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Earlier today, I posted a diary  in which I lamented the fact that 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.

However, it wasn't until people started commenting that I began to realize how widespread this problem is. 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...


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Comment Preferences

    •  Lots of confusion here. (5+ / 0-)

      Peopel miss the "marginal" in marginal tax brackets.

      Hey, let's give the bully all our lunch money then he'll like us! He'll really, really like us!

      by nightsweat on Tue Jul 26, 2011 at 11:17:45 AM PDT

      [ Parent ]

      •  Great Diary... (1+ / 0-)
        Recommended by:

        Here's how I explained the concept of steeply progressive marginal tax rates in THE PROGRESSIVE INCOME TAX: Theoretical Foundations:

        Imagine that one year Bill Gates is the top income earner with a gross income of one billion dollars.  If all of that income were taxed at a 99% rate, he would be forced to somehow get by on 1% of a billion dollars, or $10,000,000.  Let's say that Paul Allen earns $800,000,000 in gross income that year and all of that income is taxed at a 98% rate.  This would leave him with $16,000,000 of disposable income.  Such a result would be extremely unfair because Bill would end up with less disposable income ($10,000,000) than Paul ($16, 000,000) after taxes even though he earned more than Paul in gross income.

        This kind of result does not occur, however, when you employ marginal tax rates, like we do now with our current tax code.  Let's say that in our imaginary scenario the first 800 million dollars of income is subject to a 98% marginal tax rate.  That means that both Paul and Bill would pay the same amount of taxes on the first $800,000,000 of their income.  But Bill would pay more in taxes than Paul because he made an extra $200,000,000 in income.  In a marginal income tax system, Bill would pay the 99% tax rate only on that extra $200,000,000.  This would leave him with $2,000,000 more in disposable income than Paul would end up with.

        What about within a tax bracket?  Well, if Warren Buffett grosses $900,000,000 the same year, he would also pay the same amount of taxes as the others did on the first 800 million dollars of their income.  He would also pay 99% on the extra $100,000,000 that he earned.  This would leave him with $1,000,000 more in disposable income than Paul ends up with, but with still $1,000,000 less than Bill ends up with.  The comparative bidding positions of all three men within the hierarchy of national income distribution would be preserved.

        Keep up the good work...
  •  Yeah, it's a very simple concept (14+ / 0-)

    but almost nobody seems to understand it. Basic, basic math.  On most of these tax increases that are being tossed around, you don't start seeing real money for a long ways after 250k in terms of additional taxes.

  •  You're forgetting deductions, though. (2+ / 0-)
    Recommended by:
    Brainwrap, lgmcp

    And don't forget that most people either use the tax table (which you're supposed to do) or fill it out electronically, in which case all they see is a number.

    We don't want our country back, we want our country FORWARD. --Eclectablog

    by Samer on Tue Jul 26, 2011 at 11:22:37 AM PDT

  •  Clear as Mud? (5+ / 0-)

    Also, someone that "made $80,000" last year pays tax on their "taxable income", not "what they made".

    So your nice clean examples need further explanation and caveats.

    Another problem is that many middle and lower income workers don't really know what their "gross earnings" are. Studies have shown (hah! all from my little ole memory) indicate many people think that they earn alot more than they actually do.

    Notice: This Comment © 2011 ROGNM

    by ROGNM on Tue Jul 26, 2011 at 11:24:13 AM PDT

  •  The way I like to explain it is to say... (13+ / 0-)

    "Everybody's tax rate is the same. Your first 10k of income and my first 10k of income and Bill Gates' first 10k of income is all taxed at the same rate."

    It's sad that a lot of people here aren't aware of this. But I no longer find things like this surprising. A whole lot of people have started displaying a whole lot of ignorance about a whole lot of things over the past couple of years.

    I'm a concert pianist with a double doctorate... AND YOU CAN BE TOO!

    by kenlac on Tue Jul 26, 2011 at 11:24:24 AM PDT

  •  good basic explanation (1+ / 0-)
    Recommended by:

    even though I gulped at the rounding off. By memory....
    15% to 34.5k

    lastly 170k to 379k

    FDR 9-23-33, "If we cannot do this one way, we will do it another way. But do it we will.

    by Roger Fox on Tue Jul 26, 2011 at 11:30:17 AM PDT

  •  Rich People Know this, but... (2+ / 0-)
    Recommended by:
    Brainwrap, DRo

    Where people get confused is the mix up taxes with withholdings.

    Employers use a trick of accounting, when people work overtime.  They use the same W4 schedule so they can withhold more of the employees paycheck.

    People seem to think the government actually comes in and takes money from their check.  That isn't how it works at all.

    An employer withholds money based on tax schedules.  Then the employer makes lump sum payments to the government.

    If your employer withholds more than they should, it helps keep their bank account full.  They are very precise in calculation, when they actually pay the payroll taxes owed.

    After all, why should they care.  Let the government pay the employee, while they earn interest off the difference.

    •  I kinda doubt that. (2+ / 0-)
      Recommended by:
      Brainwrap, elfling

      That claim makes my BS sensor start to sing.

