Learing to Love Taxes

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Prerequisites

In all seriousness, if you can't do basic math, you shouldn't have an opinion on taxes. Part of the problem with tax policy is that the real policy is obscured by inflammatory rhetoric that's repeated by people who have no idea what they're talking about.

This isn't elitist. Unless someone has a learning disability, they can learn the math necessary to understand taxes, it's not hard. The requirement to understand math before talking about taxes is simply because tax collection and tax policy is all defined by math. If you don't understand math, you simply cannot understand the policy. It's impossible.

If you can't understand the policy, you shouldn't discuss the policy because your opinion is just noise at that point. If you want to parrot someone else's opinion because you trust them and you believe that person does understand the policy (sometimes a dangerous assumption), then be sure to get your quote right and make sure you attribute it to the source. Otherwise, you're essentially lying by claiming to understanding something and give weight to an opinion which you neither understand nor are adding anything to.

Checklist:

  • Do you know what 10% of $100 is?
  • Do you understand the term "weighted average"?
  • Bonus: not necessary, but good to know the difference between mean, median, and mode

Current Attitudes: US

No one likes taxes. For some, railing against taxes is a common past time activity. Googling "tax attitude" (2010-03-31), the first two hits are newspaper articles from 1987 and 1960. The first talks about the public's perception of "public officials at almost every level... in a tax and spend frenzy".[1] The second article looks at the causes of the general, acknowledged ill-will the populace feel towards taxes.[2]

The IRS's own survey[3] Finds that 13% of Americans think it's okay to cheat on your taxes (not "maximize return", but outright cheat). 87% non-cheaters may not be so bad, except that only 28% think tax cheats should be reported. Clearly, even among those who wouldn't personally do it, most don't think of tax cheating as anything like stealing, even though one could argue that a tax cheat steals from everyone.


Why don't we pay? Only 48% think that additional information from the IRS would help people file correct returns. So, most people think that most incorrect fillings are willful.[notes 1]

Who should pay? The survey further finds that people feel the IRS should be more lenient with lower income individuals and most strict with corporations.

Why should we pay? The biggest factor in honest reporting is "personal integrity" with 92% saying it's important. 95% think "[i]t is every American's civic duty to pay their fair share of taxes". Meaning that 5% or so feel that integrity and cheating are consistent... presumably because they're only correcting an unjust system.[notes 2]

As a final note, most people (70%+ depending on the specific question) felt the IRS was doing a good job and where satisfied with their IRS interactions.

Current Attitudes World Wide

Selling Taxes

This is me talking, but I find it hard to understand the general "taxes are bad" argument. We know what pre-tax civilization was like: it was terrible. Average life expectancy would be 30 or so, there'd be no healthcare, we'd literally be living in caves, and the standard of living would be 1% of what it is today.

This isn't to say that all taxes are good all the time, or that a particular tax might be too high, dysfunctional, unfair, etc. but the idea that taxes themselves are bad is ludicrous. Even thinking of taxes as a "necessary evil" is simply wrong. Taxes are literally how we fund civilization. You cannot reject taxes without rejecting civilization.[notes 3]

So if taxes are so great, why do we hate them? Well, remember that in other countries, they don't. Loathing taxes is not universal. I think this leaves us with two options.

First, the US government doesn't market it's programs very well. TODO

Second, the US government doesn't give us good value for our taxes. TODO

My Ideal World

Voluntary taxes.

Other Opinions

TODO: move this to debukning tax myths or something.

Claim: The Rich Pay More in Taxes

Essentially false, but the numbers depend on how you cut the pie.

In absolute terms, this is clearly true. It would be ludicrous if middle class earners taking in $60,000 a year paid less in dollars than million dollar earners. Sometimes this point is made by saying something like, "the top 1% pay more in taxes than the bottom 95%". This may sound shocking and unfair at first, but all it really means is that the top 1% are much, much richer than the bottom 95% and says as much about the disparity of wealth in this nation as it does about tax structure.

When used as more than trivia, the absolute comparisons are inherently disingenuous. For instance, it's not so surprising that the that the top 1% pay more in taxes than the bottom 95% if you also know and understand the implications that the median earner in the US takes in twice as much as the median earner. (TODO: reference discussion on that).

The only serious question is how much different earners pay relative to their income.

Googling "total income paid taxes" on 2010-03-31, I found about half the articles "debunking" the idea that a the middle class pay out a higher percentage of income into the tax system than the rich. The problem with all the first page results: they spoke exclusively about income tax. This clearly excludes sales tax--which is harshly retrogressive and clearly hits the poorest Americans hardest. Income tax also excludes Social Security, which is effectively retrogressive since you pay no SE tax on earnings over $106,800 (2010), and Medicare, which is a flat tax. By excluding these, you end up magnifying the effect of income tax.

"Income tax" refers to a particular tax, but it's only part of the tax you pay on your income. The only serous question is how much tax do you pay on your income?

An individual earning $60,000 a year pays 17.47% in income tax, but 15.3% in FICA taxes.[notes 4] So the effective tax, considering the 2009 standard deduction of $5,700, rate is 30.05%.[notes 5] That uses the standard deduction of $5,700 and a single exemption.

