What is a Marginal Tax Rate?

Lots of people are talking about Alexandria Ocasio-Cortez (AOC). She’s young. She’s popular. She doesn’t owe anyone anything, so she’s clean (for now) of the political incentives that generally make politicians act against their constituency’s best interests. She’s all for some really big changes, and is a wunderkind when it comes to making those ideas look very attractive. All in all, she’s poised to be a pretty amazing politician (again, for now).

A great policy-maker, though? No, not so much.

Let’s just get this out of the way: Many of her ideas are profoundly bad. It all pretty much revolves around one simple fact: the government is generally an awful steward of money and power. AOC wants to create some huge social help programs, and wants the government to be in charge of them. I’m all for social help. But I’m much more for social help that actually helps, instead of just trying to help, and ending up either failing, or doing such an inefficient job that it’s little more than a giant waste of taxpayer dollars.

There’s one thing that I want to address here, though. AOC wants to implement a 70% marginal tax rate. Though it is a bad idea, I really want people to understand why it’s a bad idea; because the current arguments against it are… well, to put it bluntly, stupendously ignorant. Bottom line up front: her plan won’t increase your taxes. Not unless you’re so rich that you spend more on your CPA than most of us make in a year, anyway.

So, then (if you’re ok with marginal tax rates), you should be in love with this idea (for the record, I’m not ok with marginal tax rates, but I’ll get to that later).

Here’s the argument that’s wrong, ignorant, and often espoused by people who know better, but are ok with manipulating people who don’t understand what that very special word, marginal, means:

“AOC wants to tax folks at 70%! That’s ridiculous! 70%?! What a bunch of socialistic madness. No one can afford that! Shame! Shame on that horrible newbie!”

Convincing people this way is like telling people that sour grapes are a tasty snack, because while you know better, you also know that most people have no idea what the word “sour” means. In a nutshell, here’s the answer (details to follow):

No one that has any trouble affording anything will be affected, at all, by AOC’s plan. Not one person.

So, here follow the math details. It’s actually pretty simple, even obvious, if you got A’s and B’s in high school math. If you weren’t much for math in high school, then it won’t be obvious, but it’s still simple.

A “marginal” tax rate just means that you get taxed one rate on the first chunk of money you make, a higher rate on the next chunk of money you make, and an even higher rate on the next chunk, etc., until you reach the highest tax bracket for your total income.

For example, suppose I make $50,000 in a year. Let’s also say my taxes are super simple; I’m single, I don’t own a home, I don’t have kids, I don’t have any investments, etc. I.e., I just graduated from college, rent a nice little single-bedroom apartment, and work a decent salaried job.

So, I use the standard deduction on my taxes (in 2019, that’s $12,200). The result is that my taxable income is $37,800. This means I pay $0.00 taxes on my first $12,200. That’s the first tax bracket, in which the tax rate is 0%. No one, in this country, in 2019, that makes $12,200 or less, pays any taxes.

The next bracket is 10%. After I’ve made $12,200 (which wasn’t taxed at all) in 2019, every dollar up to $21,900 is taxed at 10%. So, from this tax bracket, I will owe:

10% × ($21,900 − $12,200) = 10% × $9,700 = $970

So far, having made $21,900 this year, my tax is $970. Now we look at the next tax bracket. After I’ve made $21,900 (which was taxed at 0%, and then 10%) in 2019, every dollar up to $51,675 is taxed at 12%. However, I only made $50,000, so for me, I pay 12% on every dollar over $21,900, but less than $50,000:

12% × ($50,000 − $21,900) = 12% × $28,100 = $3,372

So, my total tax is now $970 + $3,372 = $4,342

If it hasn’t clicked yet, here’s the kicker: Let’s say I get a bonus, and now my income at the end of the year is $51,676 (i.e., $1 more than the 12% tax bracket limit). I will have done the “dreaded” thing: I’ve just made enough money to raise myself into the next tax bracket: 22%. But—and here’s the crucial part, the reason why this tax bracket bump should not be dreaded—I will only have to pay a 22% tax… on that $1 that is in that tax bracket.

I will pay 12% taxes on all the money between $21,900 and $51,675 (this ends up being $3,573 in taxes), and I will also have to pay a 22% on $1. Yup, that’s 22 cents. So, my total tax, now that I’m in the 22% tax bracket, will be $970 + $3,573 + $0.22 = $4,543.22.

In other words, I made $1,676 more, bumped myself into the 22% tax bracket, and only had to pay $201.22 more in taxes. Not bad, considering I’m now in the 22% tax bracket…

Let’s look at it another way: “Effective Tax Rate.” Basically, this just takes your actual tax bill (after all the marginal math), and looks at it as a percentage of the actual income you got for the year. Following the above examples, this is what my tax rate “really” works out to be:

(Actual taxes paid) ÷ (Total income) = Effective Tax Rate

When I made $50,000, my effective tax rate was:

$4,342 ÷ $50,000 = 0.08684 = 8.684% = about 8.7%

When I made $51,676, my effective tax rate was:

$4,543.22 ÷ $51,676 = 0.08792 = 8.792% = about 8.8%

The point is, my taxes, effectively, didn’t go up from 12% to 22%. They went up from 8.7% to 8.8%.

If you run the same numbers (I won’t bore you with the math), on a super rich guy that makes $10M in 2019, his tax bracket is the highest one in the current system: 37%. He is taxed on every dollar he makes above $522,500 at that 37% rate. His effective tax rate is 36.6%. Note that his effective rate is so close to his tax bracket rate because he made a lotmore than $522,500, so the majority of his income was taxed at this rate; i.e., the lower taxes he paid on the first chunks of money he made didn’t have much effect on his effective tax rate.

