Marginal Tax Rates 101

Tax Forms and Calculator - photo by 401(K) 2012

You can blame President Obama and Democrats for inadequately explaining the impact of a tax rate increase, but it’s really up to people to understand how marginal tax rates work before foolishly criticizing tax policy.

Understanding how marginal tax rates work is not complex, but it takes more than a few words to explain. Republicans are able to take advantage of this because the public has the attention span of a gnat. Many have no interest in learning how something works, they instead want someone to tell them sweet little lies to make them feel good and confirm an existing bias. So go ahead and blame Democrats for losing on messaging, but it was a battle lost before it began.

For the sake of those who are still reading that might not understand how marginal tax rates work, here’s a brief, but slightly hyperbolic explanation by David Weigel at Slate:

How do you get to be as rich as the people in this New York Times story without ever figuring out how taxes work?

Kristina Collins, a chiropractor in McLean, Va., said she and her husband planned to closely monitor the business income from their joint practice to avoid crossing the income threshold for higher taxes outlined by President Obama on earnings above $200,000 for individuals and $250,000 for couples.

Ms. Collins said she felt torn by being near the cutoff line and disappointed that federal tax policy was providing a disincentive to keep expanding a business she founded in 1998.

“If we’re really close and it’s near the end-year, maybe we’ll just close down for a while and go on vacation,” she said.

You see these idiots every time a tax hike becomes possible again. They have no apparent idea how marginal rates work. Right now, if her and her husband make $250,000, they pay at most a 33% tax on some of that income. If they made $251,000, they would have to pay the same rates for everything except that last $1000 — that, they’d be taxed at 35%. If the rates increase across the board that top rate becomes 39.6%. – The Rich People Who Don’t Know How Tax Rates Work

And here are a few comments from Weigel’s article that further emphasize how marginal rates work, and why it’s not a disincentive to make more money:

As someone who has had the privilege (and I do mean privilege) of paying the highest marginal rate under many different tax regimes, they never never never inhibited me from earning more. Never. And I travel in these circles and know no one — Republican or Democrat — who has ever been so inhibited. No one. Ever.

I think the point is that it’d be a tiny increase in actual new taxes paid because it only applies to the amount above $250,000, for a couple. Thus, if it increases 4% that’s only $40 for every new $1,000. That is unlikely to discourage anyone from earning more money unless they’re just looking for an excuse to complain.

Why would you make less money because some of the new money would be taxed at a higher rate? Spite? Principle?

Regardless of how many times Bill O’Reilly says otherwise, a 4 or 5 point increase to the top marginal tax rate is not a disincentive to make more money. It’s absurd, and I’m pretty sure the people who try to defend this “logic” know it’s absurd. / photo by 401(K) 2012

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