Wednesday, January 25, 2012

Romney and Buffett's "tax rates" (vs. the little people)

Romney and (supposedly) Buffett pay lower tax rates than common people?!

Variations of this story have been increasingly popular over the last few years. (Apparently, the President used this in the SOTU last night!) This isn't too surprising, given the economic doldrums inspired by the "Financial Crisis" and extended for more than four years now by the policies of Presidents Bush/Obama and their Congresses. Envy and resentment find more fertile ground in tougher times. (I wonder whether the politicians are dopes or are doing this on purpose, but that's another story.)

There are a variety of factors to consider-- differential taxes on capital gains vs. labor income; whether to include onerous payroll taxes on income in the calculations (but we usually ignore these, despite the pain inflicted on the lower-middle and middle classes, so why start now?); whether to include state and local taxes (more complicated and difficult to compare cases). In any case, the most common comparisons are simple (and simplistic), focusing on federal income taxes only.

Unfortunately, the comparisons often suffer from ignorance of the tax code and different expressions of "tax rate". Most notably, few people understand the difference between average tax rates (ATR) and marginal tax rates (MTR).

ATR is the proportion of one's income devoted to a tax or taxes in general. For example, if one has an income of $100K and pays federal income taxes of $12,000, then their ATR is 12%.

MTR is the proportion of tax paid on the last dollar earned. If one is in the 28% "tax bracket", then the last dollar earned is taxed at 28%. Each dollar earned is taxed in its respective tax bracket. Instead, most people believe that if you're in the 28% tax bracket, then every dollar earned is taxed at 28%. Not true! (The Tax Foundation does a really nice job with the big picture.)

For example, singles have a standard deduction of $5,800 and exempted income of $3,700. So, the first $9,500 earned is not exposed to any federal income taxes. (They've already lost about $1,400 to payroll taxes, but who cares about that?) If they earn $10,000, only the last $500 is exposed to the 10% MTR in the lowest tax bracket, resulting in taxes of $50 and an ATR of .5%.

In the Romney example popular on Facebook, Romney is said to have a tax rate of 13.9% while a teacher is said to have a 25% rate. Since there is no 13.9% tax bracket, the author must be referring to Romney's ATR. But if you do the calculations, a teacher who is single would need to earn at least $232,600 to have a 25% ATR (married with no children = $367,000; head of household with only one child = 314,700.) Why do I say "at least"? I'm assuming no itemized deductions, so our prospective teacher is a miser and doesn't have a mortgage on her home.

The irony of a valid comparison? The Occupy Wall Street crowd would say that she needs to be paying higher taxes!

Of course, teachers don't make this much money. So, those making such comparisons are invoking Romney's ATR and the teacher's MTR-- comparing apples and oranges, or better, apples and rocks.


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