      •  Yeah, not a chance employers can make (1+ / 0-)
        Recommended by:

        a float in withheld taxes.  Per pub 15, if they pull in more than $100k in withholding, they have to deposit it the next day.

      •  Look it up (0+ / 0-)

        Your company's payroll department handles the withholdings.  It isn't the government.

        When you work overtime, they simply use the W4 schedule as if you were making that amount as your base salary with your set deductions.

        This makes an overtime check seem taxed at a much higher rate.  However, you are over paying on taxes on that check, because it isn't reflective of your annual salary.

        This allows the company to defer some of the cost of overtime until they have to meet their payroll tax.

        •  Maybe it helps from a cash flow standpoint, (1+ / 0-)
          Recommended by:

          but they're not making money on the deal.

          •  They are if they're big enough (2+ / 0-)
            Recommended by:
            tardis10, trumpeter

            Most large companies don't leave money lying around.  They are constantly accruing money (hopefully), so I've even seen them accept the 2% penalty for reporting 5 days late.

            If you ever saw inside accounting books of large companies, you'd be shocked by the absurdity present.  They don't think in terms of ethics, but rather bottom line numbers.

            Often the payroll fund is loaned from a larger fund, just to cover the payroll period.

            Smaller companies are really screwed in this way.  Even if they outsource their payroll, the company handling it has massive leverage with massive capital from all of the companies they handle.

            We desperately need fair laws about what a company can do with money, and what they can't.  GE Capital and AIG should have set the stage for massive reform.

            •  Your contention is ridiculous (0+ / 0-)

              Employers do not game their employee's payroll withholdings in this way.

              Any company that pays a 2% penatly for depositing 5 days late is company in deep, deep trouble.  That's an annual rate of about 150%.

              "Well, I'm sure I'd feel much worse if I weren't under such heavy sedation..."--David St. Hubbins

              by Old Left Good Left on Tue Jul 26, 2011 at 01:29:25 PM PDT

              [ Parent ]

    •  And here I thought that my deliberately high (1+ / 0-)
      Recommended by:
      Dr Teeth

      withholding, was helping me accumulate non-raidable savings at the cost of letting the IRS get the extra interest.  And all along it was my employer!  Well, that's okay, since I'm in the public sector.

      "The extinction of the human race will come from its inability to EMOTIONALLY comprehend the exponential function." -- Edward Teller

      by lgmcp on Tue Jul 26, 2011 at 11:50:42 AM PDT

      [ Parent ]

  •  This is one of my (7+ / 0-)

    favorite lectures to give every semester, because it's an iron-clad guarantee that none of my students (high achievers at a competitive national private university) will know this going into the lecture.

    I'm less thrilled with hearing journalists consistently get it wrong; and I'm disappointed (but perhaps not surprised) at just how often folks here convey various fundamental misunderstandings of tax policy.

    Families is where a nation finds hope, where wings take dream.

    by cardinal on Tue Jul 26, 2011 at 11:36:29 AM PDT

  •  You are absolutely right (3+ / 0-)
    Recommended by:
    Brainwrap, lgmcp, Dude1701

    people are confused.  

    However, I think some of the confusion is due to the way entitlement programs work.  In the case of assistance, a single dollar over the amount will throw you out of the program.  If you have exceeded the means test you can't get any assistance at all. And many of the guidelines are insane. In example, for food stamps, you cannot have more than $2,000 in liquid assets, but you can have a boat (no value limit). If you sell the boat to get by, and it's sale upped your cash you are cut out of food stamps.  

    This why we should fight against means testing for Medicare, in addition to the fact that once a program is deemed 'entitlement' for the under privileged it is a target for elimination by the GOP.

    Be the change you want to see in the world. -Gandhi

    by DRo on Tue Jul 26, 2011 at 11:40:35 AM PDT

  •  Like w/ the repatriation debate: (0+ / 0-)

    when people don't understand marginal tax, they look at a corp's effective rate and say things like, "their tax rate is 20%, and they shouldn't mind paying that!"  When, of course, every dollar repatriated will be taxed at the marginal rate of 35%.  Whatever deductions are reducing the statutory to the effective rate have already been taken, so every additional dollar of income will be hit at the marginal rate.

  •  I encountered this concept in the fight (2+ / 0-)
    Recommended by:
    Brainwrap, Dude1701

    about extending the Bush tax cuts, but previously I must admit that I embraced the same fallacy you describe.  For a long time.  In fact it has become some deeply ingrained in the popular understanding of "tax brackets" that I fear it can never be exorcized.  People will just stick to what they think they know about it, and refuse to believe you.  At least, all Republicans will, and more than a few Dems and Independents.

    "The extinction of the human race will come from its inability to EMOTIONALLY comprehend the exponential function." -- Edward Teller

    by lgmcp on Tue Jul 26, 2011 at 11:47:34 AM PDT

  •  Thanks for posting this (2+ / 0-)
    Recommended by:
    Brainwrap, lgmcp

    As a CPA married to a tax attorney, it's easy to take it for granted that people understand this, but many don't.

