 am
Jim, why is it wrong for Harden to stereotype Obama supporters but Ok for you to stereotype fiscal conservatives?
March 13th, 2009 at 5:20 am
As I said, the economic arguments of the right-wing are bankrupt these days. Thanks for proving that by not addressing anything that I had to say and instead trying to push the “messiah” meme.
March 13th, 2009 at 8:29 am
What is there a time-delay for harping? Again, this idea that the economic dialectic of centralized planning versus the free-market is utterly bogus. Someone should inform Gary Becker, Albert Alesina, Robert Barro, Harald Uhlig, Luigi Zingales, Greg Mankiw, Keven Murphy, Eugene Fama and many, many others economist.
Look, you can try to pull the Gore tactic of declaring the argument “done” all you want, but just because you wish it so doesn’t necessary make it true. Furthermore, do you see the irony of Obama supporters complaining the “right” has already concluding the stimulus package a failure, while at the same time the “left” is claiming the stimulus and tax-hikes definitive will be a success?
I have an idea. You know, really good business form quantitative vision statements (with actual projected numbers) to determine success. So lets do that with the economy (you can pick the numbers) and if its a quantitative, measurable success then I will happily concede and drift happily forever into some state agency cubicle to collect a salary and pension.
You know, Justin, for someone that puts up all this pretense about civility and bipartisanship, ext. — you have pretty sharp elbows when someone hints at challenging your orthodoxy.
March 13th, 2009 at 12:40 pm
J,
Yes, let’s talk about Obama supporters.
No serious economist, politician, etc. is suggesting that capitalism needs to go away. Do they argue that deregulatory free market principles have failed us? Yes. Even Greenspan admits that.
Also, nobody is saying that vast government spending in perpetuity is sustainable. Some liberal economists are saying that the stimulus should be bigger, but not that this type of thing should replace supply and demand.
Nor do I see many people claiming definitely that the stimulus will be a success. They’re pointing to historical precedent that this works in short bursts. Also, Obama has talked pretty plainly that they’re going to try some ideas and if they don’t work, they’ll try something else. Again, I challenge you to find me a collection of serious people who are actually claiming what you’re accusing.
To answer your idea…
The Obama administration has put together real job and GDP growth projections and they’ve talked openly and honestly about them. I don’t know what else you’re looking for from a quantitative perspective. Maybe I’m missing something.
Also, I’m not suggesting that the argument is done. Far from it actually. But am I saying we should try something besides tax cuts? Absolutely. Ironically, it’s libertarian folks like you who have said this type of thing has never worked, will eventually end up taking away our freedoms, etc. But yes, I take particular exception to the framing that’s going on right now about “generational theft” and Carbone’s nonsensical thumbs up of the genocide comment. If that brings about sharper elbows than usual, so be it. Vigorous, respectful debate is completely in line with a site that’s much more moderate in it’s tone. How many other sites in the blogosphere can you go to, argue your point and not get kicked out? You seem to come back every single day, so I must be doing something right.
March 13th, 2009 at 1:21 pm
I am extremely impressed with your management & growth & branding of Donklephant. It has been interesting and fun to watch over the years. The government could not have done it better.
Allow me to pose an example of one of my problems with government intervention in the market…and please consider carefully: If I were from the Department of Bloggation (US government) and I offered you a $200,000.00 grant for Donklephant, but as a requirement for taking the money you could not post more the 5 negative posts about any signal politician in a year– Would you take the grant money? What if it was $300,000/$500,000/$1 million? What if the government paid you 50,000.00 to install an application on Donklephant, but it caused your readers’ computer to run slower when on the site? Would you take the grant? Certainly, a $50,000.00 to Donklephant will “stimulate” the economy, but it also might turn the website into a boring, malfunctioning peice of crap. I could not blame you for taking the grant money though, you have to do what is in your economic best interest — but I have seen with my own eyes, the distortive economic effect of government intervention lead to huge mal-investments by the public and the market.
Like I’ve said before, I hope it works out and we’re all fat, rich and happy in few years due to Washington’s injection of magic money. I’m just not banking on it.