Someone You Know Doesn’t Understand Tax Brackets

 

I don’t presume you, the reader, are particularly uninformed or ignorant. You are reading a newspaper, after all—you’re seeking out information. But I find most of us have someone we know who is uninformed or ignorant of fundamental concepts. This unsolicited advice goes out to them, even if they are you.

Every year around tax time, I hear a particularly foolish claim: “I don’t want to make more money, because I’ll move up in tax brackets and have to pay more in taxes/end up with less money overall.” My college educated brother said it last year, demonstrating at least one failure in his education.

In more refined terms, the claim being made is both a mathematical word problem and a political theory: the feeling that the income tax provides a disincentive to work. Luckily, when the math proves true, the political theory can be dismissed. The income tax is mathematically structured to prevent that negative outcome.

In our country, income taxes are applied marginally via brackets. Only the income that falls into each bracket is taxed at that bracket’s rate. As income increases, each successive bracket applies a progressively higher tax rate to the income within that bracket. The end result is that nobody will ever end up with less money because they move into a higher bracket. It’s mathematically impossible.

An approximation of my life will serve as an example. My spouse and I file as “married, filing jointly.” Between the two of us, we earned between $40,000 and $50,000 in 2013. For 2013, only the two lowest tax brackets will apply to us: 10% on every dollar from $0-17,850 and 15% on every dollar between $17,851 and $72,500.

For simplicity’s sake, imagine two scenarios for our tax filing, ignoring all possible deductions and tax credits. In Scenario A: We have $40,000 in taxable income; Scenario B: We have $50,000 in taxable income.

In Scenario A, we pay a 10% tax on $17,850 in the first bracket, and a 15% tax on the remaining $22,150 in the second bracket. In total, we pay $5,108 in tax—an effective tax rate of 12.77%.

In Scenario B, we pay the same $1,785 on the first bracket, and 15% on the remaining $32,150. In total, we pay a total tax of $6,608—an effective tax rate of 13.22%.

Did we end up losing money because we earned more? No. Was it better to earn more even though we paid more in taxes? Yes. By earning an extra $10,000, even after paying taxes on it, we ended up with an extra $8,500. If someone you know doesn’t like extra money, then recommend they pick Scenario A.

If you overhear someone repeat this ill-informed claim, please feel free to hand them a copy of this article, or email it to them. Furthermore, if you have any questions, suggestions, or lack the ability to Google “2013 tax brackets,” feel free to email me. I’ll do what I can to help.

 

 

BY ELVIS ENWRIGHT – EDITORIAL@SYNTHESIS.NET