Monday, April 18, 2016

TAXES - Understand Tax Brackets

"Do YOU understand how tax brackets work???" by Brainwrap, Daily KOS 11/19/2012

Note: This is a repost of a diary of mine from about a year and a half ago; I was inspired to repost it by Jed's current diary, Prospect of earning more than $250,000 terrifies business owner, because Obama.

Basically, a HUGE part of the problem with trying to have any rational discussion about tax policy is that there's a huge number of people who don't have a basic understanding of what "marginal tax rates" are.

To put it simply, there's a whole lot of people out there, including some who are very intelligent and/or successful professional types, who believe that if their income nudges them over into the next-higher tax bracket by even $1.00, that this somehow means that the entire amount they owe in taxes goes up to that percentage.

This problem is disturbingly widespread.  It's not just Republicans/right-wingers/Tea Party people; there's a lot of Democrats/progressives/other left-leaning folks who apparently don't "grok" the concept either.

With that in mind--and at the risk of sounding patronizing--here's a very basic demonstration of the problem and the reality:

Here's a modified version of the current Federal Income Tax Brackets (I've rounded off the numbers to make it easier to follow):

Taxable Income Tax Rate
$0 - $10,000 10%
$10,000 - $30,000 15%
$30,000 - $80,000 25%
$80,000 - $200,000 28%
$200,000 - $400,000 33%
More than $400,000 35%

So, let's suppose that someone made $80,000 (taxable) last year, but makes $80,001 (taxable) this year.

(Note: I'm not even getting into deductions and all the other stuff; I'm just talking about the end-of-the-line taxable income for simplicity's sake)

The folks I'm talking about THINK that they paid 25% in taxes last year ($20,000), and they THINK that this year, because they made $1 more (pushing them into the 28% tax bracket) that they're going to owe 28% on everything ($22,400).

That is, they think that they owe an extra $2,400 in taxes even though they only made $1 more in income, and therefore are going to lose $2,399.

However, they're wrong about both what they owed last year AND what they'll owe this year.

Last year, they owed:

  • 10% on the first $10,000 = $1,000
  • 15% on the next $20,000 = $3,000
  • 25% on the next $50,000 = $12,500
  • = a grand total of $16,500 opposed to the $20,000 that they thought they owed.

This year, they'll owe:

  • 10% on the first $10,000 = $1,000
  • 15% on the next $20,000 = $3,000
  • 25% on the next $50,000 = $12,500
  • 28% on the next $1 = $0.28

= a grand total of $16,500.28

...or just $0.28 more than last year, not $2,400 more, and certainly not the $22,400 they thought they owed.

The same holds true at every level:  You're only paying the higher rate on any income ABOVE the threshold in question, not on EVERYTHING.

Hope this helps some folks when talking to others, and hope I didn't come off as a dick in doing so...

Addition:  Thanks to Addison in the comments for making this additional, very important point:

For those people who don't understand this, but aren't really affected by the marginal tax rate, you're not stupid, not dumb.  Not anymore than I'm dumb for not knowing how to fix an automatic transmission.  We all have our knowledge base, borne of experience.

But people who presume to speak as experts about business, who fail to understand something as relatively simple as marginal tax rates? That's like a farmer screaming at the president about dairy policy by talking about how the milk from the chickens he raises is taxed too much...

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