What’s your number? You know, your tax rate for federal income tax purposes?
I know, you’re thinking 20%, 30%, maybe even 35%. Far higher than Mitt Romney, right?
You probably pay much less than you think.
Most people think of their marginal tax rates when you ask them what they pay in tax. A marginal tax rate is the rate that you pay on the last dollar of income (in other words, the highest rate of tax that you pay). Our system is a progressive income tax system. That means we all pay the same rate at the bottom and the rate changes as income increases — but only on that income. Your actual tax rate is what you pay after all of the adjustments, credits and deductions and taking into consideration the progressive tax rates.
What exactly your “tax rate” is differs for International Accounting Standard purposes as it does for GAAP (Generally Accepted Accounting Principles). The press also uses it differently. And as you know from the blog, even tax professionals use it differently. The difference in those terms is huge and shows how complicated the discussion about tax rates, tax burden and tax reform can be.
For purposes of this article, I’m calculating tax rates as follows: the rate of total federal income tax you actually owe vs. your total income. Not your adjusted gross income (AGI). And not your taxable income. The Tax Foundation – which is an an excellent source of data — uses taxable income for its calculations, but since that income includes a number of variables, I’m choosing not to. The key is to keep the definition somewhat consistent so that it’s really apples to apples. So, if you’re playing along at home, here’s what you need to know: on a 2012 federal form 1040, I’m using line 61 divided by line 22.
For 2010, Romney’s big number is 13.9%. That’s his tax rate for 2010 using income as reported on his federal income tax return ($21,661,344) divided by the tax due ($3,009,766). You can read all about his returns and check them out here.
Like Romney, I’m still on extension for 2011. But I checked out my draft returns today and we’re sitting at about 16.8%, even though theoretically we’re in a higher tax bracket. If you use the Tax Foundation’s definition using taxable income, we’d be at 22%, about twice the rate for the average taxpayer. The Tax Foundation reported that, for 2009, the average rate for those with a positive tax liability, like my family, was 11.06%. That number does not include the 51% of households that are estimated by the Joint Committee on Taxation to have paid no federal income tax in 2009.
Before you start asking about my accounts in the Caymans, let me clue you in: There are none. No fancy tax tricks at all. Pretty basic, really. Family of five. Wages reported on a W-2. Schedule C (reporting a gain). Schedule D (reporting a gain). Some taxable interest. But then we figure in the deductions and credits. Home mortgage interest. Credit for local and state taxes paid. Child tax credit. The number whittles down pretty quickly.
Warren Buffett’s rate is around 11% – but based on adjusted gross income and not gross income (I didn’t have his gross income available). I don’t love using AGI as a comparison point for this discussion because it includes adjustments to income which may lower your income — to me, those are “above the line” deductions and should be ignored just like itemized deductions because they are tax breaks. To be fair, Buffett probably is not claiming the most popular adjustments from income to adjusted taxable income such as student loan interest, IRA contributions or alimony (his first wife is deceased and his current wife is still, well, his current wife), so I suspect that number is pretty close to accurate.
I went through the Tax Analysts’ library of presidential tax returns and calculated some other tax rates. Here’s what I found:
- President Barack Obama, 2011: 19.2%
- Vice President Joe Biden, 2011: 23.2%
- Presidential nominee Mitt Romney, 2010: 13.9%
- Vice presidential Nominee Paul Ryan, 2010: 17.4%
- Presidential candidate Newt Gingrich, 2010: 31.4%
- Presidential candidate Rick Santorum, 2010: 25.1%
- Former President George Bush, 2007: 23.7%
- Former Vice President Dick Cheney, 2007: 19.7%
- Former presidential candidate John McCain, 2007: 20.8%
- Former vice presidential candidate Sarah Palin, 2007: 14.8%
- Former President Bill Clinton, 1999: 22.1%
- Former President George W. Bush, 1991: 23.7%
- Former President Ronald Reagan, 1987: 25.0%
- Former President Jimmy Carter, 1979 (note that return copies were hard to read): 33.3%
- Former President Gerald Ford, 1974: 38.1%
- Former President Richard Nixon, 1972: 32.4%
- Former President Franklin D. Roosevelt, 1936 (note that return copies were hard to read): 15.6%
All over the place, right? Almost all of the rates are considerably above the national average for all taxpayers.
If you look through the returns, here’s what you’ll find: wealthy people pay a lot — in terms of sheer dollars — in taxes. However, the actual rates vary depending on circumstances (and historical rates — I did not adjust for rate differences or inflation). Those at the very top — the Romneys and the Buffetts of the world – tend to pay a lower rate because capital gains are taxed at a lower rate. In fact, the top 0.1% wealthiest taxpayers pay an average of almost 10% less than the highest marginal rate.
