There really are people planning to reduce their income to get below Obama's $250k bracket
blogs.tnr.com
blogs.tnr.com
Some people feel progressive taxation is unfair. Even if you think it's fair, you might have objections to tinkering with the level of progressivity to buy votes, or in times of crisis, or in times when the politically-favored (be they defaulting homeowners, too-big-to-fail banks, or those running agencies and projects fortified by stimulus spending) are drawing extra billions (trillions?) from public funds.
So while these >$250K earners are not being hyperrational after-tax income maximizers -- and hardly anyone is -- they are behaving in a very typical human way.
Meanwhile, the tax accountant quoted on page 2 allows that it's possible a discontinuity with regard to deductions could create a situation where you would net more by reducing your income. The tax code is gigantic and buggy; it's not out of the question that a few taxpayers, in certain narrow situations, sometimes face marginal rates over 100%.
In any case, my point is not with an overly-literal interpretation of the ABC story. It's that this parade of commentators throwing around words like 'idiot' -- starting with Chait at the TNR piece and continuing here -- are the real know-nothings.
This taxpayer behavior is not idiotic; it's evolved human behavior, in the presence of perceived unfairness, that may serve long-term survival strategies.
Last year, my wife and I made $X more than the previous year. The end result on our taxes was that we paid about (0.75)X more in taxes. This was due primarily (as the account explained to us) to a combination of increasing hit due to AMT as well as declining mortgage interest deduction as we approach the end of our mortgage.
With an apparent marginal tax rate of 75%, what's the point of working harder? And, in fact, if I can stand to lose, say $1,000 in income in order to buy myself $4,000 worth of "life", that seems like a good investment.
Looking at the picture with an understanding of what's going on, it's clear that there's a degree of apples and oranges here. I don't know what my tax liability would be if I were to take the previous year's data and apply the current tax rules to it, but that's what would show what my actual marginal rate is.
What I'm trying to illustrate is that the real-world experience of a taxpayer, under the regime of a byzantine tax code, can (and did, in my case) experience a severe dis-incentive to further productivity. And the farther the tax code moves in a "progressive" direction, the more frequently this will be true.
Incentives matter.
(Sorry, I'm not going to announce all my financial data on the Internet)
The top marginal rate is around 40%. SSI is around 15%. CA's top is around 10%. Add in some deduction phaseouts and it's easy to see 70%.
The SSI stops after 105k (or so), so it is immaterial, because the marginal fed tax rate is 28% at that point.
True that state income tax is a big one, for some states. So I completely didn't bundle that in my estimate.
Phaseout deductions never _increase_ marginal tax rates, so also immaterial.
Nevertheless, exceeding 50% marginal tax rate with today's tax rates is unlikely.
There's a surtax that puts it at 39+.
> The SSI stops after 105k (or so),
Today.
> Phaseout deductions never _increase_ marginal tax rates, so also immaterial.
Phaseouts affect the amount of income taxed and thus affect the amount of taxes due for a given increase in income. Suppose that earning $1k more costs me $300 in deductions due to phaseouts. The result is that my AGI has gone up by $1.3k. Assuming no bracket change, the taxes owed because of that $1k increase is 1.3x the bracket rate.
Let's put some numbers on it. Suppose that the tax rate for that bracket is 10%. That's $100 for the $1k and $30 for the $300 for a total of $130 owed. Do you really want to argue that the marginal rate for that $1k is not 13%?
I also left out sales taxes. Their effect depends on what the mix of goods purchased (at least some food is tax free in most jurisdictions while gas, tobacco, and booze isn't) and the average tax rate up to that point.
For a state like CA, with sales taxes typically over 8% and soon to be 9%, that can add another 3-5% to the marginal tax burden.
Wealthy families often make much of their money from investing, so a 5% capital gains tax increase can be pretty significant.
Based on Wikipedia (which may be wrong, but at least explains it more clearly), the long-term capital gains rate will be 0% for those in the 10% income tax bracket, 10% for those in the 15% income tax bracket, and 20% for all others, meaning the discontinuity for joint filing happens around $65k. http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United...
