Thursday, February 20, 2014

The *real* math behind the beer tab tax comparison

I wrote this a while ago for a Facebook post a few years ago as a reply on some vitriol spewed by Glenn Back, basically regurgitating the beer tab analogy to our tax system.


Too bad Mr. Beck (along with most of the world) doesn't understand how progressive taxes really work, and how the American tax system in particular works.  There are some key facts that he has elected to leave out.  But before we get to what's missing from Beck's mischaracterization of taxes, a quick primer on the American progressive taxation system.

There are five main different systems of taxes in the US: sales taxes, payroll taxes, income taxes (standard and the alternative minimum tax), and capital gains taxes:

Sales Tax

Pretty easy.  It's a flat tax determined by your state and applied to products that you purchase. It's consumption based and regressive.  Consumption meaning, you pay it on the things you purchase or consume; regressive meaning that it disproportionally affects those with lower incomes.  The only method to legally avoid this tax is not to buy stuff.  In most states, unprepared food (groceries) is exempt from sales tax, while prepared food (restaurants) is not.
Payroll taxes 

Wage earners pay these.  It's your combined Social Security and Medicare tax. The current rates are 4.2% for SS tax (up to the first $110,100 of earned income) and 1.45% for Medicare (no earned income limit).  These taxes only applies to wages, not to investment or dividend income.
Income Taxes
This is the most complex of the taxes.  The standard tax is currently divided into 6 brackets for two filing statuses: Married Filing Jointly (MFJ) and Single (S):
Bracket, Income range for MFJ, Income range for S
10%, $0-$17,400, $0-$8,700
15%, $17,400-$70,700, $8,700-$35,350
25%, $70,700-$142,700, $35,350-$85,650
28%, $142,700-$217,450, $85,650-$178,650
33%, $217,450-$388,350, $178,650-$388,350
35%, Over $388,350, Over $388,350

The AMT is a lot more complicated and applies to about 4% of US households in a given tax year and kicks in around $175,000 (give or take), and is always a moving target because Congress changes the income threshhold.  Since it applies to such a small portion of people, we're going to ignore it for this discussion and treat those people like normal tax payers.

Captial Gains tax
Taxes on investment income (dividends, sales of stocks/bonds).  It is currently 10% or 15%, depending on qualifying investments and such.

As to the parts that Beck (and other commentators) either doesn't know or conveniently leaves out:

  1. Everyone pays taxes (depsite the claims that half the population doesn't pay any).  They may, however, get rebates and deductions that make their overall tax liability zero, but before those get applied, everyone pays taxes.  One of those credits for lower-income and middle-income earners is the Earned Income Tax Credit, the expanse of which championed by the patron saint of the Republican Party, Ronald Reagan in the Tax Reform Act of 1986.
  2. Everyone pays the same rates on their earned portion of income.
  3. When politicians are talking about "the rich pay less taxes" or "making everyone pay their fair share," they're not talking about income derived from salaries or wages.  What they're talking about is the primary source of income for the wealthy--investments.  If you have an income of $400,000 per year, and you receive that income as wages, you'll pay something in each of the six tax brackets.  If that income comes from investments, you're going to be paying the 10% or 15% rates.
So, let's take a look at three individuals, and assume that neither have any deductions or exemptions (because this is an FB post and they have limits.  Also, I'm not an accountant or tax professional, so I'm not going to run really complicated numbers). 

Individual 1 is a Joint filer with a salary of $84,000.  Individual 2 is an investor whose $168,000 income came solely from sales of his long term stock holdings.  Individual 3 is a "high-income wage earner," with wages of $400,000.
 Individual 1's tax liability looks like this:
Income (Salary) $84,000
FICA (4.2%), -$3,528 ($84,000 * 4.2%)
10% Bracket, -$1,740 ($17,400 cap * 10%)
15% Bracket, -$7,955 (($70,700 minus first $17,400) * 15%)
25% Bracket, -$3,325 (($84,000 minus first $70,700) * 25%))
Total liability: $16,548 on a total income of $84,000, or 19% of Individual 1's income is taxed
 Individual 2's tax liability looks like this:
Income (sale of stocks) $168,000
FICA (4.2%), $0 (only applies to earned income)
n% Bracket, $0 (only applies to earned income)
10% Capital gains liability, $16,800
Total liability: $16,800 on an income of $168,000, or 10% of Individual 2's income

In this example, Individual 2 had *twice* as much income and was taxed only $452 more (or paid half as much tax proportional to their income).
 Individual 3's tax liability looks like this:
Income (Salary) $400,000
FICA - SS (4.2%), -$4,624.20 ($110,100 * 4.2%)
FICA - Medicare (1.45), -$4,203.55 (($400,000 minus $110,100) * 1.45%)
10% Bracket, -$1,740 ($17,400 cap * 10%)
15% Bracket, -$7,955 (($70,700 minus first $17,400) * 15%)
25% Bracket, -$18,000 (($142,700 minus first $70,700) * 25%)
28% Bracket, -$20,930 (($217,450 minus first $142,700) * 28%)
33% Bracket, -$56,397  (($388,350 minus first $217,450) * 33%)
35% Bracket, -$4,077.50 (($400,000 minus first $388,350) * 35%)
Total liability: $117,927.25 on an income of $400,000, or 29.5% of Individual 3's income

As you can see, the tax system is unfairly weighted against wage-earners (as opposed to people who derive their income from investments).  Why should one type of income be "preferred" over another?  Individual 2 gets a pretty sweet deal in this case.  Individual 2 wouldn't pay the same dollar amount in taxes as individual 3 until he gets to $1.17 million in income (he'd be paying the same 10% capital gains tax).  When Democrats are talking about the wealthy paying their "fair share," *this* is what they're talking about, not some silly math on a beer tab.

If we took Glenn's beer tab example and applied the US's real wage distribution against it, it would look dramatically different.  According to the Tax Foundation (, I think it would look more like this:
 1 - $2.30
 2 - $2.30
 3 - $2.30
 4 - $2.30
 5 - $2.30
 6 - $19.18
 7 - $19.18
 8 - $19.18
 9 - $19.18
10 - $11.80

That being said, persons 6-9 (who represent the 50th through 99th percentile or the middle class) pay 75% of the bill, while the bottom 50% and the top 1% pay roughly the same percentage.

In other terms, 40% of the people pay 75% of the bill, and 60% of the people pay 25% of the bill.  Not terribly fair.