Tax Brackets Are A Fiction And Barely Apply To The Wealthy

Are there tax brackets? Absolutely. Do they apply to everyone? Technically, they do. Can the wealthy get around them?

What do you think?

I stumbled across a discussion on Twitter of what top tax rates might be reasonable and how much tax the wealthy should pay. The discussion was fine so far as it went, given the inherent brevity of tweets.

But tax brackets, besides a tool to implement—in the legal and economic sense— a progressive tax structure that increases taxes as someone’s income grows, often are a way for the wealthy and powerful to bamboozle everyone else.

Marginal rates

In my experience, most people, at least the ones I’ve communicated with and listened to, don’t understand marginal tax rates. How many times have you heard—or maybe said to yourself—“Oh, if I make a bit more money, I’ll get pushed into a higher tax bracket,” assuming that extra taxes would take more away from what was already earned?

Marginal rates are tax rates that apply only to specific intervals of income. In 2018 (it’ll be clear in a moment why we’ll look at that year), the Internal Revenue Service tax rates for a single individual were as follows:

The federal government taxes portions of your income at different rates. Someone making $103,214 a year would pay 10% on the first $9,524, 12% on the amount from $9,525 to $38,699 ($29,174 at 12%), 22% on the amount from $38,700 to $82,499 ($43,799 at 22%), and 24% on the balance from $82,500 to $103,214 ($20,714 at 24%).

That person making $103,214 isn’t paying 24%—their top bracket—on all their earnings. That top rate is on only part of the total. When you hear someone talk about raising the tax rate on the rich, what they generally mean (whether they realize it or not) is pushing up the top marginal rate.

It sounds as though some sense of justice could come to taxes. Those who benefit the most from the system and who can direct it, through influence that changes law, for their own benefit might pay in proportion to the benefits they accrue.

However, through tax loopholes, structures that favor capital gains (money made from investments), and favorable accounting treatments, people pay far less than you might think.

Real tax burdens

I mentioned 2018 before because that is the most recent year for which the IRS has released overall statistical data. Here are the income ranges, based on adjusted gross income, along with the taxable income for each, the taxes levied, and the resulting average tax rate per income range.

Based on 2018—the first year that reflects taxes after the so-called Tax Cuts and Jobs Act (really major tax cut legislation) Republicans pushed through in late 2017—taxpayers in the country paid an average 18.3% of their income in taxes. But that’s an average only. Individual experience varies widely.

All people making between $18,000 and $20,000 in 2018, to choose one category, collectively were at a 9.7% effective tax rate, which is the percentage of generated taxes divided by the group’s collective income. Because the IRS reports the numbers by returns, it’s impossible to tell how these totals break out by individuals, married couples filing together, married people filing separately, or some combination under the same household.

You might reasonably expect that taxes owed go up with income. We have a progressive tax system—to a point. Make between $75,000 and $100,000 and you’re in the category that pays 13% on average. At $200,000 to $500,000, the average effectively tax rate is at 19.7%.

Now allow your eye to wander up back to the first table. The marginal tax rate for sums over $500,000 a year is 37%. As the income grows beyond that, the portion of income taxed at lower rates becomes smaller, so you might expect the effective tax rate to approach 37%. Except, it never does.

The high point, 30.3%, is for those making between $2 million and $5 million. Then the average effective tax rate starts dropping again until, for all making $10 million a year or more, it 27.6%.

Not everyone at that level earns such amounts year in and out. Many might be selling a business they built over many decades. Some could have seen have a windfall.

Whatever the case, though, the wealthy find ways to lower their technical burden.

Results of influence

On the lowest end of that wealthiest group is the return showing “only” $10 million in income a year. Everything below $500,000 is supposed to be taxed at lower rates, leaving $9.5 million—95% of all the money they make—at the 37% tax rate. Even if everything under $500,000 was exempt from tax, the filers would on the hook for a 35.2% effective tax rate.

As income soars over that $10 million number, the portion coming under the 37% tax bracket you’d think would move beyond 95% and start approaching 100%.

And yet, according to IRS figures, for the wealthiest category of return, only 58.5% of the income is in the 37% tax rate.

The reason owes to all the ways the tax codes favor the wealthy. Get income from investments and suddenly the rates drop to between 15% and 28%, because that’s capital gains and Congress has decided to provide the wealthy with an incentive to invest their money. As though they wouldn’t invest it if taxes were higher.

Channel investment income through the kids, report it on your taxes, and the rate is 10%. Have a business and you can put family members on the payroll at much lower interest rates and then claim the salaries and perks as business expenses that reduce the taxes the business owes.

Or own parts of businesses that lose money on paper through accounting rules, if not in terms of cash, and you create losses to reduce your obligations even while your net worth expands.

To be fair, large portions of individual tax revenue do come from the wealthy. Returns for $500,000 and up do represent 25.5% of taxable income and 38.6% of all taxes. But what some argue as fair isn’t, really.

A person working a job and making $50,000 a year is in the category with the average effective tax rate of 12.1%. If that’s the tax they pay, which is significantly lower than the official 22% marginal rate, that leaves them with $43,950 to pay for everything. It’s $3,662.50 a month to cover housing, food, transportation, school loans if any, clothing, entertainment, health insurance premiums and deductibles, and everything else. What remains is the basis of savings for things like retirement.

At $10 million a year, the average effective rate of 27.6% leaves $7,240,000—$603,333.33 a month. The wealthy often cry poor but, really, how much of a burden is this 27.6%? The average lifetime earnings of a man with a bachelor’s degree is $2.19 million, according to the Social Security Administration. (For a woman, it’s $1.32 million, owing to the gender pay differential.) Within a third of a year, a person at $10 million annual income has already bested those lifetime earnings averages. The resources and possibilities are mind-numbing.

Double the total taxes for local, state, and who knows what else, and the amount left still tops $300,000 a month. Now it takes a full nine months to beat the average lifetime earnings of a college graduate. Brutal.

When listening to discussions about taxes, remember that even a progressive tax system and high marginal rates aren’t everything they appear to be.