Marginal Tax Rates 101

With all the current hysterical coverage of the impending "Fiscal Cliff" - or "Obama Tax Storm," depending on who you're listening to - and seeing what certain of my friends and associates are saying or posting online about it, it is unbearably clear that most Americans haven't the faintest idea of how marginal tax rates work.

It's not their fault. Politicians and the media have been talking down to us and "simplifying" the discussion for so long, that they'd have you believe things that simply are not true. For example, you may accept as "fact" that President Obama and Congressional Democrats want to raise the tax rate on those who earn more than $250,000 from 35% to 39.6%.

Using that statement and some basic arithmetic, you would assume that a family with $251,000 in income would see their taxes rise from $87,850 (35% of $251,000) to $99,396 (39.6% of $251,000) - a total tax increase of $11,546. You would also be wrong.

The statement "President Obama and Congressional Democrats want to raise the tax rate on those who earn more than $250,000 from 35% to 39.6%" contains three major "simplifications" that lead to these sloppy (and expensive) calcluations:

1. Uses "earnings" (implying total gross salary) instead of "taxable income" (after all deductions, adjustments, and exemptions).
2. Implies that you pay a single rate on all your earnings, instead of explaining how marginal rates apply.
3. Uses a $250,000 figure that is two decades out of date. That figure for the 2012 tax year is actually $388,350.

Let's take these one at a time...

Earnings versus Taxable Income: Nobody, but Nobody, pays income tax on 100% of their income. Each version of the IRS form 1040, from the one-page EZ to the more complicated versions with dozens of attached schedules and sub-forms allows you to reduce the amount of income on which you owe taxes. Frankly, the more complicated a form you use, the more you are reducing your tax liability.

But even a single guy, just starting out, with no dependents, educational expenses, mortgage, or anything else to deduct, just using little old form 1040EZ, will take a standard deduction of $5,950 for 2012. That means, if he earns $30,000, he'll only pay taxes on $24,050. That tax will come out to $3,173, or about 10.5% of his gross income, or 13.2% of his taxable income, even though he's in the 15% tax bracket.

What's that? You don't get how somebody in the 15% tax bracket only pays 10.5% in taxes? Let's move on to that second "simplification" ...

Marginal Rates apply to earnings above the margin: When politicians talk about raising the rate on "incomes above $250,000" (really: taxable income above $388,350), they only mean the increment, or margin, above that figure. It doesn't change the taxes paid on the first "$250,000" you earn ($388,350 taxable).

To explain, we'll build a more complicated example than our single guy above. Let's assume a couple with a nice home, two kids, and combined total salary income of $450,000. They're going to file jointly, so they'll look at Tax Rate Schedule Y-1. Their taxes will be:

• 10% on taxable income from $0 to $17,400, +
• 15% on income over $17,400 to $70,700, +
• 25% on income over $70,700 to $142,700, +
• 28% on income over $142,700 to $217,450, +
• 33% on income over $217,450 to $388,350, +
• 35% on taxable income over $388,350.

But, before they figure out their taxes, they'll itemize their deductions to reduce their gross actual income and find their net taxable income:

• Mortgage Interest: $16,500
• Two Kids ($3,800 each): $7,600
• Charitable Giving (1.5% of their income): $6,750
• Business Expenses: $7,500
• Miscellaneous: $3,500
• Total Deductions: $41,850

(This is a real simple example with modest deductions - I didn't include any medical expenses, educational expenses, deposits to retirement accounts, etc. - These are just a few of the ways to reduce your tax liability.)

So, using Schedule Y-1 above, here's what their federal income taxes will break down to:
-->

	Earnings	Tax
Deductions	$41,850	$0
10%	$17,400	$1,740
15%	$53,300	$7,995
25%	$72,000	$18,000
28%	$74,750	$20,930
33%	$170,900	$56,397
35%	$19,800	$6,930
Totals:	$450,000	$111,992

Their bottom line is $111,992, or 24.9% of their total income of $450,000 ... even though they're in the top 35% bracket.

Using the media/political simplification of all things numerical, we would have thought they were paying $157,500 in taxes (35% of $450,000). We would also assume that the Democrats' proposal to let the top rate return to 39.6% would increase their taxes by $20,700 to $178,200 (39.6% of $450,000).

But, now that you know how real math works, you know that raising the top marginal rate on this well-to-do family will bring their total federal income tax burden to $112,903. An increase of only $911 (0.2% of their total income) - quite a bit less than the $20,700 certain politicians and journalists would suggest. Because, now you understand, the rate change from 35 to 39.6% only applies above the margin, to that last $19,800 of their taxable income.

So, where's  $250,000 in all this? When President Clinton's tax increases created the 39.6% rate twenty years ago, it was for taxable income over that figure. And, because politicians and journalists are lazy, they've just continued referring to that number ever since (if you don't like "lazy" please come up with a better explanation that doesn't include "lie"). But the cut-off point for each of the tax brackets actually adjusts each year for inflation.

By 2003, when the Bush tax cuts were going into effect, "$250,000" was $311,950, but we kept saying "$250,000" out of habit. During the 2010 "Fiscal Cliff" discussions, "$250,000" was $373,650. Today, it's $388,350. Is that really so hard for reporters and politicians to understand? Never mind...

