Rather Than Effective Tax Rate, Lets Talk About Effective Income.

uncle_samI have been trying to pay more attention to discussions about the economy, government, and taxes. My problem with how these discussions typically go is that using a tax rate alone to discuss taxes is deceptive. This becomes even more true when you talk about high income earners, which seems to be what most tax discussions revolve around these days. It is very easy to lose track of, or completely overlook, exactly what a specific tax rate means in the real world. Earlier today I saw someone asking the question, “does a total tax rate (federal, state, ect) of 70% seem fair on income earned above 110k/year”? They were trying to make the case that this would be incredibly unfair and at first glance this does seem like quite a lot. However, I argue that this seems like a lot because we are only looking at the rate, in this case 70%, and because we have a hard time thinking about what this rate means beyond the numbers average people tend to work with. In 2011 median household income in the United States was $50,054/year which at 40 hours a week comes out to approximately $24/hour pre tax.

Before we dive into our hypothetical 70% tax rate, lets get some real world numbers and see what is actually going on right now, in terms of effective income. I am a Maryland resident so I am going to use the combined Federal and Maryland tax brackets for my calculations and I am going to assume a 40 hours work a week and filing taxes as single.

There is a wonderful federal tax bracket break down available here: Federal Tax Brackets

Similarly there is break down of the Maryland tax brackets available here: Maryland Tax Brackets

After calculating the both the Federal and State Tax and determining after tax income I calculated hourly after tax income based on a 40 hour work week for a range of incomes starting with a minimum wage of $7.25. highlighted in red. I also included, highlighted in blue, the US 2011 median household yearly income.

Table 1

Net Yearly Income Hourly Pre Tax Total Taxes After Tax Income Hourly After Tax
$15,080.00 $7.25 $1,505.70 $13,574.30 $6.53
$20,000.00 $9.62 $1,702.50 $18,297.50 $8.80
$30,000.00 $14.42 $2,102.50 $27,897.50 $13.41
$40,000.00 $19.23 $4,403.75 $35,596.25 $17.11
$50,054.00 $24.06 $7,003.41 $43,050.59 $20.70
$75,000.00 $36.06 $8,001.25 $66,998.75 $32.21
$100,000.00 $48.08 $16,646.25 $83,353.75 $40.07
$250,000.00 $120.19 $64,211.25 $185,788.75 $89.32
$500,000.00 $240.38 $160,329.80 $339,670.20 $163.30
$1,000,000.00 $480.77 $424,518.30 $575,481.70 $276.67
$2,500,000.00 $1,201.92 $1,104,768.30 $1,395,231.70 $670.78
$5,000,000.00 $2,403.85 $2,238,518.30 $2,761,481.70 $1,327.64
$10,000,000.00 $4,807.69 $4,506,018.30 $5,493,981.70 $2,641.34
$100,000,000.00 $48,076.92 $45,321,018.30 $54,678,981.70 $26,287.97

Please let me know if you want a copy of the excel sheet I calculated this in and I will make it available somehow.

 

Lets run some numbers and look at the effective hourly income after the 70% tax rate has been applied.

Table 2

Net Yearly Income Hourly Pre Tax 70% Tax After Tax Income Hourly After Tax
$15,080.00 $7.25 $10,556.00 $4,524.00 $2.18
$20,000.00 $9.62 $14,000.00 $6,000.00 $2.88
$30,000.00 $14.42 $21,000.00 $9,000.00 $4.33
$40,000.00 $19.23 $28,000.00 $12,000.00 $5.77
$50,054.00 $24.06 $35,037.80 $15,016.20 $7.22
$75,000.00 $36.06 $52,500.00 $22,500.00 $10.82
$100,000.00 $48.08 $70,000.00 $30,000.00 $14.42
$250,000.00 $120.19 $175,000.00 $75,000.00 $36.06
$500,000.00 $240.38 $350,000.00 $150,000.00 $72.12
$1,000,000.00 $480.77 $700,000.00 $300,000.00 $144.23
$2,500,000.00 $1,201.92 $1,750,000.00 $750,000.00 $360.58
$5,000,000.00 $2,403.85 $3,500,000.00 $1,500,000.00 $721.15
$10,000,000.00 $4,807.69 $7,000,000.00 $3,000,000.00 $1,442.31
$100,000,000.00 $48,076.92 $70,000,000.00 $30,000,000.00 $14,423.08

I decided to tweak the numbers into the absurd. If someone who makes $10,000,000/year was to be considered working literally every hour of every day for the entire year and were taxed at 99% they would still be making $11.40/hour after taxes which is well over federal minimum wage.

