Jozrael

I'm borrowing the recent post in the blog of a respected game developer that I know: Dave’s random thoughts.

Why income tax in the United States is unfair
September 28th, 2008

Both political candidates seem to have ideas on how to reform the US tax system. I think that there is a certain unfairness in the US tax system that isn’t addressed often, so I’m going to talk about it here.

Many people with higher incomes ($200k or more) seem to think they pay a high rate of tax. One of the candidates seems determined to extend tax cuts to those with such high incomes. The US, of course, has a progressive tax system. Let’s look at the tax rates:

Here are the tax rates for a single filer in 2008:

To $8025: 10%
To $32,550: 15%
To $78,850: 25%
To $164,550: 28%
To $357,700: 33%
Above $357,700: 35%

This seems relatively fair, I suppose. Tax rates go up progressively as one earns more money, though the final 2% jump once someone earns a whopping $357k does seem a little small.

However, in addition to income tax, tax payers must also pay social security tax. Social security tax differs from income tax in that it goes into the social security fund, and those who pay social security tax may be eligible for certain social security benefits.

Let’s be realistic for a moment, though. Money paid into the social security fund is used to pay social security benefits to those currently receiving them. There is no guarantee that those paying into the fund now will ever see any benefits. If one could choose to opt out of the fund and instead manage the money themselves (perhaps having it put in their 401(k)) and waive social security benefits, they would almost undoubtedly be better off.

Thus, social security tax is essentially a tax like income tax. Worse, social security tax is flat, at 6.2%, until one reaches a certain threshold of income, $102,000 in 2008, and then it cuts off. Thus it is a regressive tax, the opposite of a progressive tax. Let’s look at what the tax rates look like if we include social security tax:

To $8025: 16.2%
To $32,550: 21.2%
To $78,850: 31.2%
To $102,000: 34.2%
To $164,550: 28%
To $357,700: 33%
Above $357,700: 35%

Look at those numbers: as soon as you’re earning over $32,550, you’re paying a marginal rate of 31.2%. That’s only 3.8% less than the very top earners who earn over $357k pay! Then, after $78k, you’re paying 34.2% — effectively the same as the very wealthiest pay.

After you earn over $102k, ironically enough, your marginal tax rate goes down considerably, due to social security tax cutting off. All income between $102k and $164k is at the rather sweet effective tax rate of only 28%.

Things are actually a little more complicated than this, because social security taxes do not have deductions applied, while income taxes do. This makes the situation even more favorable to the highest earners, though. It means that tax deductions really, truly matter to the highest earners, because they get the full benefit of them. To earners under the $102k threshold, tax deductions have more limited effect.

All in all, I think that people earning between about $50k and $120k are treated the least fairly under the current tax system. They must bear the burden of a regressive tax that brings their marginal tax rate — and in some cases even their average tax rate — at close to that of the very highest income earners.









That's kind of disturbing. I'm quite in favor of a progressive tax system, and was always under the impression that the stated income tax was pretty much the reality of it, and that only the stratospheric income bracket (like top .01%) were really getting out of paying their taxes by putting all their income in tax-exempt shelters.

Rekna

One thing to keep in mind is that an individual is not taxed at a single rate. Income within said tax bracket is taxed at that tax bracket. Thus the first $X are taxed at one rate and later money is taxed at another rate.

(Just to be clear i'm not making any statement for or against what you have said only pointing out a common misconception that people have that can skew ones judgment.)

Jozrael

Thanks, I had forgotten about this, but was aware.