Middle Class Taxpayers Still Lose

December 29th, 2011 at 9:45 am | 25 Comments |

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The recent fight over the extension of the payroll tax holiday has once again shown that the Republican Party does not particularly care about the middle class tax burden. The party is quite interested though in cutting taxes on the highest earners. What gets completely ignored is the fact that most billionaires already have lower effective tax rates than some segments of the middle class.

Warren Buffet reports paying about 17% of income in taxes. And according to the IRS, 400 U.S. taxpayers with the highest adjusted gross income are subject to the effective tax rate about 18%. How do these numbers compare to those of the middle class?

Let us consider a hypothetical not-so-average Joe. Not Joe the Plumber, but Joe the Scientist. Suppose Joe earned his PhD in a STEM field a couple years ago and last year was earning a salary of $9,000 a month. Furthermore, let’s suppose that Joe is single, lives in a rented apartment and has a sizable student loan, just a few thousand dollars in savings and no other assets to speak of except for a nice (but not too fancy) new car (which, alas, comes attached to a car loan with the principal currently exceeding the realistic resale price). In other words, Joe has a negative net worth. Joe is certainly in the middle class and not rich by any stretch of the imagination (in fact, if he lives in a place with very high cost of living like New York City or San Francisco, I’m not even sure he qualifies for the upper middle class).

Finally, let’s suppose that Joe was not yet making any 401(k) contributions last year and that his health insurance cost $500 a month of which $400 was paid by his employer and the other $100 was deducted from his pay (so Joe’s 2010 W-2 showed $108,000 Medicare wages and $106,800 taxable wages). So, what was Joe’s effective tax rate last year?

In order to determine it, we need to calculate both the total taxes and total compensation. The latter needs to include not only all money paid to Joe by his employer but also all money paid on Joe’s behalf by his employer. The employer paid $4,800 for health insurance, $108,000 x 1.45% = $1,566 for the employer’s share of Medicare taxes and $106,800 x 6.2% = $6,621.60 for the employer’s share of Social Security taxes. That brings the total compensation to $120,987.60. Let’s just ignore negligible additions like unemployment insurance and workers comp premiums, interest on Joe’s savings account etc.

Now, the taxes. The employer’s share of FICA taxes was $1,566 + $6,621.60 = $8,187.60. Joe paid the same amount (remember, we are talking about last year, when there was not payroll tax holiday). So the total FICA taxes were $16,375.20.

And then there’s income tax. Joe was considered too rich to be allowed to take any student loan interested deduction, so his adjusted gross income was $106,800. Since Joe is neither old nor blind and has no dependents, he can take only one personal exemption, $3,650. Joe does not have any mortgage interest to deduct, and let’s suppose that he paid $5,000 in state income taxes and $200 in personal property taxes (on his car) and also had documented charitable donations totaling $500. His potential itemized deductions amounted to a total of $5,700, which also happened to be the standard deduction, so itemizing did not actually make any sense.

Subtracting the personal exemption and standard deduction from the adjusted gross income, we arrive at the taxable income of $97,450. The income tax table shows us the amount of tax due: $21,002.

The addition of the FICA taxes and the federal income tax gives us the total federal taxes paid by Joe in 2010: $37,377.20.

Finally, dividing this amount by total compensation of $120,987.60, we obtain Joe’s effective tax rate – 30.9%. Wow! The federal government took over 30% of Joe’s earnings! Just as a reminder, typical Joe the Billionaire pays 18%.

We constantly hear lamentations over the low number of Americans pursuing doctorate degrees in STEM fields. Perhaps this hypothetical example of Joe the Scientist might suggest one of the reasons?

When people invest in their education, our human capital increases. But do taxes discourage such investments? Let’s not forget that getting a doctorate degree does not only require a big investment of time and effort – it can also be a very substantial financial investment. When people think of really expensive graduate education, they think along the lines of the Harvard Law School. But a doctorate degree in science, math or engineering at a modest public university can cost a fortune too – because of opportunity costs. A bright young person with a BS in, say, chemical or computer engineering can earn a pretty good salary straight out of school and still higher salary after gaining a couple years of experience. Spending several long years in grad school instead can mean foregoing hundreds of thousands of dollars in gross earnings. Sure, an advanced degree means higher income after graduation, but the reward is not all that high (especially when we compare workers with PhD with workers with BS and several more years of experience).

