Taxes, Taxes, Taxes

With only a month until the deadline, it’s time to start thinking about taxes for those who haven’t already begun.  When I think about taxes in general, two things come to mind.  First is that the tax system is too complicated, and for all the talk in Washington late last year not much was done to make it simpler. 

The second stems from the first.  Because it is so complicated and intimidating, most people have given up preparing their own taxes, turning to professional organizations, accountants or those many on-line systems guaranteeing your maximum return.  A result of no one doing taxes or even bothering to become familiar with the process is a general misunderstanding by both citizens and politicians of how it works and the impact of proposed tax changes.

Addressing the complexity first, I ran across this website called 1040.com listing all the IRS tax forms someone might need with a link to each.  As I scrolled down, eliminating duplicates and Spanish language versions, I counted over 240 unique IRS forms, 9 schedules and over 140 worksheets!  That tells a complicated and intimidating story without even going into the details.

It is no wonder people pay someone else or buy a computer program to help them through the maze of regulations and calculations, the purpose of which is to get back their own money, money that they didn't need to pay in the first place.  They paid too much and are due a refund.  But if you don’t do it correctly, you may still be subject to penalties and interest.

This complexity leads to a misunderstanding of the fact that lowering tax rates automatically favors the rich.  But this fact becomes a source of outrage to some and easily becomes a political rallying cry.  I even heard one politician say that he wants to lower taxes on the middle class without lowering taxes on the rich.  Well, good luck with that!  The system doesn’t work that way, and it would have to be completely redone – perhaps not a bad thing, but totally unrealistic.  Let me explain.

Page 90 of the Form 1040 Instructions is headed “2017 Tax Computation Worksheet – Line 44.”  This is where the rich calculate their taxes because the tax tables go up only to $100, 000.  I have reproduced the top line of Section B, the one used for the filing status of Married Filing Jointly, just to use as an example.  It may look a little scary, but the explanation is simple.

Someone making between $100,000 and $153,100 enters the amount under (a), multiplies by 25% and enters the result under (c). Next they subtract $8,522.50 to get their total tax. But where does that $8,522.50 come from?

Here’s the catch.  The first $100,000 is not taxed at 25%. Rich people are taxed the same amount on their first dollar or their first $100,000 as anyone else would be! That $8,522.50 is the difference between paying 25% on all of it and paying middle class taxes on the first $100,000 and then paying 25% on the rest.  (It’s exactly the same for higher brackets.  Oprah pays the same amount of tax on her first $200,000 as someone making exactly $200,000.)

Therefore, lowering taxes on the middle class by lowering rates automatically lowers taxes on everyone.  It’s built into the system.  It’s easy for politicians to appeal to a stoked-up sense of unfairness, but those making claims like the one above are either not leveling with us or don’t understand the very system they are in charge of fixing.  And all it takes to detect their error is a little critical thinking.