On Fair Taxation

There has been a lot of hype lately about how the US progressive income tax is not fair. These tax protesters are calling for a flat tax because they consider that to be fairer. I believe they simply do not understand how the current system is actually fairer than the flat tax.

Let us compare the tax impact on a family of four under three different tax schemes: the Cut, Balance and Grow plan proposed by Governor Rick Perry (R-Texas); a modification of President Clinton’s flat tax proposal espoused by Todd Ganos in Forbes Magazine; and the 2014 Federal Income Tax rules.

We will examine the impact of each scheme at three different levels of income:

  • Minimum wage. $7.25/hr. X 40 hr./wk. X 50 wk./yr. = $14,500/yr.
  • Median income. $55,000/yr.
  • High income. $500,000/yr.

For ease of calculation, the following assumptions were made:

  • All income levels had only two weeks vacation. There is no paid vacation at minimum wage.
  • No additional income was earned and no adjustments to income were incurred. This merely simplifies tax computation by making earned income and adjusted gross income equal.
  • The Alternative Minimum Tax is not computed for the highest level of income, although it qualifies.
  • The Earned Income Credit is computed for the lowest income level.
  • The standard deduction is taken at all levels of income.

The Perry flat tax is a 20% rate with a standard deduction of $12,500 and no exemptions.

  • AGI           ; Taxable Income; Income Tax; Disposable Income
  • $   14,500;             $    2,000;       $     400;                     $ 14,100
  • $   55,000;            $   42,500;      $  8,500;                    $ 46,500
  • $500,000;            $ 487,500;     $ 97,500;                    $ 97,500
  • Total Federal Revenue $106,400

The modified Clinton flat tax is a 30% rate with a standard deduction of $66,000 and no exemptions.

  • AGI           ; Taxable Income; Income Tax; Disposable Income
  • $   14,500;             $             0;     $            0;                 $   14,500
  • $   55,000;             $             0;    $            0;                 $   55,000
  • $500,000;             $434,000;   $ 130,200;                $ 369,800
  • Total Federal Revenue $130,200

The 2014 Progressive Tax levies taxes on income in graduated percentages with both personal exemptions and a standard deduction. For 2014, the per person exemption is $3,950 and the standard deduction for Married Filing Jointly is $12,400.

  • AGI           ; Taxable Income; Income Tax; Disposable Income
  • $   14,500;            $             0;    ($   5,460);                 $   19,960
  • $   55,000;            $  26,800;     $      3,113;                 $   51,887
  • $500,000;            $487,000;     $ 139,843;                $ 360,157
  • Total Federal Revenue $137,495

At minimum wage, the family of four would be entitled to a return of all income tax paid (if any) and a refundable credit, the EIC, of $5,460. In order to qualify for this credit, there must be earned income.

The income tax on $500,000 is considerably less than most people expect because it is not computed as 39.6% of the taxable income ($193,090).

Only a part of earned income is taxed at each bracket, as follows:

  • Rate; Upper limit; Taxable amount; Computed Tax
  • 10%;      $  18,150;               $  18,150;      $   1,815.00
  • 15%;     $  73,800;               $  55,650;      $  8,347.50
  • 25%;     $148,850;               $  75,050;      $18,762.50
  • 28%;     $226,850;              $ 78,000;      $21,840.00
  • 33%;     $405,100;               $178,250;      $58,822.50
  • 35%;     $457,600;               $  52,500;      $18,375.00
  • 39.6%;       NONE;               $  30,000;      $11,880.00
  • Total taxable – $487,600.00; Total tax – $139,842.50

The effective tax rate is only 29% (Total tax/Total taxable income).

The modified Clinton plan closely approximates the effective tax rate imposed on high income earners under 2014 IRS rules, while removing the tax burden completely from minimum wage and middle-income workers.

The Perry “Cut, Balance, and Grow” plan significantly shifts the tax burden down to the low and middle-income wage earners. This leaves them with significantly less disposable income than the other alternatives.

The current IRS system recognizes that low-income workers may not be able to meet cost of living expenses without some help. The refundable credit is a reward for working, and give those with the least amount of disposable income a reason to continue working. The IRS system also reduces the tax burden on middle-income workers, who end up paying far less tax than they would under Governor Perry’s scheme.

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About Julirose

Amateur word arranger, avid number cruncher, and science fiction and fantasy enthusiast.
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