Tax Brackets 101, Ctd

Apr 14 2011 @ 7:37am

A reader writes:

Your reader's chart may lead others to think that the highest earners (in terms of adjusted gross income) will pay an effective tax rate in the upper 20% to low 30%. In fact, the top 400 taxpayers, with the highest adjusted gross income, paid an effective tax rate of 17% in 2008; the top 1% of all taxpayers paid an effective tax rate of 23% in 2008 (IRS figures from Bloomberg's Businessweek April 11-17, 2011 edition, page 45).

Another writes:

There were several arguments in that post that need addressing:

Argument 1) Bill Gates only pays payroll tax on up to $106,800 of salary

Payroll taxes fund social security. The formula that pays out social security benefits is loosely tied to the income you earned while working, but with a cap. Earning more than $106k a year won't entitle you to any more in social security benefits, so one should not be taxed on income in excess of that. The system as a whole is progressive, too, so Bill Gates is paying more in to the system than he takes out.

Argument 2) Dividends and capital gains are income that is only taxed at 15%

Dividends are paid by corporations who are already subject to 35% federal tax rates on the income they earn. So while Bill Gates personally may pay 15% on the cash Microsoft pays him as dividends, Microsoft has already paid 35% of federal income tax on its earnings in that year, whether or not it chooses to pay the dividend. And that dividend the company pays out is not deductible against its tax bill.

Similarly, a capital gain arises when you sell an asset for more than you paid for it. That asset is income producing or expected to be income producing in the future … and so is expected to have a tax liability on the income it earns. If Microsoft was subject to a lower corporate tax, its expected earnings would be higher and Gates could sell his shares at a higher price. So taxes do bite into the value of the shares Gates sold, beyond the simple 15% he pays himself.

Argument 3) High income people can claim so many deductions they avoid most taxes

Three words: Alternative minimum tax. There's a limit on how much you can lower your effective tax rate through deductions such as taxes paid and charitable contributions.

For a resident of New York City making $250k a year, the effective tax rate (federal, state, local, social security, medicare) is close to 40%. That's a sizeable chunk.