Taxing the rich

By Felix Salmon
May 16, 2011
Andrew Ross Sorkin gives credence -- but doesn't directly link to -- Karen Hube's rather offensive analysis of what it means to be "down and out on $250,000 a year". Hube's article comes up with a hypothetical two-earner family -- Mr and Mrs Jones -- who between them earn $250,000 a year, and who "end up in the red" at the end of the year.

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Andrew Ross Sorkin gives credence — but doesn’t directly link to — Karen Hube’s rather offensive analysis of what it means to be “down and out on $250,000 a year.” Hube’s article comes up with a hypothetical two-earner family — Mr and Mrs Jones — who between them earn $250,000 a year, and who “end up in the red” at the end of the year.

How do they do this? Well, for one thing, they put $41,000 a year into savings; they also pay $9,069 per year on out-of-pocket medical expenses and going to the dentist. And check out those two cars, which add up to as much as $16,277 per year between them. Are these normal and reasonable expenses for the average family of four? Of course not: the average family of four earns roughly that much money ($66,346) in a year pre-tax — and then, first and foremost, has to buy or rent a house of some description.

In any case, the Jones’s lifestyle ($19,000 a year for daycare and after-school activities; $1,571 a year for the dog) is hardly that of a “down and out” family.

Meanwhile, Sorkin quotes Roberton Williams as saying that when it comes to the $250,00-a-year cut-off, “the very round nature of it suggests that it’s arbitrary.” Which is about as sensible as criticizing a 14% cut-off on pinot noir alcohol levels on the grounds that it’s arbitrary. Any cut-off is going to be arbitrary, but $250,000 seems like a good one to me: it’s low enough that tax hikes above that level can move the needle in terms of fiscal revenues, while being high enough as to affect only a tiny percentage of taxpayers.

And while $250,000 a year certainly isn’t don’t-need-to-ever-worry-about-money rich, both Sorkin and Hube completely miss the point about marginal tax rates, which is that they’re marginal. If the tax bracket over $250,000 a year were raised to 99% tomorrow, the effect on the Jones family would be zero: no one’s suggesting raising federal income taxes on the Joneses by a penny.

And in fact Hube’s analysis shows that federal income taxes are a very small part of the total Jones tax burden. Let’s say that they both got 15% raises, so that their household income rose to $287,500. And let’s say that the tax rate on income over $250,000 a year is raised to 39.6% from the current 33%.

Right now, the Jones family pays somewhere between $29,909 and $34,317 in federal income taxes, depending on where they live. Let’s split the difference and call it $32,113. That’s just 12.8% of their total income. With their pay rise, they’d pay an extra $14,850, bringing their total federal income tax burden to 16.3% of their total income. (Update: As several commenters point out, that’s the gross extra tax they’d pay. Even if taxes didn’t go up at all, they’d still pay an extra $12,375 in taxes.) They would probably pay extra state income tax too, depending on where they lived — but they would still end up with an extra $20,000 a year or so in post-tax income to spend on fancy vacations or flashier cars. That kind of money is a real windfall for the vast majority of families in America; for the Joneses it would be a nice benefit at the margin.

The thing which really annoys me about all these pieces is that they seem to be based on the idea that a sensible fiscal policy would only raise taxes on people who are so rich that they never need to worry about money. Which of course is ridiculous. And when Sorkin says that “tax brackets could be added for the wealthiest,” he starts talking about tax brackets at the very highest levels of the income distribution — which look more punitive than useful. Instead, why not implement a wealth tax? Ask anybody with a net worth north of, say, $5 million to pay 1% of it per year in taxes. Then you’re certainly taxing the rich. Even Karen Hube would have to admit that people with $5 million in the bank count as rich. Wouldn’t she?

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Comments
21 comments so far

Aha! Felix has finally recognized the difference between high-income and high-wealth. Certainly people with $5M “in the bank” are rich; $5M of net worth probably counts as well, or is at least at the very upper reaches of “upper middle class.”

