“Over and over again, courts have said there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor, and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced extractions, not voluntary contributions.” Judge Learned Hand, Commissioner v. Newman, 159 F.2d 848 (CA-2, 1947).Thanks to this ruling every individual is right, in trying to pay the littlest amount of taxes that they are required. The other day, I was talking to a veteran IRS agent who said he was auditing a business and was actually able to give them a refund. Though this does not happen often, it does indicate that we are right to try to pay less.
To understand our tax system today we have to first understand the idea of equal pain, as Congress thinks it should be. We always have the right to disagree and we can act on that disagreement to change our tax system.
The idea of a fair tax system starts by debating how to make everyone feel the pain of paying taxes equally. The way Congress has decided to distribute that pain is by looking at the different classes and the revenues they each make. A person that is in a tight position in life, say a single mother of six working as a clerk at a gas station, values $20 more than a CEO of a large corporation that makes six or seven figures a year.
Marginal and Effective Tax Rate
Next we have to understand the idea of a marginal tax rate. The marginal tax rate is the rate we pay on the next dollar of income we make. If we are in the 25% marginal tax rate bracket, we pay $.25 on every additional dollar we make while in that bracket.
With this in mind we can then discusses the basic individual income tax schedule and how it applies to all US Citizens. The table below in the 2012 individual income tax schedule.
| Marginal Tax Rate | Taxable Income Upper Limit |
10
|
8,700 |
15
|
35,350 |
25
|
85,650 |
28
|
178,650 |
33
|
388,350 |
35
|
Over 388,350 |
This means that with $100,000 of taxable income, you have a marginal tax rate of 28% since the next dollar of income will be taxed at 28%. But the effective or real rate of tax is the tax liability divided by the taxable income:
21,386 / 100,000 = 21.4%
The 21.4% is the real tax rate for the person.
This progressive system means, as the example shows, that no matter the amount of income, everyone pays the same portion of taxes on the same amount of income. Thus the poor pay the same amount as the rich for the first $8,700 of income. Then as the rich make more, they are required to pay a higher percentage to the government.
Taxable Income
Taxable income is where we start to see a lot of differences. The tax code has over 73,000 pages which is exceptions to the general rules and code trying to prevent loop holes.
It takes a Master's degree or PhD to learn the tax code and really then you are just learning how to research really well. Thus the reason why tax CPAs and Lawyers are able to charge so much. However, taxable income is what everyone has left after they figure in their home owners deduction, children deduction, going to school deduction and so on.
Tax Loop Holes
If you really want to play into the idea that there are loop holes for the rich, then you are partially right. The thing about the loop holes plays back to the original quote from Judge Learned Hand. Everyone can take advantage of them, however, the rich are better equipped to do so because 1) they can pay for the CPA to find it for them and 2) the have the money to take full advantage of them.
A great example of this "Loop Hole" is capital gains. The best example of capital gains is dividends to individual shareholders. The everyone in the world can buy shares in a corporation either through a stock brokerage or online using discount traders such as eTrade.
The rule is that capital gains are taxed at 0% or 15% depending on the amount of taxable income you have. The poor do not pay anything on capital gains and the rich only pay 15%. Congress passed this law to stimulate the market so there would be more buying and selling of stock. The problem here is that the average person has very little money to invest in buying stock. They are more concerned with buy food and gas than stock.
The rich on the other hand, have the money to put into investing. Then there are people that all their money on the stock market or in other forms of investing that result in capital gains. A great example here is Mitt Romney. During his campaign, the media made a big deal about his effective tax rate. Most of his income comes in the form of capital gains. One example is that he took a lot of risk, investing in a small office supply store in California that grew into Stables.
So all his taxable income result from capital gains, taxed at 15%. Then you take into account any deductions he qualifies for such as charitable contributions and then *puff* you get the reported 14.1% effective tax rate that he claimed to have paid. He paid a lower effective tax rate than his own secretary who was making wages and would have to pay taxes using the normal progressive tax schedule.
Thus a loop hole for the rich. I'm not saying that this is right or wrong. One day I hope to fully take advantage of this "Loop Hole" as everyone can. However, I am also not pushing my beliefs onto anyone else, and can easily see how this is wrong. So if you disagree you can change it, that is the beauty of our democratic system (as long as it is working properly).
