Taxes, math and semantics

Headline from today's NY Times: "Senate Rejects President's Plan to End Tax Cuts for Top Earners" The statement is 100% true, but what does it really mean? To "end tax cuts for top earners."

I think very few understand even the basics of how tax brackets and marginal tax rates work, and because of it many people believe that Republicans want to extend the temporary Bush tax cuts for everyone and Obama wants the top earners to go back to the (higher) Clinton-era tax rates (which are scheduled to kick back in on Jan 1.)

This is not correct.

Both sides want to give everybody lower taxes (than what is scheduled to happen on Jan 1), the Republican just want to go further for the top earners. There is nothing obscure about this (other taxes, exceptions, etc) - just the simple facts about the basic tax bracket proposals. So, the real question is whether top earners should get a smaller tax cut or a bigger one.

At this point I should clarify that the semantics around tax cuts versus tax increases depends on what you compare the taxes to. Compared to the current law for 2011 (higher scheduled taxes than in 2010) we're talking about 2011 tax cuts for everybody (both the Democratic and Republican proposals.) Compared to the 2010 taxes we're talking about tax increases for top earners.

Now, let's review the two proposals (comparing the taxes to what's currently scheduled for 2011). Obama wants to lower taxes in all tax brackets below $200,000 for individuals ($250,000 for families). As a standalone proposal, who will benefit the most from this: someone who makes $40,000 or someone who makes $400,000? If your first thought  was "the person making $40,000" I'm pretty sure you'd be in the majority. And you'd be wrong. The person making $40K (slightly better than the median US income) would get their taxes reduced on all their earnings up to $40K. The person making $400K would get that reduction plus their taxes also reduced on the next $160K (if filing individually, $210K if filing as a family).

Without running the numbers, the $400K earner will receive a tax cut that is 5X (tax reduction up to $200K instead of $40K) the one received by the $40K earner. In actuality the difference is much greater since most of the income below $35K didn't receive a Bush tax cut at all and isn't scheduled to change for 2011. Being a geek, I looked up the tax tables and did the math and the $40K earner gets about a $580/year tax cut while the $400K earner gets approximately a $5,400 tax cut.

This is the Obama proposal compared to doing nothing. The Republican proposal means also lowering taxes on the second $200K earned by the $400K earner, which would result in about an additional $6,200 for a total tax cut of $11,600.

To summarize:
Obama wants to lower the taxes for the $40K earner by $580/year and the taxes for the $400K earner by $5,400.
Republicans want to lower the taxes for the $40K earner by the same $580 and the taxes for the $400K earner by $11,600.

I'm all for taxes being as low as possible for everyone, but the problem is that the additional tax cut by the Republicans costs about $700,000,000,000 (seven hundred billion) over 10 years, and without a plan to raise that money some other way, that's added to the already massive US debt. And this is on top of the $3,000,000,000,000 (three trillion) cost of the tax cuts that both sides agree on.

Finally, a few words on what it takes to be wealthy. I've heard over and over again people saying that the Obama proposal will tax people that are not wealthy, which makes me wonder what it takes to be wealthy. First, I believe people misunderstand again and think that people making $200K will pay more taxes under the Obama proposal than under the Republican proposal. That's obviously wrong, since the proposals only differ on income above $200K.

So, let's instead look at someone making $250K. For this person the difference between the two proposals is 3% for the $50K above $200K which comes to $1,500/year ($125/month). Let's assume that the person also pays 10% in other income taxes (State & Soc Sec). This would mean that they have a take home net pay of just over $13,700/month under the Republican proposal and just under $13,600 under the Obama proposal. 1) I think that kind of monthly income makes you wealthy, especially considering that it's about $11,000 more than the median working American. That's a lot of extra money to spare. Every month. 2) I doubt that most people making $250K will even notice whether they get that $125/month tax cut or not.

For the $400K earner, again, the difference is $6,200/year which is just over $500/month. That sounds like real money. To me. But when your income is that high, I'm not sure you'll really notice if your after-tax check is $20,700 or $20,200/month. You still have an extra $17-18,000 to spend every month compared to a typical person. For example, a person with a $1,000,000 mortgage would still have $13,500 in money to spend on other things (or save) each month.