My sense is the difficulty here is logistical. How do you track everyone’s wealth and how do you value the non-liquid assets? It would require a whole new infrastructure for the IRS to manage.

Also, Felix says: “The thing which really annoys me about all these pieces is that they seem to be based on the idea that a sensible fiscal policy would only raise taxes on people who are so rich that they never need to worry about money.” It seems to me this is not what “a sensible fiscal policy” needs to be, but that it’s the clear implication of how President Obama and the Democrats describe their plan. The argument seems to be that people earning over $250K can “afford” to pay more in taxes (people like Bill Gates and Warren Buffett have said this explicitly); it’s only logical to examine this claim, although I agree that some of the analysis has been poor.

Posted by right | Report as abusive

How about a compromise: let’s raise the marginal tax rate on income above $300,000 a year to the same marginal rate that I, a retiree(age 69), self-employed part-time with a total AGI of $53,000 per year, pay. Certainly that couldn’t be too much could it? Well, my marginal income tax rate is 58.7% (66+ percent, including state tax): 25% (based income tax rate) +21.3% (tax on 85% of Social Security income) +12.4% (self-employment tax) = 58.7%.

Posted by bmz | Report as abusive

add more marginal brackets… duh.

Posted by KidDynamite | Report as abusive

For comparison, here is a dual income tax payer in CA Bay area

Combined income 300K, 401K contrib =25K, net 275K
State taxes 17.5K, Federal taxes 49K [AMT], Total taxes = 66.5K

If you include payroll taxes, (SS + Medicare for 2 people = 17.5K),Total taxes = 84K

That is a *flat rate* of 28% on 300K. NOT MARGINAL. More correctly, this is a *flat rate* of 30% on 275K. (as the 401K will be taxed later)

[This is when you rent. If you buy a home (a 50 year old rundown, termite eaten ranch house goes for 800-900K here, on a 720K loan) you end up with property taxes of 11K and tax deductions (state, Fed) of 13K - a wash. What MID gives, property taxes take away.]

Taxes on wage earners are high, taxes on unearned income is low. There is no one earning a million+ who pays 30% as taxes. They pay more like 16%. And none in the median income range.

If Obama’s proposal to raise SS taxes, goes through, then this will raise taxes to 31.9% FLAT on 275K. It won’t raise taxes on high earners. Same is the case with raising taxes on 250K+, or higher brackets.

Raising payroll/income taxes is code for raising taxes on LABOR income. What is required is to raise taxes on UNEARNED income -capital gains, dividends – and WEALTH.

And for the record, 19000 in child care is standard if you have 2 kids. An average run-of-the-mill day care is 12000/yr, and aftercare is 6000/yr here.

Posted by Wagerat | Report as abusive

Felix, you’re not framing the tax difference for the $287K income dramatically enough. The difference in taxes on the $37,500 pay raise is less than $2500, which is less than 1% of the total income. It’s not a huge increase, and if we agree that tax revenues need to be increased, this isn’t imposing an unfair burden on the $250K+ set.

And if you don’t believe that tax revenues need to be increased, then please suggest another alternative to cutting spending and dealing with the implications of those cuts.

Every boundary in a man-made system is going to be arbitrary.

Posted by KenG_CA | Report as abusive

There is a huge difference between high income and high wealth. It starts with the tax rates, among other things.

If a person has a high income, but not a high wealth, then it is almost certain that much their income will be taxed as ordinary income with FICA and Medicare as well. However, if the high income is derived from high wealth as investment returns, then the taxes paid may be less than half of the ordinary income rates due to the low capital gains and divdend tax rates, as well as potentially tax-free munis.

If much of the $250k income family’s $40k in savings is in retirement accounts, then they will pay ordinary income tax in retirement on that deferred income. On the other hand, the high wealth family will pay at the capital gains rate and dividend tax rate if the accounts are outside retirement accounts.