But aren't we Taxed Enough Already? The Tea Partiers are both wrong and right on this. Regarding federal income tax rates they are completely wrong. Current federal income tax rates are at their lowest point in over 60 years. And, yes, because the base line for each marginal rate has gone up at least as fast as inflation (why $250,000 is now $388,350), that means this year's tax burden is less than last year's.

But, in part because federal income taxes have been held at historically low levels for a decade, other taxes and fees have gone up. States, not getting as much as they used to from the feds, may have increased their income, property, or sales taxes, as well as made cuts. Counties and cities, not getting what they used to from the states, may have raised local sales taxes or passed "special assessments" added on to property tax bills, and/or made cuts in services. Across the board, fees for everything from parking to getting married etc., may have increased to make up for shortfalls from another area.

Because sales taxes, use fees, etc., are not progressive, like the federal income tax (multi-tiered, the rich pay a higher rate), the burden of these taxes falls more on lower and middle income earners. So, depending on where you live, what you earn, and a few other factors, you may indeed feel as if you're paying more in taxes over-all, even with a smaller annual bill from the IRS.

Bottom Line: You probably know where I stand on this. I don't believe it's asking too much of a family that earns nearly half-a-million dollars annually to kick in another grand in taxes when the country faces a fiscal crisis. To insist on holding even this top rate down will only result in more cuts in services and/or increased taxes and fees elsewhere down the line.

But regardless of whether or not you agree with me on the politics, can we all at least agree to use real numbers and real math?

For more fun with tax brackets, this page on moneychimp.com has an easy, interactive tax calculator that allows you to see how all of this works and check your tax rates across time and space.

The Occupation is Over: Long Live the Occupation

News from Portland is that the parks have been cleared of all OWS protesters. Closer to home, efforts have been made in Oakland and Santa Cruz to end, or severely curtail, the extent of encampments and daily protests. In the online world it is in current fashion to write Occupy Obituaries, with a general theme of "enough is enough," repeating some popular myths about the movement, and be done with all this protesting nonsense before the holiday shopping season. So, here's my attempt at summing up a few points.

1 - "Enough Already" - Of course, the far right, tea party crowd never supported OWS, but this last week I've seen many posts from people who describe themselves as (at least somewhat) liberal echoing that they're bored of OWS, sick of seeing/hearing about the protesters, worried about conditions in the camps (see #5), and "most important", concerned about the cost to the taxpayers for law enforcement and park clean-up.

While I understand and appreciate each of those concerns, none of them rises to the level where a repeal of the Bill of Rights seems to be necessary. There's nothing in the First Amendment that limits "the right of the people peaceably to assemble, and to petition the Government for a redress of grievances" only to when it's convenient for commuters, good for business, in the budget, or when it's sunny outside.

I've not been very active in OWS, but I have spent some time at Occupy Santa Cruz (attended a couple of General Assemblies, took part in protesting, brought food and supplies to the campers). I am also a tax payer and I protest because I pay more in federal taxes than General Electric, PG&E, Dupont, Wells Fargo, and Verizon ... combined.

Is there a cost to the taxpayer (me!) for exercising our right to free speech? Yes. Of course there is. Just as there is a huge cost for elections, multiple branches of government, etc. Democracy and freedom are far more expensive than dictatorship, and generally worth the investment. Freedom is not cost effective, but I'll take it anyway.

And I really don't care if you preface your posting with "I supported them for a while, but..." Whether or not the protests are well organized, whether they have fifty million or only a single supporter, whether or not you've reached the end of you're limited attention span doesn't much matter. Either you support freedom of speech or you don't. You don't get to pick and choose the voice, the time, or the place.

2 - "Get a Job!" - Much of the criticism from the right, that the bench-warmers on the left now seem to have accepted is that the occupiers are all unemployed, on the public dole, and just looking for a hand-out. I can't speak for other cities, but in talking to people at Occupy Santa Cruz I've been surprised by how many of the key people are employed full-time. And not just among the day-time protesters, but even those camping out are packing up at 6 AM, running home for a quick shower, and then going to work before returning the camp in the evening.

The occupiers I've spoken with include lawyers, high-tech engineers, and other "respectable" sorts. Yes, there are people there who are victims of the economic downturn, who have lost their jobs, homes, health care, etc., but they are not the total occupy population.

3 - "Get a Message" - As much as people are repeating the mainstream media's contention that the OWS protesters have no message, I find it hard to believe that there's anybody outside of Fox News who doesn't know that this is about economic injustice, from the ponzi scheme that led to the foreclosure crisis, to the bailing out of the very banks that profited from that ponzi scheme, to Congress' inaction on any comprehensive jobs bill, to the Supreme Court's declaration that corporations are people.

Considering the lack of centralized leadership (see #4) or the engagement of a national PR firm, there's remarkable unity in this message across all the occupations, and coordination of imagery/branding. Yes, there's other complaints being voiced, but the overall theme of economic injustice has been clear.

