The recent revival of the flat tax proposal in the Republican primary has once again highlighted the widespread lack of understanding that people have about the Federal Tax code. While the details are incredibly complicated (as evidenced by the shear volume of the tax law) the basic principles are not that complicated and it will help the progressive cause if people understand them better, follow me for some explaining.
TAX BRACKETS
This has to be one of the most misunderstood concepts in the whole tax code and it is shameful that democrats have not done a better job of setting the record straight. Lets start with the Tax brackets themselves
2011 income tax bracket
I think the thing that confuses people the most about this is that you do not pay your tax rate for your entire income, let's use an example to explain this
Example
Let's say that a single guy named Tim makes $195,000/yr which puts him in the upper end of the 28% bracket, Ignoring deductions what is his overall tax rate?
Answer
Most people would think that being the 28% bracket means that Tim would pay 28% tax on all of his income but that is not true. Tim would pay 10% on his first $8,600 then 15% on $8,601 - $34,900 and so on until his 28% bracket
10% $8,600 = $860
15% $8,601 - $34,900 = $3944.85
25% $34,901 - $84,500 = $12,399.75
28% $84,501 - $195,000 = $30,939.72
Adding all of that up Tim's total tax burden is $48,144.32 which is no small chunk of change but let's not forget that Tim would have taken home $146,855.68 (not too bad). But what is that actual percentage? that is $48,144.32 / $195,000 which is 24.7%
What is key about this part of the example is that everyone pays the same amount of taxes on the first $8,600 they earn. They also pay the same on the next level of income as well. So when George W Bush would say that he thought everyone should get a tax cut (and that all brackets should be reduced) he was being disingenuous because if you reduced the rate of the first $8,600 to 0% EVERYONE would get an $860 tax cut (provided you make $8,600 or more). For someone like Tim it is not as noticeable ;)
Example 2
The overall lack of understanding about the Tax brackets leads people to have a very unfair view of the tax code. Let's stay with Tim and see a scenario where he gets a very modest $1,000 raise. What will be the affect of Tim's tax burden for crossing into the 36% bracket.
Answer
Many people think that by getting that $1,000 raise that Tim will be paying a lot more tax and that is why they think that our tax system is so unfair. Many people believe that Tim pays 28% on $195,000 ($54,600) and that crossing into the new bracket will increase his burden to 36% $196,000 ($70,560). If this were actually the case it would be incredibly unfair and people would be justifiably upset but in reality they will only pay 36% on the $50 over $195,950.
What Next?
So how can we affect the debate about taxes?
With the tax Code So complicated are there ways to simplify things fairly?
What do you think?
Update
I accidentally used a proposed tax bracket for 2012 rather than the actual current brackets as pointed out. The source for the brackets is here. The concepts should be the same however ;)