All in all, it probably requires $5 million in net assets to generate a consistent disposable income from investment returns similar to the $250k income family. The $250k family will need to save that $40k/year for many years in order to be able to retire “wealthy” with a similar pot of gold.

I will point out that many tax breaks start phasing out above $100k for families and many are completely gone by about $160k in AGI. Also, a $250k family won’t get a dime of non-merit financial aid, especially grants, from colleges, so a couple of kids eats up that disposable income pretty quickly for a decade while they are in college.

Posted by ErnieD | Report as abusive

I’m personally in favor of cutting off prosecution of crimes committed against rich people, really. I mean, if they want their tax cuts, then they can’t complain if services are reduced.

Posted by GRRR | Report as abusive

The above are numbers from an actual TurboTax filing. It may not fall into any clean tax bracket math – but this is the reality for dual income families on the coast today.

I have analyzed Piketty and Saez’s numbers [from 2007 IRS tables] to some extent, and what it shows is that taxes *paid* max out at ~400K income. [2007 $ amounts AGI]

That is the dirty secret of talking in quintiles, and top 10%, 5% etc. Classifying along those lines hides the fact that tax rates start fall when you cross ~400K income. Because of the low tax rates on investment income.

Posted by Wagerat | Report as abusive

As KenG_CA points out, I still don’t think you are framing this correctly.

Old Salary: 250k
New Salary: 287.5k
Income subject to marginal rate: $37.5k

Old Marginal Rate: 33%
New Marginal Rate: 39.6%
Difference: 6.6%

$37.5k * 6.6% = $2,475

So you’re asking a couple that earns $287.5k per annum to pay an additional $2,475 in taxes. That is $206/month, or 15% of what this couples pays per month for its vehicles.

Posted by MitchW | Report as abusive

I think the real message is that even having a high income doesn’t mean you can’t piss it all away if you think that your birthright is to have a very nice car, nice holiday, lots of gifts, and a big, expensive house in a very desirable area. Being middle-class doesn’t mean you get to have everything you could possible want.

I mean, those numbers are just ridiculous – if they are spending that much on everything, they can’t be trying very hard to economize.

Posted by timg | Report as abusive

How are you “in the red” if you are saving 40k a year? What am I missing? Savings /= spending

Posted by rab5566 | Report as abusive

All this really says to me is that people who make somewhere north of $150k a year have completely missed the implications of the housing bust. All these budgets are based on what are still aspirational houses that are much bigger and more expensive than any families realistically need. Having a single family house that is over 3000 square feet is the reason is also the reason that utilities are running $440 a month and $400 a month in house cleaning. Oh and realize that you probably can’t afford to live in the same zip code with the same brand of car as your boss.

Posted by tuckerm | Report as abusive

Don’t these people have any deductions? You’d have to deduct them from the $287.5K to determine how much actually gets taxed at the higher rate.

Posted by KeithOK | Report as abusive

bmz, you can’t possibly be paying double/triple tax on all of your income, right? shouldn’t your effective gross tax rate be a weighted average across self-employment vs. social security income rather than a straight sum? i.e. something like 25% + (actually) 15.8% on your self-employment income, then another 21.4% on 85% of the social security income above the designated limit. you also get to deduct half of the 15.8% from your agi, which is an implicit benefit. in total, your margin rate should be something like 30-40% of AGI – not great, but nowhere close to the 58.7% rate, either.

Posted by thetrblmkr | Report as abusive

Yes. The argument is being made that because people earning x have made certain choices that they should not be taxed. They might make $500k a year and have to pay for the nanny and private school and the vacation home(s) but they earned those and therefore it’s wrong to force them to make different choices.

The argument is essentially that you get what you deserve, but in an extremely illogical manner. There are two parts to this.