And how is that return on investment in human capital taxed? Well, the top portion (last $15,000) of Joe’s earnings is taxed at 28% plus there’s a total of 15.3% in FICA taxes. So the federal government alone takes 43.3%, and there are quite a few states with income tax rates over 7%. So depending on which state Joe lives in, the government may well receive higher reward for Joe’s educational investment than Joe himself!

If any investment in financial markets received such tax treatment, supply-siders would scream bloody murder. But they seem to be curiously uninterested in other, equally important, kinds of investment.

And while the case of somebody in the middle class with an effective tax rate over 30% is rather rare (although far from impossible, as I have shown), there are millions of people in the middle class with effective tax rates above 20%. The GOP needs either to give them some really good arguments for further cutting taxes on the wealthiest taxpayers who already pay less than 20% – or come up with a different party platform.

Recent Posts by Andrew Pavelyev



25 Comments so far ↓

  • kccd

    While I have no argument with your estimated tax burden for someone making $120K, that person is not likely to be a scientist a few years out of grad school. Here are salary ranges for various disciplines in science and at various levels:

    http://www.prweb.com/releases/2011/12/prweb9009903.htm

    While some newly minted engineering grads may command high salaries, most other Ph.D. holders make do with much much less. Post-doctoral fellowships take 2-5 years and generally pay under $50K. This helps explain why the profession is not so attractive to top students, along with the fact that tenure is a thing of the past and the fact that grant money is a career-long struggle and at the present time has all but dried up.

    The other point is that most scientists in my experience do not leave school with significant student loans. My Ph.D. in the 1970s was completely paid for by various graduate fellowships, and my son, who is currently in a Ph.D. program, has full financial support from a company.

    • Andrew Pavelyev

      The salary is actually $108K. It is nothing unusual for a recent graduate with a PhD in Physics or Math working at a private company (let’s just say that I have some insider knowledge). And I can only guess that a PhD in Biochemistry may pay still more.
      Also, in my experience (I was in physics grad school in the 90′s and my wife was in biology grad school in the last decade) it is not unusual for an American citizen or permanent resident to graduate with sizeable student loans (of course, there were also a lot of foreign students who did get by entirely on teaching assistantships etc. since they could not get student loans). Don’t forget that before people even get to grad school, they need to get a BS, and that’s getting more and more expensive.

  • Graychin

    “…400 U.S. taxpayers with the highest adjusted gross income are subject to the effective tax rate about 18%.”

    The odds are high that FF favorite Mitt Romney is among those 400. Romney’s effective tax rate is probably less than that since he has been “unemployed” for some time now and earns no salary income to be taxed at higher rates. Most if not all of Romney’s income these days is treated as capital gains income:

    http://thinkprogress.org/economy/2011/12/09/386564/romney-admits-all-investment-income/

    Does Mitt Romney care about the middle class? You betcha! He wants to eliminate the capital gains tax for people who earn less than $200,000 per year – who, of course, have few if any capital gains. (Watch for that $200,000 figure to creep higher and higher, eventually eliminating the capital gains tax entirely – the Holy Grail of the plutocratic agenda.)

    Romney also wants to eliminate the estate tax (aka the “death tax”). That will give a big break to middle-class families with taxable estates greater than $5 million – and, coincidentally, allow him to pass his fortune to his five sons tax-free. Everyone wins!

  • TerryF98

    Why do you think Romney is refusing to release his tax records. The answer is he is only paying 15% tax, if that.

  • icarusr

    Frankly, I’m getting really tired of all this harping on the “middle class”. In a Republican forum. By Republican authors who will support a BSE-addled donkey painted red if s/he were to stand against the Kenyan socialist incompetent weak anti-Israel compromiser in-over-his-head Mooslim in November. (Then again, said donkey might be less dangerous and possibly brighter than some of the actual candidates.)

