Understanding a Progressive Tax Code


FeaturedImageAs confusion over tax rates and the fiscal cliff dominates the conversation in Washington, it is becoming apparent people do not understand how a progressive tax code works. . A progressive tax code increases a person’s tax rate as their income increases unlike more regressive taxes, which set a uniform rate regardless of income. The federal income tax, being the most progressive tax, has 5 different brackets or tiers. As an individual earns more, that income is taxed at a higher rate with rates set at 10%, 25%, 28%, 33%, 35%. The top rate of 35%, which gets all the attention, is only paid on income over $200,000 for an individual or over $250,000 for a couple.

Now, if a person makes $251,000 a year, all that income is not then taxed at 35%. Only $1,000 (the amount over $250,000) is taxed at 35%. Everybody, from business owners to the working poor, pays the same amount in taxes on the same amount of income. Whether it’s a CEO who makes a million dollars a year or a factory workers who makes $50,000 a year, both pay the same tax rate on the first $50,000 they earn. The difference is the CEO goes on to make much more, and that money, and only that money, is taxed at a higher rate.

Understanding people will not all of a sudden be forced to pay exorbitantly more in taxes because they make more money has important implications for a lot of the arguments thrown around in tax rate discussions.

It seriously weakens the argument that raising taxes will disincentivize people to make more money – the “why work harder if Uncle Sam is just gonna take my money” people.  This argument falsely assumes if you make too much money then you will be bumped up into the next tax bracket and therefore have a greater tax burden. As noted before, it is only those dollars above the set limits that are taxed at the higher rate; it’s only the dollars greater than $250,000 that are taxed at 35%.

This also has important implications for the debate over whether or not to let the Bush tax cuts expire. The Bush tax cuts were across the board cuts for every income bracket. If they do expire the 10%, 25%, 28%, 33%, and 35% rates will increase to 15%, 28%, 31%, 36%, and 39.6% respectively. It is unlikely we will see all these rates go up, but what is likely to happen is the top two rates will go up (33% to 36% and 35% to 39.6%).  This has prompted rage from the Republican Party, and is the basis for the claim that the President is engaging in class warfare.  The richest Americans will pay higher taxes on some of their income, but as Ezra Klein has pointed out, “It’s an under appreciated fact that extending the Bush tax cuts on income up to $250,000 cuts taxes for rich people, too.”

Republicans also defend low rates on the top 2 percent of people by deeming it as an attack on small businesses citing those that file their earnings as personal income.  Small businesses, ones that pay their taxes on an individual basis and make more than $250,000 would see a higher tax burden if those top rates expired. But, those businesses still receive a tax cut on their income up to $250,000. And 97 percent of small businesses do not fall into this upper echelon.

So as the parties continue to wage debates over tax rates and the Bush tax cuts remember the importance of a progressive tax code in all these discussions.

Advertisements

8 thoughts on “Understanding a Progressive Tax Code

  1. I agree that most Americans don’t understand this. I am a former factory worker. I can’t tell you how many times I hear comments like, “I am not volunteering for overtime because I end up making less money than I do if I work 40 hours.” As a former business owner as well I know how the tax codes work and I actually had to explain to a few people that what they were telling me was in fact impossible. I am against the current proposed increases but not because I don’t understand them. I have just seen throughout history that you can’t raise taxes on the most wealthy people without the bill ultimately ending up with the lower and middle class. Wealthy corporations prove this all of the time. Wealth became wealth because they know how to pass the buck. At any rate I thoroughly enjoyed this piece and I am reblogging it to D.C. Clothesline. Thank you for a very factual and non-slanted article that all American people need to read.

  2. I would hope that most of the people you have conversations with on this topic understand how it works. Anyway, you’re argument that if people understood how it works than they wouldn’t make the argument “why work harder if the government is only going to take my money anyway” shows that you don’t really understand it yourself. These people are fully aware that it doesn’t mean that they run the risk of having less income after taxes if they work hard and get a raise. What they are saying is, “is it worth it? If 2x work only equals 1.3y income, but 1x work equals 1y income, why work twice as hard if I won’t get near twice the money back?” The truth is $200,000 is not a lot of money anymore (especially if you live in a big/expensive city), and paying close to 50% income tax makes it incredibly hard to climb the social ladder and can turn many away from ever even trying.

    • I guess where I take issue with your analysis is that you seem to purport the difference in rates is much larger than they are. Right now it’s only a 2 percent bump to the top bracket 33-35. The only really big jump is from the first tier to the second, but I don’t think most people stop trying as hard at work at that lower level. Also, this gets to a larger point, I think for the most part workers don’t calculate how hard they’re working compared with their effective tax rate. This argument (the why work harder argument) is really pushed forward by right wing pundits and opponents of tax increases in general because it’s an argument that “sounds good” but lack factual backing. We’ve had higher rates and greater growth (like the 90’s) , and we’ve seen anemic growth since the Bush tax cuts. There’s actually evidence that suggests tax rates could be much higher and not dissuade people from working. This paper http://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.25.4.165 argues tax rates could be much higher and not adversely affect economic growth.

  3. This is exactly why the debate over increasing taxes is a joke. You make a good point that the impact on the high earners is minimized due to the Progressive Tax Code. So the proposed tax increase will also have minimal impact on our annual budget deficit. Assuming Obama gets all of his $1.6 Trillion tax increase over the next 10 years out of the high earners, that means at best an increase in tax revenues of $160 billion per year. We are running an annual deficit of $1.1 trilion. So the tax increases will cover about $15% of our annual deficit.

    We are still waiting for Obama and Reid’s plan to cover the other 85% of the deficit. Since they are afraid to offer any budget cuts, they can blame the GOP for not doing enough and Obama and Reid can put us over the fiscal cliff. Then they can collect more taxes from all of us and blame the GOP. So who wants to really balance the budget on the backs of the middle class? The Dems can do it by doing nothing on January 1st as long as they can position the move that the GOP caused everyone’s taxes to go up. Great political move by the Dems but terrible for the country. Welcome to Obama’s 2nd term.

Comment Here

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s