This is one of the greatest problems with humanity. Our inability to understand the implications of growth and/or deal with large numbers intuitively. Working with %s alone can be incredibly deceptive. While yes, a 70% tax rate definitely too high for someone earning 50-100k/year or less, it is probably not that unreasonable for individuals earning over $500,000/year. Also, keep in mind that the above 70% tax rate calculation applied the 70% to the entire $500,000.  In the scenario proposed in the original question this rate would only be applied to income after the first $110k/year. I have a hard time agreeing with an argument that a tax rate that results in someone earning over$72/hour after tax on income over $110k/year is unfair.

Edit: It was pointed out to me that many individuals who make over 100k/year work more than 40 hours a week. I did look at this but neglected to mention that I cut the tables out of my original post to keep it short and to the point. I will, however, add an updated versions of that chart based on 50, 60, and 70 hours per week.

50 Hours per week

Net Yearly Income Hourly Pre Tax Total Taxes After Tax Income Hourly After Tax
$15,080.00 $5.80 $1,505.70 $13,574.30 $5.22
$20,000.00 $7.69 $1,702.50 $18,297.50 $7.04
$30,000.00 $11.54 $2,102.50 $27,897.50 $10.73
$40,000.00 $15.38 $4,403.75 $35,596.25 $13.69
$50,054.00 $19.25 $7,003.41 $43,050.59 $16.56
$75,000.00 $28.85 $8,001.25 $66,998.75 $25.77
$100,000.00 $38.46 $16,646.25 $83,353.75 $32.06
$250,000.00 $96.15 $64,211.25 $185,788.75 $71.46
$500,000.00 $192.31 $160,329.80 $339,670.20 $130.64
$1,000,000.00 $384.62 $424,518.30 $575,481.70 $221.34
$2,500,000.00 $961.54 $1,104,768.30 $1,395,231.70 $536.63
$5,000,000.00 $1,923.08 $2,238,518.30 $2,761,481.70 $1,062.11
$10,000,000.00 $3,846.15 $4,506,018.30 $5,493,981.70 $2,113.07
$100,000,000.00 $38,461.54 $45,321,018.30 $54,678,981.70 $21,030.38

60 Hours per week

Net Yearly Income Hourly Pre Tax Total Taxes After Tax Income Hourly After Tax
$15,080.00 $4.83 $1,505.70 $13,574.30 $4.35
$20,000.00 $6.41 $1,702.50 $18,297.50 $5.86
$30,000.00 $9.62 $2,102.50 $27,897.50 $8.94
$40,000.00 $12.82 $4,403.75 $35,596.25 $11.41
$50,054.00 $16.04 $7,003.41 $43,050.59 $13.80
$75,000.00 $24.04 $8,001.25 $66,998.75 $21.47
$100,000.00 $32.05 $16,646.25 $83,353.75 $26.72
$250,000.00 $80.13 $64,211.25 $185,788.75 $59.55
$500,000.00 $160.26 $160,329.80 $339,670.20 $108.87
$1,000,000.00 $320.51 $424,518.30 $575,481.70 $184.45
$2,500,000.00 $801.28 $1,104,768.30 $1,395,231.70 $447.19
$5,000,000.00 $1,602.56 $2,238,518.30 $2,761,481.70 $885.09
$10,000,000.00 $3,205.13 $4,506,018.30 $5,493,981.70 $1,760.89
$100,000,000.00 $32,051.28 $45,321,018.30 $54,678,981.70 $17,525.31

70 Hours per week

Net Yearly Income Hourly Pre Tax Total Taxes After Tax Income Hourly After Tax
$15,080.00 $4.14 $1,505.70 $13,574.30 $3.73
$20,000.00 $5.49 $1,702.50 $18,297.50 $5.03
$30,000.00 $8.24 $2,102.50 $27,897.50 $7.66
$40,000.00 $10.99 $4,403.75 $35,596.25 $9.78
$50,054.00 $13.75 $7,003.41 $43,050.59 $11.83
$75,000.00 $20.60 $8,001.25 $66,998.75 $18.41
$100,000.00 $27.47 $16,646.25 $83,353.75 $22.90
$250,000.00 $68.68 $64,211.25 $185,788.75 $51.04
$500,000.00 $137.36 $160,329.80 $339,670.20 $93.32
$1,000,000.00 $274.73 $424,518.30 $575,481.70 $158.10
$2,500,000.00 $686.81 $1,104,768.30 $1,395,231.70 $383.31
$5,000,000.00 $1,373.63 $2,238,518.30 $2,761,481.70 $758.65
$10,000,000.00 $2,747.25 $4,506,018.30 $5,493,981.70 $1,509.34
$100,000,000.00 $27,472.53 $45,321,018.30 $54,678,981.70 $15,021.70

 

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