    Day after day, Frum and his gang criticise this or that right-wing dork or politician for failing to offer a program or provide support for the middle class; and day after day they extol the virtues of the admittedly cynical flip-flopper millionair serial liar Romney and the wholesomeness of their vaunted Republican Party. Cognitive dissonance, much?

    So I say, enough already. The middle class ship has sailed for Republicanism. There is no program but to help the rich; there is no policy but to defeat the anti-Christ ni**er; there is no objective but to wage perpetual war against all enemies of America – browns, yellows, f*gs, Democrats, whatever. This is what the party is now. It will not change between now and November. It might after that – who knows – but not now.

    So let us have it out: will Frum Forum and all the bleating sheep who write here actually denounce the clown the Republicans will nominate, on the basis that the Party has no coherent program to help the middle class and to deal with America’s problems – no coherent program, period? Because, as everyone knows, unless you are willing to walk, you are not serious.

    So are you all willing to walk in November?

    • TerryF98

      About time someone laid it out in plain language. Romney is no better and in many ways worse than clowns like Bachman. At least she is sincerely wrong. He is knowingly wrong and totally cynical.

      Yet Frum and friends will continue to fluff this flip flopping cyborg and gladly pull the lever for him.

      • chicago_guy

        Ah, the irony of the Romney candidacy. At its heart, even those of us who aren’t Republicans have to admit that the Tea Partiers are right about one thing; Romney is a craven little boy, willing to say whatever he thinks will make him popular with whatever group he’s addressing. As with Stein’s assessment of Oakland, “there’s no there there.”

        Unfortunately for the TPers, the remainder of the field run the gamut from whack job (Paul/Bachman) to mentally retarded (Perry) to terminally sinister (Gringrich). So they’re gonna be stuck with a little rich boy whose policies are only geared toward helping him and his, because in his heart of heart, Romney believes that, just as with his ‘very special’ religious beliefs, some people are just a little better, a little more informed than others – and he’s one of those special ones.

      • margoharris1

        The republicans demand to be lied to. And they will by damn find the biggest liar to vote for. Bet on it.

    • valkayec

      From Rolling Stone:

      “In an internal memo written just days after the inauguration, O’Neill advised Bush that he had a “great opportunity” for quick action on his tax cuts if he framed the choice for Congress as tax cut vs. recession. “We can get this argument on our ground,” O’Neill wrote, “and stop the drumbeat about a tax cut for the rich.”

      With no patience for the specifics of tax policy, Bush deputized Vice President Dick Cheney to push through his tax cut for the rich. Once a deficit hawk who confessed that he was “not convinced that the Reagan tax cuts worked,” Cheney had emerged from his tenure as CEO of Halliburton as a leading advocate for rewarding big corporations and their executives – even as GOP moderates warned that Bush’s tax cut would foreclose needed investments in education and infrastructure. “The vice president had no interest in what I had to say,” recalls [Sen. Lincoln] Chafee. “He ran the show right from the beginning, and he suffered no compromise.”

      Read more: http://www.rollingstone.com/politics/news/how-the-gop-became-the-party-of-the-rich-20111109#ixzz1hy

  • Rob_654

    Some Conservatives and Libertarian-types I know are finally starting to catch up with what other people have known and been thinking for a long time – that when it comes to what the wealthy really pay in taxes and what middle class folks really pay in taxes – the middle class is getting hosed and the Republicans will do anything to protect the wealthy but only pay lip-service to the middle class.

    This latest Republican disaster really brought out some folks who love Conservatives to say “Wait a minute – they were fighting for the wealthy just a while ago to protect their tax cuts and now when its “my” tax cuts they suddenly say “no” unless they can “pay for it” and add their own goodies to the tax cuts”.

  • Reader123

    Andrew: Presumably the 18% effective rate is largely (not entirely) attributable to the 15% long-term capital gains rate. But haven’t many of those dollars already been taxed, generally at the corporate rate of about 35%? There are all sorts of asterisks here (offsetting losses, the possibility that the burden of the corporate tax falls more heavily on consumers/labor/management than the shareholders, etc.), but it’s hard to believe that the corporate tax has zero effect on Warren Buffet’s effective bottom line.

    • SteveT

      Except, of course, that many of those corporations don’t pay any taxes. Some are getting tax credits on top of not paying taxes.