Long term gains are taxed at a flat rate. If you make N dollars in capital gains, you are taxed the same % on those N dollars. This % is determined by what tax bracket you are in, but is the same over all your gains.
That was my original point: Under Obama's plan, people who enter the highest tax bracket will suddenly see all of their capital gains taxed at a higher rate.
That's not how tax brackets work. Jumping into the higher bracket doesn't mean you make less money, it means you pay more taxes for the amount above the bracket, but you'll pay the same tax rate on the 249k as the guy only making 249k. So he'd only pay the 20% rate on the extra dollar, hardly far more than the other guys.
A family making 190,000 dollars a year in normal income and 50,000 dollars a year in long-term capital gains will pay the normal taxes on 190,000 dollars (as you describe it, with brackets and what-not), and 15% on the 50,000 dollars. A family making 200,000 dollars plus 50,000 in LTCG, however, will break the 250,000 dollar barrier and will have to pay 20% on that 50,000. That means the cost of that extra 10,000 dollars in income cost them 2,500 dollars in additional taxes.
How much money in real dollars do I lose when I earn a buck more to make it to a quarter million?
The first $250K any American makes gets taxed at exactly the same rate. For everybody. It's the same for any value -- Bill Gates pays exactly the same tax rate on the first $50K he makes in a year as I do. The rates go up for successively higher values -- your first n dollars may not be taxed at all; then your next n dollars is taxed at a low amount, and successively higher. These bottom rates will not change no matter how much your total income is.
When they talk about raising the tax rate for people that make more than a certain value, they are talking only about taxes on the money OVER that value. So only your 250001st dollar gets taxed at the higher rate -- as will every other dollar you make on top of that. The tax rate for the rest of your money will not change at all.
The author of the original article doesn't quite understand this point.
A blog post by (right-wing) Harvard professor Greg Mankiw clearly explains this: http://gregmankiw.blogspot.com/2008/10/blog-post.html
I don't believe that people change their work habit, or choose to work less, just because of a relative tax increase. However, they may be more inclined to find more tax efficient schemes.
You're thinking of it from the wrong side.
You want these people to work hard and long because they're good at what they do.
You benefit from their work. You don't benefit as much from their vacation.
Most people won't change their habits, but it is always the marginal earner who has to decide Do I work x% harder for x% less money?
Sure, I'll agree that the percent of your net income that is spent on necessities is continually decreased as your income increases. This is definitely true.
I'll go one step further and say that taxes probably don't largely effect human behavior. If I have worked hard enough to earn $250k/year, it's due to some intrinsic motivation, not the benefits of that salary in the US tax code.
However, if America was built on encouraging the masses to converge on an average income, then it wouldn't be America at all. This country stands above the rest because of its tremendous wealth. It's built on incentives of self-interest. It's the ability to create unbound wealth that attracts the most brilliant minds to this country, and everybody else reaps the benefits. We should be encouraging these people to work, not take a vacation because added tax pressures are further reducing the value of their work.
This is particular relevant to the entrepreneurial crowd of Hacker News; entrepreneurs are, after all, responsible for 0.2% of the country's input and 17% of its output.
Of course, our income tax system (not payroll or sales tax!) is already quite progressive, so this was already the case. Also, if you believe in utility functions, you can imagine that the 250,000th dollar is intrinsically less alluring anyway. But Obama wants to make the system yet more progressive, so no one will be surprised when these effects increase, with negative knock-ons for jobs and growth. It isn't as though business owners have nothing better to do with their time than provide jobs. Few of them will close up shop, but all of them will reevaluate their workload. When they're not getting paid enough for their work, they'll do less of it. Actually, I think most of us plebes are basically the same.
Actually it is perfectly rational; it just doesn't have as much to do with with a progressive tax as you might think: http://en.wikipedia.org/wiki/Marginal_utility
I'm not saying it's a bad or good article, I'm just saying it's politics, this is HN, and I've flagged it.
2. What if these people are trying to defer income to a later date when the income tax isn't as high?
3. Or the people can invest capital in their businesses now, get below the income tax increase by taking deductions, wait for the rate to decrease and then cash in on higher profits due to lower taxes and gains from investment in the business.
