A friend who teaches federal tax law explained to me how marginal tax rates work [View all]

[ehrnst]

"Agree or disagree with AOC about preferred tax rates on millions a year of income, understanding marginal tax rates is critical. And what I've found from teaching federal income tax to law students is that many many many smart people don't understand the concept.

What people think: if the marginal tax rate on income of, say, $1m/year of income is 50%, a single taxpayer making $2,000,000 of income (after retirement savings and other personalized deductions) has a tax bill $1,000,000.

This isn't right. Instead, the first $12,200 is tax-free as the "standard deduction". The next $9,700--so up to $21,900 in income--is taxed at 0%. So the tax bill on up to $21,900 *for everyone* is $0.

From $21,901-$51,675, the marginal tax rate *for everyone* is 12%. So someone making $51,675 owes $3,573 total in federal income tax (again: 0% ($0) on the first $21,900 + 12% on the next $29,775 ($3,573) = $3,573).

From $51,676-$96,400, the marginal tax rate is 22%. So the total tax bill for someone making $96,400 is $13,412.50 ($0+$3,573+$9,839.50).

From $96,401-$172,925, the marginal tax rate is 24%. The total tax bill for someone making $172,925 is $31,778.26 ($0+$3,573+$9,839.50+$18,365.76).

For income between $172,926-$216,300, the marginal tax rate is 32% so the total tax bill for someone making $216,300 is $45,657.94 ($0+ $3,573+ $9,839.50+ $18,365.76+ $13,879.68).

For $216,301-$522,500, the marginal tax rate is 35%. The total tax bill for someone making $522,500 in a year? $152,827.59 ($0+ $3,573+ $9,839.50+ $18,365.76+ $13,879.68 + $107,169.65).

For amounts above $522,500, the marginal tax rate is 37%. So our hypothetical taxpayer with $2,000,000 in taxable income pays $699,502.59 ($0+ $3,573+ $9,839.50+ $18,365.76+ $13,879.68 + $107,169.65 + $546,675) in federal income tax currently.

Under the hypothesized new highest marginal rate of 50%, this taxpayer would pay $829,502.59 in tax ($0+ $3,573+ $9,839.50+ $18,365.76+ $13,879.68 + $107,169.65 + $176,675 + $500,000) in federal income tax. No, it's not a small bill. But it is $170,000 LESS THAN if the effect of a 50% marginal rate at $1m was in fact a 50% tax on income.

Why have a progressive tax structure like this instead of a flat tax? Because minimum costs for food, housing, and clothes--the bare necessities--are the same whether you earn $21,900 or $2,000,000 per year and we (as a society) believe people should be able to earn the funds to pay for these things without contributing to the general federal coffers. (Keep in mind these people still pay social security tax, sales tax, property tax, and often state income tax.) Above that, the importance of each dollar of income to sustaining life goes down: for the person making $21,900 a year, an extra $1000 is A LOT of money in terms of the lifestyle difference it makes. For the person earning $1,000,000, it is almost literally nothing.

You can disagree with the concepts or with the appropriate numbers, or with the idea that people who have more (and get more from the government, in terms of protection for private property and access to interstate travel, for example--since it's hard to do a vacation on $21,900/year) should pay in at a higher rate, but understanding the effect of marginal tax rates is the basis for having an educated opinion on it all."
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The practical upshot is to understand that a 50% marginal federal income tax rate on the very wealthy will not require that they write a check to the IRS for half their income, whether one is in favor of a 50% marginal tax or against.