      This has been well documented and reported.

      • Reader123

        I already conceded that corporations have ways of reducing their taxable income. But that doesn’t eliminate the corporate tax. For example, there’s was a November 2011 study by liberal groups (easily found on google) that claims to show that the average effective corporate tax rate for about half of the Fortune 500 is about 18.5% (instead of 35%). 18.5% is not zero, and when combined with the 15% rate on long-term capital gains and qualified dividends, is in the ballpark of ordinary income rates. Also, even if the 18.5% number is accurate and representative, it’s almost certainly unusually low because the study was looking at years 2008-2010, when many of these companies likely had huge losses to offset income.

        The point of all this is that the actual effective tax rate of the 0.01% is higher and much more complicated than their tax returns suggest.

        • sweatyb

          The richest 400 people do not pay the taxes of the corporations they run or the ones they invest in. They do not pay the taxes of the employees of those corporations. They do not pay the taxes of the people who use the products of those corporations.

          They pay taxes on the money they report as income. Just like everyone else in the country. And while their tax bill is large, their income is even larger. And they pay taxes at an effective rate that is much lower than the rate at which the middle class (and even the top-20%) pay.

    • sweatyb

      All money is taxed multiple times as it moves through the economy (prominent exceptions being criminal activity and — as SteveT points out — corporate profits).

      It seems to me that you are clouding the issue with the pedestrian insight that Buffet would make more money if his investments performed better.

    • balconesfault

      For what it’s worth … when corporations are deciding on compensation for their employees, there are two big factors in play – corporate profitability (amount of money they have to invest in labor), and the going market rate for labor (how much labor costs).

      At a societal level … corporate profitability is incrementally reduced by corporate taxes, leaving corporations less money to pay employees. When extended across industry as a whole, this means that that there is less money available to compete for labor, which means labor is paid less.

      So just as the investing class takes a hit from corporations being taxed … so does labor. But for some reason we have some ideology that money obtained without labor should be taxed at a substantially lower rate than money obtained via labor.

      Well – not “some reason”. The reason is that the class that makes the vast majority of their money from investing, rather than labor, has a strong vested interest in promoting those media and politicians who echo that ideology. And our system responds accordingly, because those who point out the fallacy are immediately branded by corporate media and corporate-owned politicians as “neo-Marxists” and the like and summarily dismissed from the discourse.

      • Reader123

        Responding to both reply-ers:

        sweatyb: (1) Corporate profits are, in general, taxed. Most instances of corporations not paying corporate tax for a particular year are due to loss carryforwards (meaning that there generally aren’t economic profits to tax). There are all sorts of special tax provisions benefiting particular industries, methods for deferring tax, etc., and you can argue back and forth about the policies behind them, but it’s a myth that corporations don’t pay tax. (2) You’re correct that the point I’m making is an obvious one (that the corporate tax is, economically, partially paid by the shareholders) — which is why it’s frustrating that most stories about Warren Buffet’s effective tax rate ignore it.

        balconesfault: (1) You’re absolutely right that the burden of the corporate tax might be borne in part by labor/consumers/management. My point was that Warren Buffet’s effective tax rate is higher than it looks. (2) There are a lot of policies behind having a reduced long-term capital gain rate — it’s not nearly so simple as “rich people power structures.” (For example: cost basis is not inflation-adjusted so a lot of capital gain is nominal and not real; to encourage realization (with a few exceptions, the government cannot tax gain unless there is a sale); capital gains is a double-tax on retained earnings; etc.). People can argue about the validity of any of these, but the policy arguments are much deeper than you’re suggesting.

        • balconesfault

          (1) You’re absolutely right that the burden of the corporate tax might be borne in part by labor/consumers/management. My point was that Warren Buffet’s effective tax rate is higher than it looks.

          Great. But then acknowledge that the functional decrease in the take home income for you average worker that results from corporate taxation is lower than it looks if you simply consider FICA and Federal Withholdings.

          Cuts both ways. Thus, I shall no shed tears for Warren … who apparently doesn’t want them anyway, or for Romney … who kindof does.