The dentist doesn't seem like an idiot to me. Maybe she never took much of a vacation before. Now she will. Then when tax rates decrease the incentive to work increases and she will increase her hours.
It is often a much better idea for both the company and the worker to use some non-monetary compensation, because the benefit and cost fits within both of their marginal value curves. Otherwise the employee would only see a few more cents, and the company would be paying significantly more taxes (withheld) that they may not be willing to pay.
>Schatsky said that the incentive to get under $250,000 may be more so if the tax plan outlines that an individual who goes over a prescribed limit would face a reduced value of their itemized deductions.
>"If the value of all your itemized deductions goes from a 33 percent level to a 28 percent level than there would be a reason for people to do dramatic things to reduce their incomes," said Schatsky.
This is coming from "Gary Schatsky, a financial adviser and the president of N.Y.-based Objectiveadvice.com". As such, he presumably has a clue about taxation matters, so I hesitate to call him out on this, but... surely no government would ever enact such a scheme; they would bracket the deductions in a similar way to the income, rather than having a magic barrier of $250k, in order to avoid a situation where people have an incentive to earn less. To me this seems common sense, but at the same time, I'm not a financial adviser -- does anyone have any input on this?
The UK actually had a 105% tax bracket back in the middle of the 20th century. Governments implement no end of stupid ideas.
I suppose there are marginal cases where your deductions at $250,001 are smaller than at $249,999, but I suspect the number needing drastic action are very few. That's why those better off than us hire accountants: to hide money under different rocks from last year.
Heh. I would not put ANYTHING into the "surely they wouldn't" category when it comes to government....
Or, to use the tone that the author used, this idiot author is so stupid that he doesn't understand the concept of marginal utility...
http://www.ratemds.com/filecache/doctor-ratings.jsp?did=2075...
=)
In the Tax Code case the person should be intelligent enough to know that they don't understand the tax code rather than pretend they do and continue to make poor decisions because of it. This personality trait may lead them to fail to acknowledge a lack of understanding when it comes to a certain dental procedure, but rather than educate themselves, they go ahead and make an incorrect decision.
I think the skill of general intelligence does indeed transfer from tax code to dentistry.
It seems that the crux of your argument is "the dentist should have known that she did not know the tax code well, and was unqualified to make the decision." One of the most common failings of the human mind is to over estimate the skill level of the self ( http://en.wikipedia.org/wiki/Lake_Wobegon_effect )
But that isn't actually how income tax works.
In reality, a family earning $255,000 will pay the higher tax rate only on its last $5,001 in income; the first $249,999 will continue to be taxed at the old rate. So intentionally lowering your income from $255,000 to $249,999 is counter-productive; it will result in a lower after-tax income.
All of these people are bullshitters. Pretty much on any site you visit you have someone claim that they are going to work less/close their business/shut down just to avoid hitting that 250K mark. Ever notice how its always a brand new member making such a post? The few times a long time member posted such drivel, it took a few minutes to find out that the person was full of shit.
When you get out of school, you'll discover that the correlation between intelligence and income is low. There are dumbasses who succeed in investment banking on account of sheer stamina and frat-boy charisma. Also, real estate is a "profession" in which idiots thrive, because they are closer to the animalistic/territorial emotions involved in that game than smart people.
Finally, there are some people in prestigious careers (doctors, lawyers, and, yes, even professors) who are not low-IQ people, but are still idiots... and you'd be amazed how uninformed many of them are. Idiocy has a lot more to do with provincial attitudes and willful ignorance than an IQ score.
The fact that different people see the same thing differently does not imply FUD.
An elephant from its rider's perspective is very different from an elephant as seen by an ant.
Yes, that's marginal, but you're forgetting the phase-outs for various deductions and credits. They can push the marginal rates up quite a bit.
Most of the ones that I know about are at less than $250k.
Every time journalists and newspapers whine and carry on about going out of business... they need this quoted to them. The problem with taking advice from stupid people is you can't use it -- you have to check everything yourself instead of trusting the information. Which essentially renders any newspaper written by reporters like this utterly useless.