Here’s what you’ll also find: Younger taxpayers tend to pay less. In fact, Ford’s tax data shows that his tax rate increased by more than 10% in the eight year span he served as House Minority Leader through the first year in the White House. While this has something to do with income, it also has to do with life choices. For example, my husband and I have three young children who are my dependents, so that results in five exemptions (the Santorums claimed eight and the Palins claimed six). That reduces my taxable income considerably.
Younger taxpayers, in addition to having children, may also be paying more expenses that push down tax bills. Like the Obamas when the President first took office, we are paying off student loans though the phaseouts completely eliminated the availability of the credit for the both of us. As young homeowners, we’re also paying more in interest on our mortgage than we will, hopefully, pay later as our principal payments increase.
When you have a business — or write a book — your income can nudge your tax bill up or down, depending on the kind of corporation and whether you pay your own expenses. Like the Obamas and the Romneys, we pay self-employment taxes, half of which are deductible before calculating taxable income. But more importantly, we also own a business which, for state and local tax purposes, takes a huge bite out of our pretax income since it’s paid at the entity level. If you factor in revenue-related business taxes (not including real estate or other excise-type taxes or personal state and local taxes), our tax rate is much higher.
And what about payroll taxes? It’s important to note that federal tax rates for purposes of most discussions don’t include payroll taxes (generally, Social Security and Medicare). Most taxpayers pay just under 8% of their income in federal payroll taxes, less in 2012 because of the payroll tax holiday. However, those taxpayers who rely on investments — the Buffetts, Romneys and soon to be Mark Zuckerbergs of the world – don’t pay payroll taxes if they’re not earning a wage; unearned income is not subject to payroll taxes. Statistically, the top 1% of income earners report 16% of total income but pay less than 4% of payroll taxes. That’s not only because payroll taxes are calculated on earned wages but also because contributions for Social Security are capped at $110,100. If you make more than that, the overage is not subject to Social Security; this is referred to as a regressive tax (as compared to our “regular” income tax system which is said to be progressive).
Payroll taxes are also tricky because in closely held companies like mine we really pay both sides of the tax — a fact that isn’t noted in most tax discussions. If I worked for, say, IBM, IBM would pay half of my payroll tax and I would pay the other half. But at my company, which is owned by my husband and myself, my company pays half of my payroll tax and I pay the other half. Realistically, I’m paying both sides because that original pot of funds belongs to me, sort of like being self-employed, only the tax rate doesn’t show up on a personal income tax return. If I simply took that money out and then paid tax on it later, my tax rate would appear to increase. That’s not the same result for a federal form W-2 employee in a “regular” company.
It gets worse. I haven’t even factored in taxes paid out of trusts and other entities. Romney, Cheney and McCain all either own or benefit from other entities, some of which (like the McCain Family Foundation) have records that are open to inspection. Trusts actually have compressed tax rates which means that they reach higher tax rates more quickly than individuals for federal purposes; to the extent that income isn’t paid or passed out of those entities, it gets taxed. We just don’t talk about those rates.
Corporate returns. Trust returns. Payroll taxes. Pass through entities. Those are all important pieces of this puzzle.
The reality is that no discussion about tax rates is simple or easy because everybody thinks that they pay a lot in taxes. Doing a quick calculation on paper isn’t always a fair assessment of a person’s real tax burden (this is a point that the Romney camp has attempted — albeit poorly — to make). When it comes to tax reform, I think tax rates are pretty meaningless. Anyone can manipulate data to prove a point – you’ve probably figured that out from this discussion. In fact, depending on which data you look at, we’ve just discussed that I pay either 18% or 22% or 36% in federal taxes. That’s a huge disparity. And that’s why I wanted to use the same set of calculations for each of the presidential candidates and presidents noted above. Apples to apples are important. But even so — as noted — it’s still not a completely accurate comparison.
Here’s what I firmly believe: taxpayers are frustrated by our complicated Tax Code. Most taxpayers don’t really know what rate they pay in taxes. Many taxpayers don’t understand that FICA taxes are separate from income taxes. And a large number of taxpayers think corporations and trusts are getting a pass because they don’t understand that income which is paid out of corporations (and trusts) doesn’t actually escape taxation.
The bottom line is that your rate — “your number” — doesn’t always reflect your actual tax burden anymore than anyone else’s does. I think it’s important to know what you pay in tax but to also understand why you pay what you do. Getting to simple is hard.
- Romney Releases 2011 Tax Returns
- Quelle Horreur! Mitt Romney Pays ‘About 15% Tax Rate’
- Romney’s Tax Returns Allegedly Held For Ransom
- Perry Wants You to Know that Romney is Rich: Do You Care?
- President Obama and Vice President Biden Release 2011 Tax Returns