          (2) There are a lot of policies behind having a reduced long-term capital gain rate — it’s not nearly so simple as “rich people power structures.” (For example: cost basis is not inflation-adjusted so a lot of capital gain is nominal and not real

          This is the one legit reason, which was the basis for the original Reagan cuts to capital gains taxes during a period of very high inflation. Obviously, for the last decade or so, that argument has been irrelevant, and maintaining the low tax rate seems more a function of “rich people power structures” than of any inherent logic.

          to encourage realization (with a few exceptions, the government cannot tax gain unless there is a sale);

          This is usually a short term phenomena, realized as a windfall by those holding onto large profits ready to be realized when a decrease in the capital gains tax rate occurs. On a long term basis, they are a forfeiture of a higher long-term tax revenue for an immediate short term tax revenue windfall by government. Which is kind of “non-conservative” economics, but that’s for a different discussion.

          In fact, there is also a decent argument to be made for tax rates encouraging a bit more stability in investments than we’ve seen over the time period since Reagan’s first massive capital gains tax cuts.

          capital gains is a double-tax on retained earnings etc.). People can argue about the validity of any of these, but the policy arguments are much deeper than you’re suggesting.

          Interestingly, you’ve made no arguments that don’t fall perfectly in alignment with the best interests of the aforementioned “rich people power structures”. Which again, I would argue, is why media empires which are owned by those “rich people power structures” have little interest in challenging them.

        • sweatyb

          thank you for replying and acknowledging my point. Though you don’t seem to understand why I made it.

          Can you explain why you would persist in viewing corporate taxes as somehow different than any other business expense? Why don’t we calculate the cost of hiring workers, to pick one example, into Warren Buffet’s effective tax rate?

          I accept that corporations (like individuals) should and will use whatever legal means to reduce their tax burden and that fluctuations in the world economy can cause these companies to have no income tax burden at all. It still seems to me that in some instances corporate profits are much higher when they’re reported to shareholders than when they’re reported to the IRS.

      • Graychin

        “(W)hen corporations are deciding on compensation for their employees, there are two big factors in play – corporate profitability… and the going market rate for labor.”

        Corporate profitability has little if anything to do with deciding on compensation for employees. Corporations will pay the going rate for labor, and not a penny more than they have to. And they will only hire when more workers are needed to satisfy demand for the company’s products.

        Demand comes first. Then hiring – at the market rate.

        • balconesfault

          Yes, but you are ignoring that across society, that market rate is influenced by the profitability of corporations. If hiring more labor/talent will enable a corporation to increase profits, it will do so. If you arbitrarily reduce all corporations ability to compete for labor by some set amount via taxation, then they will individually need to pay labor less, because their competitors also have less money to spend on labor.

          I am not arguing for getting rid of corporate taxes, btw. Just acknowledging as Reader does above that corporate taxes in some proportion reduce the money available to investors and labor, and forces increases in the prices to consumers.

  • Reader123

    n/t

  • Oldskool

    Yes, but, a lot of those $108k earners believe the sh*t shovelled by Rs and consider themselves “job creators”. Does anything else matter? Nope. Rs know that if they con enough people, they get to do whatever they want. Invading another country for no good reason, for example. If you can con an entire country into invading a country that poses no threat, is there anything you can’t do? Hell no. They have earned the right to be ambitious!

  • Grace

    Wow, Mr. Pavelyev, you’ve sold me! The top 1% pay a much lower tax rate than the middle class or even the upper middle class, and it’s harming the nation. That sure hasn’t turned out to be good policy! Why, it even turns out that not all tax cuts pay for themselves!

    What to do, what to do?? Any ideas, Sparky? I know! We could stop working against our own interests and stop supporting the party devoted to continuing and worsening this problem! That’s the ticket! We could support and vote for people who don’t salivate at the thought of selling us down the river!

    Are ya with me, Mr. Pavelyev? Wait, what? You’d do that, but that would mean abandoning the tribe and admitting you’ve been played for a sucker all these years? Ahh, now I see the problem. Better to get to work on how to “give them some really good arguments for further cutting taxes on the wealthiest taxpayers who already pay less than 20%…”

    And what, pray tell, would those arguments be?