With no deductions, an individual earning $1,000,000 pays 32.77% in income taxes, but only 4.2% in FICA.[notes 6] The million dollar earner doesn't get the standard deduction, but almost surely itemizes so the 36.77% tax on income is only a starting point.

The bottom line: if the million dollar earner deducts $154,438.57 or more, hey pays less than the $60,000 earner. Otherwise, the million dollar earner pays more.[notes 7]

So the question is: does the average million dollar earner deduct $197,667 or more? Actually, the question is a little more complicated because the average million dollar earner is almost certainly "earning" a portion of their money from capital investments, which are taxed at a lower rate, lowering the deduction threshold. But even setting that aside, the best answer I have at the moment is this: if you're making $1M a year, it wouldn't be hard to deduct $190K if you wanted to. If you're not deducting that much, then you're probably not very savvy financially and may soon find yourself earning much less money any way.

I haven't found numbers on average deduction by income yet, but most millionaires should be deducting at least that much. I say "should" because as a million dollar earner, you really should be generating sufficient economic activity to have $190K in deductions. If not, then I guess we'd have to question "trickle down" economics as well!

Considering that the preceding discussion completely ignores sales tax, which is highly retrogressive, as well as capital gains tax, which is at most 28% and often much less, I find it very likely to the point of near certainty that the guy with a $1M income pays proportionally less in taxes than a guy earning $60K. Whether or not "the middle class" pays more or less in taxes would really depend on how you cut up your demographics.

The thrust of the "rich man's burden" argument is, however, misleading and cynically disingenuous. The trick of the whole thing is to look at numbers of "income tax" and exclude all other taxes. Even just including the income-based FICA taxes, which most people would correctly assume you're including when you talk about tax on income,[notes 8] it's hard to see how the top earners pay more. When you get to sales tax and capital gains effects, the general argument that the rich are somehow unduly burdened with taxes becomes even less plausible.

Even with billion dollar earners who pay close to the an effective 35% on regular income, the analysis is not clear. Proportionally more and more of one's income tends to come from capital gains the richer one gets, and capital gains are taxed relatively lightly. What's certain is that the rich in America are in no way especially burdened by taxes. At worst, some rich pay a little more in proportional taxes than middle class earners and it's certain that many pay proportionally less.

Notes

  1. ↑ I have to interject a personal note here. I want to minimize my tax burden, but I've always tried to file correct returns, even when I knew I could easily get away with fudges. As a small business owner with employees, 1099, personal loans, and rental property, I know for a fact that accidental mistakes are not only possible, but virtually guaranteed. The 1040EZ filer is severely underestimating the complexity of tax filing. My biggest mistake I ever made was caused by bad advice from a tax filing company that was confirmed by the IRS. Even the professionals and the IRS don't always know what they're doing.
  2. ↑ Obviously the direct personal benefit and the fact that everyone else pays for these "corrections" calls into question these lofty motives.
  3. ↑ Some argue, and I would agree, that coercive tax is not necessary, so if you define tax as inherently coercive, then yes, we it is possible to have a civilization without taxes. However, that civilization would still have voluntary payments to a central civic organization that functioned as government. To me, that sounds like a voluntary tax. Whatever you want to call it, the distinction is lexical, not functional.
  4. ↑ The idea that "the employer" pays half this tax is ludicrous. That money has to come from somewhere and it's coming from the employee's pay. It's more realistic to think of half the tax as hidden.
  5. ↑ (($60,000 - $5,700 standard deduction - $3,650 single exemption) * 17.47% average income tax + $60,000 * 15.3%)/$60,000 = 30.05%
  6. ↑ (106,800 (SE wage base limit) * 12.4% (SE Tax) + 1,000,000 * 2.9% (Medicare)) / 1,000,000 = 4.2% effective tax rate.
  7. ↑ 31.57% - 4.2% = 25.85%, which is the rate income tax rate, not including FICA taxes, the million dollar earner would have to pay to end up with a lower effective rate. $1,000,000 * 25.85% = $258,500. The total tax for everything up to the top bracket of 35% at $372,950 totals $108,216. Thefore $1,000,000 - ($273,700 - $108,216)/.35 + $372,950) = $197,667.57. Feeding the $802,332 back into the online tax calculator, we indeed get $273,700, confirming we have the correct answer.
  8. ↑ I would expect most readers don't make a distinction between "income tax" and "tax on income". Nor should they, it's a trick the writer's using not a mistake on the reader's part.

References

  1. ↑ [http://news.google.com/newspapers?nid=1291&dat=19870804&id=-CgQAAAAIBAJ&sjid=f40DAAAAIBAJ&pg=2673,750809 Boca Raton News, August 4th, 1987. Quotation from paper's editor, quoted in rebuttal article "Tax attitude survey questions need to be asked"
  2. ↑ Eugene Register-Guard, November 18, 1960. "Federal Plan Blamed for Tax Attitude"
  3. ↑ IRS Oversight Board 2009 Taxpayer Attitude Survey; completed Feb 2010, just a month ago, what a get!

General references used throughout article and for background:

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