Taxes

What percentage of your income do you pay in taxes? At the beginning of March, I heard a working class person complain that Obama was “soaking the rich” at 35%. Presumably this person was complaining on principle. By another principle, that of self-interest, a working class person might also cheer that Obama is “soaking the rich.”

What is rich? For 2006, IRS data shows that the top 1% of tax returns had an AGI (Adjusted Gross Income) above $389K. I would say that the top 1% qualifies as rich. Yet, some rich people don’t feel rich.

In the 4/16/09 WSJ weekly “Currents” feature, Gary Fields spoke with several of the rich and near rich, those in the top 1 and 2% income tiers. The owner of a human-resources company in Silicon Valley, California and his wife make about $400K but feel like they are barely getting by. San Jose, CA mayor Chuck Reed calls a family making $250K in Silicon Valley “upper working class,” unable to afford a home in the area.

What did this top 1% pay in Federal income tax? Just under 23%. Wait a second.. what happened to the 35% rate? That is the marginal rate, not the average rate.

If someone is in the 35% tax bracket, that doesn’t mean they pay 35% on all of their income, only on the portion of income that is above the 35% bracket threshold. A person making a $500K salary still only pays 10% tax on the first $16K of that salary. In the 2008 tax year, if someone made $357,701 they paid 27% or $96,770 on the $357,700. They paid 35 cents on the extra dollar.

Warren Buffett once wryly remarked that he paid less in taxes as a percentage of his income than his secretary did. How do the top 1% cut their average tax rate? Many have a significant portion of their income in capital gains, which are taxed at 15%, the rate for middle class taxpayers earning less than $65K.

In a history of the capital gains tax, the Tax Policy Center reports that “The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) cut the top tax rate on long-term capital gains from 20 percent to 15 percent, the lowest level since World War II.” Obama’s budget proposes to restore the 20% tax rate on those families making more than $250K. For some historical perspective, this level is more favorable than the recommendations of a 1997 Congressional Joint Economic Committee Study.

There is an old saying: “The poor fight the wars, the rich pay for them.” Former President Bush, together with his party, had a novel idea on this centuries old maxim. Why not have the poor fight the wars in Iraq and Afghanistan and not have the rich pay for it? Instead, the U.S. would charge the war expense on its “credit card”, the U.S. Treasury. It was an interesting idea that didn’t work out so well as the “credit card balance”, the national debt, of the U.S. grew from $6.2T in 2002 to over $10T in 2008.

Defense spending has almost doubled since 2002. To keep our country strong, the rich need to do the noble thing and pay for it. Defense spending is an insurance policy on one’s assets.

President Obama and his wife paid over $700K in taxes last year on $2.7M in income, most of it from the sale of Obama’s books. They didn’t complain about paying that much in taxes and I promise that I will be noble and won’t complain if I make $2.7M next year.

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