A surprising new report from FORBES: Here’s the dirty little secret that we don’t like to talk about – when it comes to income tax, top earners really do pay more in federal income taxes. According to recent Internal Revenue Service (IRS) data, Americans earning over $100,000 paid 79.5% of federal income taxes in 2014.
The preliminary data… indicates that 148,686,586 Americans filed individual income tax returns in 2014. Of those, only about 112,831,339 taxpayers reported taxable income (adjusted gross income less deductions). Of those, 96,612,233 taxpayers filed individual income tax returns showing $1.358 trillion in total income tax due. Total income tax is the sum of income tax after credits plus the infamous Net Investment Income Tax (NIIT). It does not include any of the other taxes that make up total tax liability including uncollected FICA (or Social Security) tax on tips, additional tax on income from nonqualified deferred compensation, and repayment of advance payments of the health coverage tax credit; those additional taxes would bump up the number of taxpayers to 101,021,848 owing $1.419 trillion in total tax.
The data shows that 23,745,195 Americans filed individual income tax returns reflecting adjusted gross income (AGI) of $100,000 or more in 2014, representing 16% of all returns. Of those, most (23,626,332) reported tax due (yes, it’s possible not to owe tax at those income levels). Those 16% of taxpayers paid $1.079 trillion in taxes or 79.5% of the total income tax paid.
I know what you’re thinking: what about all of those supposed tax breaks for the rich? What about Warren Buffett? The self-made billionaire Warren Buffett has attracted a great deal of interest for making comments suggesting that most wealthy Americans pay a lower tax rate than those who work for him, saying in 2007: “I’m willing to bet anyone in this room $1 million that those rates are less than the secretary has to pay.”
In 2010, Buffett continued the conversation when he announced that he paid an effective tax rate of just 11.06%. Today, Buffett is the third wealthiest person in the world with a current net worth of $67.2 billion…
And here’s where the math can get funny. While the top 16% of Americans paid nearly 80% of taxes by dollars, that doesn’t mean that they paid an 80% tax rate. Don’t conflate percentage of all taxes paid with tax rates. Remember, we have a progressive income tax. With a progressive income tax, the rate of tax increases as taxable income increases but – and it’s a big but – everyone pays the same rate for the same income.
Here’s an example: Let’s assume you have taxable income of $100,001 as an individual. You might look at a tax table and assume your tax rate is 28%. But that’s your marginal tax rate or more simply, your top rate. For federal income tax purposes, every dollar that you make over $100,000 will be taxed at 28% until you hit the threshold for the next rate. But every dollar that you made from the first dollar was not taxed at 28%.
That’s because every dollar of taxable income (income figured after deductions, exemptions, exclusions and other adjustments) from zero dollars to $9,225 is taxed at 10% for every person filing as single. Every dollar of taxable income from $9,226 to $37,450 is taxed at 15% for every person filing as single. Every dollar of taxable income from $37,451 to $90,750 is taxed at 25% for every person filing as single. Every dollar of taxable income from $90,751 to $189,300 is taxed at 28% for every person filing as single. In other words, all taxpayers in the same filing status are taxed at the same rate for the same income. (Those are numbers figured using the tax rates for 2015.)
It’s typically more helpful to look at the effective tax rate. The effective tax rate has different meanings depending on the context but at its most simple, it’s calculated by dividing your total tax by your taxable income.
Using that math, the effective tax rate for all taxpayers in 2014 is 19.6%. The effective tax rate for taxpayers making more than $100,000 in 2014 is just a bit higher: 23.6%. Here’s how it breaks down:
Huh? That doesn’t seem to jive with what I said earlier about 16% of taxpayers paying 80% of tax. Why not? You have to look at all of the numbers in context. While it’s true that taxpayers reporting over $100,000 pay most of the total taxes, it’s also true that they generate most of the income. The top 16% of taxpayers reported $5.574 trillion in adjusted gross income (AGI): that’s 57.7% of the total adjusted gross income for all taxpayers.
The numbers are even more stark when you look at taxable income: the same 16% of taxpayers were responsible for generating 66% of all taxable income. When you think about it in those terms, the numbers begin to make a little more sense: those that generate the most taxable income pay the most in total tax by dollars. Whether that’s “fair” or not is another story.
Keep in mind this is preliminary data which means that it represents estimates of income and tax items based on a sample of individual income tax returns for 2014 filed between January and late September 2015. Returns are weighted to represent a full year of taxpayer reporting. That means some data gets left out – in this case, it’s mostly data for those filing last minute tax returns on extensions. Those tend to be – though not always – higher income taxpayers.
You can get a better handle on figures by using the IRS’ complete year data, but the problem with that is that it tends to be a bit old and doesn’t reflect contemporaneous data or changes in the tax laws. In our case, preliminary data (what I used) is available for 2014, but the last set of complete data available dates back to 2011.
It’s also important to remember that this data focuses on income tax rates, not other taxes such as Social Security and Medicare taxes. If you factor those in, the rates look very different. Medicare taxes are flat (all taxpayers pay the same 1.45%) as are Social Security taxes (all taxpayers pay the same 6.2%), but they are capped so that taxpayers who make over $118,500 do not pay Social Security tax on the amount over $118,500. Additionally, under a law that kicked in beginning in 2013, an employer must withhold additional Medicare tax of .9% from wages paid to an individual earning more than $200,000, regardless of filing status or wages paid by another employer.
Gary D. Halbert is the president and chairman of Halbert Wealth Management, Inc. His Forecasts & Trends Weekly E-Letter may be obtained free of charge by subscribing at www.halbertwealth.com.