Others admit that the message is clear, but follow up quickly with, "Complaining is easy, give us solutions." I agree, it's easy to say the outhouse stinks, but tearing it down before installing modern plumbing is a bad idea. Looking back at that First Amendment again, however, I don't see that the right to petition the Government for a redress of grievances is limited to those who have ready solutions.

Meanwhile, looking at the signs of protesters I see that they are offering some ideas, whether required or not, including closing tax loopholes and ending corporate welfare, a Constitutional Amendment reversing the Citizens United decision, forgiveness of student loans, prosecution of those responsible for the foreclosure scandal, the passage of a comprehensive jobs bill, and much more.

(And, going back to #2 and the idea that the protesters are all just looking for something for nothing, the only one of the above demands that comes close to that is student loan forgiveness. Most of the protesters are willing to pay their fare share; they only want the same from the corporations and for their government to put people first.)

4 - "Get a Leader" - One of the most frustrating things for the mass media has been the lack of a single person, already in their contacts list, who they can call for comment. This "everybody's a leader" has been great in getting more people involved, amusing to watch the press attempt to navigate, as well as frustrating to those of us in General Assemblies who lack the patience to herd cats for even the most basic and simple decisions.

But beyond being a symbol of the desire for true democracy and consensus, the distributed leadership has been one of the messages of OWS. Distrust of leadership - any leadership - is such an inescapable symptom of our current global political crisis, that OWS protesters rejected any form of hierarchy, even when it would have benefited them.

The right also recognizes and feeds on this distrust of self-appointed leaders. The irony is that the Tea Party protests have been largely funded by the Koch Brothers, and that two of the largest Tea Party groups are suing each other over trademarks and (more vital and valuable) mailing lists. The right's answer to distrust of leaders has been pure astro-turf and deception.

As messy as some Occupy meetings have been, at least it was authentic. But, to move forward, the movement will have to develop some form of leadership, as distasteful as many may find that to be.

5 - "We're Concerned for their Health & Safety" - Yes, it's a concern when you have a few hundred people camping out with a couple of port-o-potties and no showers. But it's their choice. This "we have to clear them out for their own good" argument would have been more effective if the first several times I heard it wasn't from people who opposed health care reform and want to dismantle the EPA and OSHA.

There's much more to write about the Occupy movement, and I'm sure there will be ample opportunity to do so in the future. Yes, there have been problems with the way the occupations have been handled, some of which have kept me from becoming more personally involved, but on the whole I still believe they have been a good thing.

While many of the camps have been cleared for now, I don't believe this is over by a long shot. Lessons will be learned, leadership will be developed, and the people will not politely go inside and be quiet.

It Ain't Over Till It's Over

With yesterday's dramatic ending to the 2010 primary election season, starring anti-masturbation activist Christine O'Donnell winning the Delaware GOP Senate nomination, and racist-sexist email comedian Carl Paladino winning the New York GOP Gubernatorial nomination, each over the "official" Republican party candidates for those offices, today's headlines are mostly of the Tea Party Victories that are expected to sweep US politics into a new era of populist know-nothing-ism come November.

As much as I fear some of these far-right xenophobic dilettantes actually being elected, I think the story line of this being a warning of what's to come in 2012's presidential race is a bit overblown.

Here's what the pundits are going off of:

• The president's party, historically, "always" looses seats in the first mid-term election.
• The majority party, historically, "always" looses seats when the economy is down.
• Trust in Washington is at "historic lows" (they say this, but I haven't actually seen polls going back very far to demonstrate just how historic these lows are).
• Turn-out in Republican primaries this year has been higher than in Democratic ones.

But let's look at things in the proper perspective.

• Despite the handful of high profile nut-cases winning Tea/Republican Party nominations this season, over 95% of Congressional incumbents seeking reelection won their primaries.
• Of course Republican primaries had higher turn-outs: they were the ones being contested by the Tea Party wing-nuts. Most of the Democrats had little serious competition to draw out voters.

And here's the big kicker of why 2010 does not guarantee a Tea Party Victory in 2012:

• They're winning this year by bringing out lots of first-time voters, and if there's one more "historically, always" we can add to our list, it's that first-time voters are typically one-time voters.

Yes, the Republicans will pick up several seats in Congress seven weeks from now, perhaps even capture a slim majority of one of the houses. And, yes, there will likely be some fresh new tea-stained faces among them. And, yes, they will cause plenty of trouble for the president. And, just as certainly, they will fail to completely destroy Washington.

While they will certainly have some successes, they will fail to eliminate the IRS, Social Security, and the Department of Education. They will not end the debate over gay marriage, put a stop to legal abortion, and effect the deportation of every Muslim and Latino. And when they fail to achieve all their goals (remember, it's all or nothing for these guys), their followers will turn on them and crawl back under the rocks where they've been hiding all along.

The Tea Party Movement may be big news today, but most polls show that they only represent about 19% of the electorate. If they're the only ones who show up on election day, they can win. But they cannot put together enough of a majority to govern. And I predict that these political neophytes will not have the stamina or the momentum to put Sarah Palin (or similar) in the White House in 2012.

At least, this is what I keep telling myself in order to get to sleep at night.