Today I joined in a discussion on Facebook that was prompted by the following video:
Clearly this video is about the destructive effects of socialism on a personal drive to succeed. The Facebook discussion quickly devolved into the liberal folks screaming about how the rich need to pay their fair share of taxes, with the conservatives pointing out how they already are. An interesting discussion on the US Federal tax system ensued, and I learned a few things I thought would be interesting to share.
Marginal vs. Effective Tax Rates
I’m a self-proclaimed conservative nutjob, and I pay some attention to various media outlets with a conservative approach to politics. Something I’ve heard frequently regarding tax rates is that the tax rate on the top 1% and higher of earners in the country has been fantastically high historically – I’d heard figures of 75% or more. While this is factually accurate, this percentage has only been on the highest marginal rates. So, what is a marginal tax rate? I won’t claim to be an expert (I misunderstood this myself until today when I read up on the subject) but here is a simple analogy illustrating what’s going on:
I go to the store to buy 10 apples. Due to mystical pricing madness of the supermarket chain, they have decided that the first 3 apples I buy will only cost $0.10 each. The next 2 will each cost $0.22 each, the next 3 will jump in price to $0.45 each, and the last 2 will each cost $0.75. My total purchase price will wind up being $3.59 (ignoring sales tax for a moment), or an average of just under $0.36 per apple. The highest marginal cost of my apples were the last 2 that I bought at $0.75 each. The effective cost of each apple after the purchase is $0.36.
What the heck does this have to do with our tax system? The tax bracketing system in the US is set up so that the first $$ that you earn is taxed at one rate, then once you earn your way into the next higher tax bracket, the additional $$ you earn is taxed at a higher rate. This means that the dollars that you earn are not taxed evenly – some dollars are taxed higher than others. I suspect that most Americans misunderstand this and assume that once their income reaches into the next higher tax bracket, ALL their income is taxed at the higher rate. This is simply not true.
What is true is that it is impossible to determine an effective tax rate on any single class of earners or tax bracket, because it all depends on just how many dollars you have taxed at the different rates. 2 people in the same marginal tax rate will have a different effective tax rate because they didn’t earn exactly the same amount of money. (I’m completely ignoring deductions – they just further complicate things.) All the discussion and angst about tax rate changes is mostly irrelevant, because not only are the rates changed frequently, so are the brackets. These changes are made in an attempt to maximize total revenue into the federal coffers, and is also part of the reason why with lower tax rates and clever shifting of the boundaries of the brackets the government is able to realize higher revenues.
The IRS releases reports detailing the effective tax rates of all taxpayers broken down by various metrics. I have looked at these figures a bit, and have found that not only are the highest wage earners paying nearly all the taxes, over the last 30 years they are shouldering a higher and higher percent of the total tax burden. Don’t believe me? Stay tuned for some pretty graphs in my next post….