And now here’s where AOC’s 70% marginal tax rate comes in. She wants to add a new tax bracket to the top. If you make more than $10M in a year, then she wants to tax the dollars above $10M at 70%. This will only affect the fantasticallyrich. The result will be that the folks that make $30k per year, the folks that make $50k per year, and the folks that make $10M per year, and everyone in between, will be unaffected. But the guy that makes $1 billion per year will see his effective tax rate go from 36.999% to 69.933%.

And that’s it.

The next time someone tells you that AOC wants to tax the crap out of everyone, you’ll know what’s up. AOC only wants to tax the crap out of folks that make more than $10M. Her justification is that those guys don’t need that much money, so no one should have a problem with the government taking it away and spending it on social programs.

And here’s where I have a problem.

Yes, this only affects the utterly Richie-Rich folks, and these guys don’t need anyone defending their money, right? They’re stinking rich. Not exactly the kind of person that elicits empathy when compared to folks that need money badly, and could get it from a new social program or two, right?

I’m not arguing who needs the money more. Folks in dire straits should have help. Undoubtedly. My argument is very different. It’s not about who needs it and who doesn’t, or who deserves it more. It’s about how the folks that need it should get it.

I have a serious problem a.) with the government taking it away because a bunch of voters decided that it’s ok, and b.) with the government’s track record in using the money they take wisely.

Point a.) is basically that a marginal tax rate is theft from the rich. This may have some nice Robin-Hoody feelings to it, but… Robin Hood stole from the Sheriff on Nottingham. The reason he’s not seen as a villain is because his victim wasn’t just rich. He was rich because he was also a thief. A worse one (ironically, he taxed the poor into starvation). While we may have a reasonable argument about how some of America’s rich got their riches, I don’t think it’s anywhere near fair to lump them all in with the Sheriff of Nottingham. Even if some benefit from unfair monopolies or other capitalistic exploits, these deserves specific anti-trust laws and regulations; not blanket taxes on all the rich.

If that doesn’t make your moral compass swing around, then look at it this way: Imagine you’re making $50,000 a year, and you live in a low-income city, where just about everyone is making around $15,000 a year; just squeaking by. They find out you’re making bank, and pass a law that says that they are now legally allowed to take a bunch of your money for themselves, because they think it’s unfair for you to have so much when they have so little. This is obviously wrong.

But this is exactly what the marginal tax rate is. The only difference is that they take sufficiently little of your money under the current system that you don’t bother to get up in arms about it… and because most people incorrectly assume that it’s ok because that’s how the government has always done it. But none of that changes the fact that it’s ethically wrong for the government (or anyone else) to take money from you simply on the grounds that you make more of it.

Do you deserve a Lamborghini when a fellow human being a few miles away is squeaking by on 1,500 calories a day? No. But does that human being deserve to steal your car? Or is it right for your neighbor to steal you car and give it to them?

This is the “is” vs. “ought” situation that so often confuses this conversation. Wealth inequality exists. That’s the “is,” and it’s a bad thing, I think we can all agree. Let’s not forget that the person squeaking by on 1,500 calories a day is actually “rich” when compared to the third-world-country citizens squeaking by on 800 calories a day. No arguing that. But how should we fix this? That word, “should,” brings us to the “ought” side of the argument. Wealth inequality is a terrible “is.” Using the government, and taxes, to fix it, as a terrible “ought.” Its only redeeming grace is that it’s occasionally a very fast fix. But then we end up regretting it when all the unintended consequences arise. This brings us to…

Point b.) Which is much simpler. The government does a bad job. They aren’t incentivized to use taxpayer money well. A few officials may have to take an oath promising that they’ll do a good job, but that’s about it. The reason the American economy has done so well for so long is because if a business does a job anywhere near as bad as the government does, it goes bankrupt, can’t pay its bills/employees, goes out of business, and is replaced by a business that does the job well. When the government does a poor job with taxpayer dollars, either no one notices or no one cares. It’s not like they have any competition, and “oversight agencies” do just as badly at their job (oversight) as any other government agency does.

When AOC says let’s put a 70% marginal tax rate on the super-rich, understand that she’s not going after your money. She’s just advocating theft from people that our society seems to think ought be stolen from.

It’s not about whether you think the poor need the money more. It’s about whether you think anyone ought to be stolen from.

Seriously rich people, in general, do give a lot to charity. They could certainly give more, sure. But when it comes down to it, the issue at hand is this: legally requiring the rich to give more through higher taxation (or any other means of law-based coercion) boils down to this: One group of Americans using the power of the government to legally steal money from another group of Americans.

If me saying that makes you think, “Well, it’s not stealing if it’s legal,” allow me to remind you that the law doesn’t release you from your obligation to morality. There are plenty of things that are both legal and wrong. The marginal tax rate is one of them.

Now, I’m not an anarchist. I do think the government should be responsible for a fair number of things. I also think income tax is a reasonable solution. But why on earth we don’t have a flat tax rate system is morally mind-boggling to me. For a country that is so deeply into the concept of fairness, this is a huge blind spot. A simple two-bracket system, in which no one pays taxes on a minimum “standard of living” income, followed by a flat tax rate (say, 15%) on everything above that, would be both far more fair, and also far simpler to deal with on tax day. I don’t have the numbers on this, but I suspect it would also result in the IRS bringing in more than it does today, thanks to the removal of all the loopholes in the system that allow the super rich to enjoy tiny effective tax rates.

If you want to talk unfair, think of the tax-savvy Richie Rich guy that manages to finagle paying zero taxes under the current system.

Bottom line: I’m usually the guy that says things are more complicated than they appear, and easy solutions are a pipe dream. This issue is a major exception. Instead of doing something complicated and unfair to one group of people in order to make things more fair for another group of people… how about just doing something really simple and make things more fair for everyone at the same time? 

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