First, let’s say you make $80k, which is a pretty good income. You pay your withholding for social security and medicare and have to come up with some more in April because your income tax withholding was light (so you’d have some extra cash each check). You can’t afford a nanny. You can’t afford much of a vacation. You can’t afford to eat out very much and certainly not at any expensive place. Sending your kid to religious school is a stretch and college means taking on a lot of debt. You have very little in savings because you need to spend what you make. But you pay taxes. The level of taxes you pay forces you into decisions about your life, just like for someone making more than you. Is the level of tax this person pays written in stone? Is the difference between you and the guy making more or less than you written in stone? Both are constrained. That people are constrained is not news. It is a phony argument to say that minor tax increases constitute a constraint as though those taxes suddenly create constraint that doesn’t otherwise exist. You always have constraints, some your choice and some forced on you.

The second part is really that paying more means you become too much like the guy who makes less, an echo of “redistribution”. I thank you, Felix, for noting how silly that is; a tax increase of a few thousand dollars barely touches the gap.

Posted by jomiku | Report as abusive

Of course, Sorkin is the guy who recently bought a 2.315 million dollar apartment on the UWS: http://www.huffingtonpost.com/2010/08/04  /andrew-ross-sorkin-pays-m_n_670407.htm l#s122559. I am sure he knows exactly how incredibly tough it is for high income people to make ends meet.

Amazing what sort of biased crap the NYT is publishing.

Posted by TSTS | Report as abusive

Well $5M would support a safe withdrawal rate of $200K, wealthy, but not as much as someone earning #250K.

Posted by MyLord | Report as abusive

thetrblmkr:

No, My numbers are correct(I actually pay them); on my next dollar(the definition of “marginal”) of self employment income, I pay over 66% total income tax. BTW in the computation of AGI the self employment tax is 12.4%.

Posted by bmz | Report as abusive

I believe KeithOK has the first point that needs to be made up front: in addition to the marginal nature of the tax rate that Felix cites, one needs to take into account that the rate is applied to the household’s AGI. The Jones family puts $40K into tax-deferred savings accounts and $30K into mortgage interest, and they have 2 kids. They are nowhere near being affected by the roll-back of the Bush cuts on the wealthy, even after getting their raises. I wonder if anyone at the fiscal times cares about how these things actually work?

The second point is as others have made here: if you choose to live in the nation’s toniest zip codes, it’s going to cost money. But you are not a regular Joe in that instance, so stop trying to claim your pain is that of every schlep living in the bottom 99.9% of neighborhoods.

Posted by kdog45 | Report as abusive

“Well $5M would support a safe withdrawal rate of $200K, wealthy, but not as much as someone earning #250K.”

Is that meant as a joke? If not, it’s just silly. If you were my financial advisor you’d be fired. How can someone with $5 million in the bank be less wealthy than someone making $250k as a wage slave? Well, I guess if you had 5M but didn’t have a job or collect social security, or own your home outright, then it would be close in terms of cash flow. But if you don’t work, then there goes those child care and dry cleaning expenses. And move some of that 5M into tax-free bonds and the tax advantages close the gap even more, if not eliminate it all together.

But the main point you’re missing is that if you have $5 million in the bank you have $5 MILLION IN THE BANK. How long would it take the Jones family to save $5 million bucks? About 70 years — in other words, they could never do it.

Posted by howardhonk | Report as abusive

You used the word punitive when you described ‘wealth taxes’. I don’t think it is about punishing anyone. – Wealth taxes are setting limits – as in framing – saying none shall exist outside of this frame set. Punitive implies something more personal. There is an obvious problem when 1 percent control 40 percent of the natural resources of a nation. Such consolidation is out of line with any paradigm which matches the value of work, innovation, and risk with personal value and reward – essentially nobody can work 1000x harder, or be 1000x smarter than an average person. A set of extents and limits should be set as a way of controlling unhealthy resource consolidation. I offer a plan here: http://99percent-economic-revolution.blo gspot.com/ and maybe it is laughable at this point – yet the conversation must begin. What exactly will the occupy WS movement demand if not a re-balancing of resources.

Posted by polarsouth | Report as abusive
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