How We Talk When We Talk About Taxes

Imagine that a politician announces a plan to cut local/state/federal taxes on income up to $20,000. Is this policy:

(A) A tax cut for struggling working class Americans?, or
(B) A tax cut for all Americans?

Now imagine a different politician announces a plan to cut local/state/federal taxes on income up to $200,000. Is this policy:

(A) A tax cut for all but the wealthiest Americans?, or
(B) A tax cut for all Americans?

If you answered based on how the policies would likely be described in American political discourse, you probably chose A as the best answer for both questions. But answer B is factually correct in both cases.

When we talk about taxes we tend to talk about groups of people when it would be more accurate to talk about income. If you make $80,000 a year and taxes are cut on the first $20,000 of income, you pay lower taxes because of a policy that “cuts taxes on America’s struggling working class families”. If you make $800,000 a year and taxes are cut on the first $200,000 of income you pay less tax due to a policy that “benefits all but the wealthiest Americans”.

The explanation for this disjunction between description and reality may be that it plays better politically for some political actors to speak of groups with putatively non-overlapping incomes (e.g., “the wealthy”, “working families”, “the poor”) than it does to acknowledge that no gets to the higher tax brackets without passing through the lower ones shared with the rest of population.

To a short order cook making $20,000 a year, it may seems appealing to think that an income tax cut that has been capped at $20,000 uniquely benefits people like him, and the politician who proposed the policy may try to foster that perception. But of course people making more than the cook also get a tax cut on the first $20,000 they make. Likewise, a sociopathic millionaire lobbyist may make political hay by saying that a tax cut on incomes up to $200,000 does not help America’s “job creators”, when it fact it is a handsome tax cut for people such as himself.

Comments

  1. Colin says

    If you cut the tax rate on income up to $200k, it’s still true that a) almost all the benefit accrues to people earning $200k or less (because there are so many more of them than people earning more than that), b) the benefit to ultra-rich is much less than a tax cut of a similar magnitude across the board (because $200k is such a small share of their income). Where the propaganda falls down is somewhere in the middle, with people who earn more than $200k but not orders of magnitude more. These people are considered rich by most sane people, but they’re still getting a substantial tax cut.

    For the tax cut on incomes up to $20k though, politicians who want this tax cut to go ahead should be selling it as money back for everyone, because they’d get a much broader coalition of support that way.

    • Keith Humphreys says

      For the tax cut on incomes up to $20k though, politicians who want this tax cut to go ahead should be selling it as money back for everyone, because they’d get a much broader coalition of support that way.

      Colin: It’s an empirical question, but this may not be correct. The experiment would be whether the support of people making up to $20k for this tax cut was affected by a politician making clear that the policy would result in millionaires paying less tax too. Maybe they would not care…but maybe they would be less enthusiastic because they resent rich people getting a break.

  2. says

    This is an excellent point; I think it’s a very common mistake to assume that people understand the math of a graduated tax.

    One common idea I hear is that wealthy people can donate just enough money to charity to put themselves in a lower bracket, and thereby end up better off (because they save more in taxes than they donate). A graduated tax does not create this effect, but are there other parts of tax law that do? Or is it an outright misunderstanding?

    • matt w says

      There are some aspects of Vermont property tax law that I think have this effect; it seems as though someone who makes $90,005 is likely to take home less than someone who makes $89,995 net of property tax. But that’s not what these guys are talking about.

      There was also the tax loophole Mitt Romney used, where he set up a “charitable” trust that allows him to defer tax payments because whatever’s left in the trust is going to the Mormon church — except it’s paying Romney so much money that there isn’t going to be anything left for the church. But that was largely banned in 1997, and probably isn’t what your informants are thinking of.

      So I’m going for “outright misunderstanding.”

    • Warren Terra says

      The number of educated people I’ve encountered who don’t understand graduated taxes appalls me.

      The other big one is people not understanding (or affecting not to understand) that businesses (and for that matter wealthy people) are taxed on their net income, not their gross revenue. Prominent examples include not-Joe the not-Plumber in 2008 (a two-fer: the plumbing business he liked to fantasize about owning was grossing about $250K, and not-Joe understood neither that this wasn’t the taxable income nor that taxes on a taxable income of that size would barely rise if at all) and Mitt Romney in the debates last month (when he claimed that business taxation discouraged hiring, even though payroll expenses are completely tax deductible).

      • Ken Rhodes says

        Warren, a reasonable guess at the percentage of people who misunderstand “marginal tax rates” is somewhere north of 90%. Anyone reading this who thinks I’m exaggerating consider this conversation:

        Person 1 — “He did that (took a loss, or donated money) because he needed the deduction.”
        Person 2 — Nods, or replies “uh huh.”

        It’s a mighty small percentage of folks who would reply “That’s silly. A deduction doesn’t create a net gain.”

        • John G says

          I don’t disagree that misunderstanding is widespread.

          However, this conversation might make sense if the deduction or loss was taken at a particular time, because it affected taxable income in one period rather than another. A person donated money now rather than later because the cumulative deductions in this period put him into a lower tax bracket than if he had waited to donate (or likewise to realize a loss – that’s why a lot of stocks are sold in December – to realize losses that can be set off against gains, or vice versa.)

          It is often said to be unfair that people in higher tax brackets ‘benefit’ more from deductions for things like charitable donations, because they have a larger tax impact. A person in a 40% bracket saves 40% of his/her deduction, while a person in a 20% bracket saves half as much, for a donation of the same number of dollars.

          I am inclined to take the view that the person in the higher bracket still pays more tax than the person in the lower one, and the deduction effect is just a collateral compensation for this status.

          However, to meet the criticism, personal donations in Canada are now allowed a tax credit rather than a deduction, so it has the same impact on the bottom line of the tax payable whatever one’s tax bracket. (Corporate donations are still deducted like other business expenses.)

        • matt w says

          Ken, I don’t think that’s dispositive; I’ve heard enough stories about creative accounting to think that when someone says something like that it might make sense. Check that link about Romney’s tax loophole, above; seems like the sort of thing that might be described as making a donation to get the exemption (except that it’s not a real donation).

  3. venice says

    Thank God someone can explain marginal tax rates.

    If you could figure out a way to explain the difference between total income, adjusted gross income and taxable income you’d be a real hero.