Monday, October 18, 2004

What Bracket Are You Really In?

Today I got into a discussion with on of my co-workers from the "right" persuasion. As we discussed Kerry and Bush, he argued that I was better off today because of Bush's tax cuts. I came back with Bush's tax cuts were a large portion of the deficit. He shot back that why should anyone pay half their income to taxes? "Half" I said? Where do you get that? He argued that if you were in the top bracket you were paying 35% of your income to the feds, plus state taxes that made 50%. That one made me think a bit, and I think I'll question that call.

Upon further review, the argument is invalid. The receiver stepped out of bracket, and included all income in the field of play erroneously.

I think this is a great misconception that the right plays upon. If you are in the "35% bracket, or any bracket for that matter, only a portion of your income is taxed at that bracket. Plus, not all of anyone's income is taxed, especially if you are lucky enough to be in the highest brackets. Mortgage interest, property taxes, home equity loan interest are "essential" deductions that people in the 15% bracket can't afford to take.

Let's look at an example. Let's say you are a lucky single person, with a plumb job working your ass off for $160,000 a year. Sweet. But, damn, that puts you in the second highest bracket: THE 33% BRACKET (cue scary music). So you'll be paying $52,800 in taxes this year! Damn that Federal Government!

Or will you...(Doctor Evil look).

Actually, unless you have no money skills, you've invested in some real estate and own your home/condo/duplex. Let's say you've got a mortgage for $250,000, which means you are paying around $14,400 a year in interest. Wow, good thing that's all tax deductable. Then you are probably paying, in my area anyway, around $6,500 in local taxes. But you know what, those babies are tax deductable too! Damn, being in debt is great! But wait, that BMW you bought with your home equity loan is a sweet ride. It's not technically a tax deduction, but it is a home equity loan, and you have enought to pay for an accountant (who's services are also a tax deduction), so the interest on that is tax deductable too! Extra sweet bonus dedution points for around another $5,200 in interest.

So that puts you at a taxable income of $133,900 assuming you don't have any other deductions (which you probably do thanks to your accountant). Now that nearly $134K puts you in the 28% Bracket. Not as bad as 33%, but still you have to pay more than one-forth of your hard earned money to The Man.

Or do you...

Funny how tax laws work. You see you actually only pay 28% on the money you've earned in the 28% Bracket. Since this bracket starts for you lucky well paid singles at $70,350, that means only roughly half your income is actually taxed at this rate. Here's the math for our example:

$133900 - $70350 = $63550 x 28% = $17,794 in tax @28% Bracket
$70350 - $29050 = $41,300 x 25% = $10,325 in tax @25% Bracket
$29050 - $7150 = $21900 x 15% = $3285 in tax @ 15% Bracket
$7150 x 10% = $715 in tax @ 10% Bracket

For a grand total of $32,119 in taxes.

Now remember, you lucky hard working single person, you make $160,000 a year. With just a few simple deductions, you've paid over $32K in taxes. Now that's a chunk of change. But is it the 33% you originally feared?

No. In actuality, a single person earning $160,000 a year with the simple deductions I've used pays 20% of their income to federal taxes - not the 33% their initial bracket may suggest.

What about the same single person not lucky enough to get that plumb job? What if they only made $45,000 a year? That puts Joe Workingstiff in the 25% Bracket. You can't afford a home in my area on that income. What happens to Joe with but the standard deductions? Let's say Joe manages to get $10K in deductions. That still puts him at $35,000 taxable income, or the same 25% bracket. Let's do the math for Joe as he can't afford the accountant:

$40,000 - $29050 = $10950 x 25% = $2737 in tax @25% Bracket
$29050 - $7150 = $21900 x 15% = $3285 in tax @ 15% Bracket
$7150 x 10% = $715 in tax @ 10% Bracket

For a grand total of $6,737 in taxes.

It turns out Joe is paying 15% of his income in taxes. Plumb Guy pays 5% more of his income to taxes, yet he earns 3.5 times Joe's income. Hmmm.

Bottom line: Arguing tax brackets is misleading at best, and a good GOP talking point to confuse people into thinking "tax relief" is really for the middle.