  •  I've never met a conservative yet who could... (6+ / 0-)

    tell me what his/her effective overall tax rate was when we were discussing taxes.  They will go on about how heavily taxed they/we are, but when I ask them, they've never even bothered to calculate it.  They take it on faith without knowing what the hell they are even talking about.

    If you ask "what color is the poster" when someone criticizes the President's policy or track record, you are probably a racist. If you assume white progressives don't like the President's policies because of his skin color, you are definitely a racist.

    by Celtic Pugilist on Tue Jul 26, 2011 at 12:01:41 PM PDT

    •  They're probably just lying (1+ / 0-)
      Recommended by:

      because Turbotax can hardly be dissuaded from calculating your effective rate and comparing your deductions with those of your peers.  

      "The extinction of the human race will come from its inability to EMOTIONALLY comprehend the exponential function." -- Edward Teller

      by lgmcp on Tue Jul 26, 2011 at 12:07:23 PM PDT

      [ Parent ]

      •  No, they don't seem to even notice it (2+ / 0-)
        Recommended by:
        Brainwrap, lgmcp

        It's in the summary page, but they always appear to be blissfully ignorant of it.

        They don't even have to go by that though.  They could simply look at the line for their tax liability/divide by their gross income and they would have their effective fractional tax rate.

        If you ask "what color is the poster" when someone criticizes the President's policy or track record, you are probably a racist. If you assume white progressives don't like the President's policies because of his skin color, you are definitely a racist.

        by Celtic Pugilist on Tue Jul 26, 2011 at 12:17:51 PM PDT

        [ Parent ]

  •  this is handy to have (2+ / 0-)
    Recommended by:
    Catte Nappe, Brainwrap

    though I already knew how it worked; it is nice to just use a link.

    "Obama won. Get over it."

    by onanyes on Tue Jul 26, 2011 at 12:08:48 PM PDT

  •  Pteach it. While I understand this (1+ / 0-)
    Recommended by:

    many of the people I run into don't. Including people who one would expect to know.

    "George RR Martin is not your bitch" ~~ Neil Gaiman

    by tardis10 on Tue Jul 26, 2011 at 12:25:26 PM PDT

  •  By the way, this isn't reality (0+ / 0-)

    This is reality for the 1040EZ crowd.  Those of us, who don't make enough money to learn tax dodges and capital gains based compensation.

    If the real tax code worked this way, we wouldn't be in the mess we're in.

    The system is rigged, and the people you are trying to refute are already 3 moves ahead.

  •  Heh... (1+ / 0-)
    Recommended by:

    Blame tax software -- no one has to do the math themselves any more  -- just gather your forms, plug in the numbers, and voila!

    Full Disclosure: I am an unpaid shill for every paranoid delusion that lurks under your bed - but more than willing to cash any checks sent my way

    by zonk on Tue Jul 26, 2011 at 12:31:45 PM PDT

  •  so I guess I thought it was the way you said, but- (0+ / 0-)

    so many intelligent people I know seemed to think it was otherwise, so I was starting to doubt the veracity of what I thought. Thanks for the clue.
        This is the same kind of misunderstanding that dogs social security from the other side:
         If there were no cap on the amount of income that is taxed for social security, then it would be more than solvent, it could afford to be generous. But somehow we accepted the "cap" without a common understanding of this issue either.
         I didn't understand a lot of things about money, finances, and taxes that ought to be part of the high school curriculum instead of a learn-on-the-job experience. But then there's education, another whole subject... no wonder good people are boggled and give up when it comes to trying to change things.

  •  A question (1+ / 0-)
    Recommended by:

    So under the first Bush2 tax cuts, the wealthiest got a tax cut for each bracket? Like 5 tax cuts plus  the one for the highest bracket that applied to everything over a certain amount?

    •  Correct (1+ / 0-)
      Recommended by:

      However, because a very wealthy individual's income is large compared to the top-bracket amount, those other cuts apply to only a small portion of his income, so the reduction in taxes is negligible compared to the reduction from cutting the top-bracket rate. It would be big money to us, but chump change to the very wealthy.

      "We recommend, as a precautionary measure, that people with respiratory infections should be advised not to blow their vuvuzela in enclosed spaces and where there is a risk of infecting others."

      by ebohlman on Tue Jul 26, 2011 at 03:25:42 PM PDT

      [ Parent ]

  •  As an aside the step function problem DOES exist (2+ / 0-)
    Recommended by:
    DamselleFly, Brainwrap

    for certain welfare programs. If you make the poverty level salary you get Medicaid (or heating subsidy, foodstamps, headstart, etc, etc). If you make one penny over that  then you're on your own. The Health Care Reform passed has this same issue as well.

    The tax codes are pretty well thought out to prevent this step function type of disincentive (disincentive meaning you get punished when you make more money). However the welfare type programs are generally not nearly as well thought out. That's the problem with limousine liberals designing well meaning policies for poor people.

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