Taxes and Voting

Another inebriated debate with my Libertarian friend about tax policy.  Not much of a debate, really.  I had a loose command of facts and figures.  The sad fact is I haven’t really examined Obama’s tax plan.  So here it is in a nutshell: http://www.barackobama.com/taxes/.  You can link from this page to a PDF of Obama’s full tax plan.  I think part of the (my) problem is I have very little faith that any candidate’s tax plan is necessarily going to meet with reality once they get into office.  For example, “According to the Tax Policy Center, the Obama plan would reduce taxes as a share of the economy to less than 18.2 percent – the level of taxes that prevailed under President Ronald Reagan.  The Obama plan pays for these tax cuts by cutting spending overall.”  OK – there is a huge assumption right there, considering the $700B and counting that is being shelled out to stabilize the financial system already.  Nevertheless, I find myself agreeing with Obama directionally.  That is, I fundamentally agree that the idea of rolling back tax increases on the top five percent of earners – note this really is a rollback, not an unprecedented tax hike – while reducing the burden on the remaining 95% makes sense.  My Libertarian friend thinks this will tank the economy (even further) by disincentivising entrepreneurs from creating jobs, causing corporations to pass on increased tax costs to consumer prices, etc.  Joe the Plumber got dragged into it of course, and there was some confusion about individual income taxes and taxes on small businesses. 

 

So now let me look at some numbers.  This is going to take several blog posts to sort out – if it is ever sorted out – but at least let’s take a stab at this.

 

I was asked if I would be willing to accept an increase in my taxes should my wife’s and my joint income exceed $250,000.  (Oh! Would it were true!)  I said yes, and my friend said I was crazy.  He said he would make sure to cap his income at $249,999.  I stuck to my guns – I would be willing to sacrifice for the greater good.  My wife was like, oh yeah, at the cut-off point you get screwed, but people figure out how to manipulate that number to their benefit eventually. Mly wife also astutely pointed out that while federal income taxes have gone down, state and local taxes have gone up because the burden was shifted to them.  (Note: Obama's plan includes subsidy-style relief at the state and local level.) Every tax structure has transitional points where someone is at a disadvantage.  Personally, I feel that in general people want to earn more money, even if at some point their taxes are increased.  There are other benefits to earning a higher salary – for example, enhanced qualification for loans, or even a sense of status – that may balance out a tax increase.

 

First of all, let me confess that I am irresponsibly ignorant of what actual tax brackets are.  I’ve been calculating the top tax bracket at 36%, but when I did a search I found it is 35%.  I’m sure someone can set me straight on this, but I’m working with 36% for now.

 

So let’s say you earn $250K now and are taxed at 36%.  Your tax is $90,000 and your net income is $160,000.  Increase that rate to 39% and you are paying $97,500, netting $152,500.  You are paying an additional $7,500 in taxes.  To get back to netting $160K, you would need to raise your income to $262.5K. 

 

Tactically, if I were in the position of being offered a raise that would put us over $250K, I might tell my employer, Why don’t we keep it just under that for now.  But I would do so with the expectation that at some point in the future I might receive another raise that might, say, put me at $260K – still within in the screwable zone.  I would take that hit to maintain the upward trajectory, banking on the dream that I would eventually surpass that break-even point, and take some practical action to minimize the tax increase.  For example, while until recently I had been contributing the max to my 401K, I haven’t put any money in Roth IRAs for years.  Theoretically, I could offset that $7,500 tax increase by $4,000 in deferred investment.  The remaining $3,500 I would eat or try to make up with some other source of income.  Perhaps it is a sales commission, or a translation job.  This is the alternative economy after all.  In any case, if I’m making $250K, I’m not complaining.

 

Now let’s look at this small business owner situation.  I did a little digging around and as I suspected, an increase in the tax rate for small business owners earning over $250K is not going to crush the American Dream.  Here are a few figures:

 

Less than 20% of small business owners earn more than $100,000, and the median is somewhere around $50,000. (Guardian: “Courting Joe the Plumber”)

 

These numbers are close to figures for individual earnings overall as reported by the US Census Bureau for 2007: About 20% earn more than $100,000, while the median is $50,223.  (Newsweek: “Sorry, Pal, You’re Rich”)  According to this article, which discusses incomes in expensive urban areas, 2.245 million Americans earned more than $250K, or 1.9% of the population.

 

According to factcheck.org, McCain’s claim that Obama would raise tax rates for 23 million small business owners is complete BS.  23 million is the total pool of small business owners – as of a 2002 US Census report.  The actual pool is larger, of course, but the vast majority neither earns close to $250 nor employ any workers at all.

 

According to ABC (“Which Candidate’s Plan Helps Small Business”), the actual number of small businesses is 27.2 million, out of which 6 million, or 22% have any employees. It reports that the National Federation of Independent Business found that only 14% earn more than $200K.

 

An interesting article on Gather.com (“Who Makes $250,000 a Year? Not Small Business Owners”) categorizes those who might earn more than $250K and very few of these are necessarily directly employing workers in a business.  For example, corporate executives and marketing or sales people are not small business employers – they work for companies.  High-earning professionals such as doctors and lawyers are generally affiliated with larger organizations such as law firms and hospitals.  And so on. 

Where is this leading me?  Based on the above, I am guesstimating that maybe 10% of small business owners - that would be some 2.7 million entrepreneurs - earn more than  $250K and have employees.  The missing number would be how many employees we are talking about here. I suppose I'll have to do a little more digging.

 
My Libertarian friend insists that Obama will actually increase the tax rate for top earners to 50%.  I did not know where he pulled that number but poking around I have seen commentary that the combination of income tax and social security tax would make this so.  But I can’t get my head around that now so that will be for another blog.