Marginal understanding

Recently, a friend bitterly complained, “Obama’s raising my taxes $12k next year.”

He was referring to President Obama’s proposal to allow Bush-era tax rates on income more than $250k to expire on 1/1/2013, raising the top marginal tax rate from 35% currently, to 39.6%.

My friend has a comfortable income, but not remotely large enough to incur anything close to a $12k annual increase.

My friend incorrectly believed: (1) the rate increase would apply to his gross income, rather than his adjusted income (after exemptions, deductions, etc.) and (2) the higher rate would apply to all his income, not just his income more than $250k.

Both mistakes are incredibly common, owing to willful misinformation by anti-tax zealots and to lazy, sensationalistic news coverage.

My friend’s gross income is $270k; had that been his adjusted income, his taxes would increase by just $920 per year (4.6% of $20k — the amount of income more than $250k). But, my friend’s adjusted income is below $250k, so under President Obama’s plan my friend’s taxes won’t increase a penny.

These same errors appeared, unchallenged, in an interview the New York Times published Nov. 18. In the article, a chiropractor and her husband lamented President Obama’s plans to allow the marginal tax rate on income more than $250k to increase to the Clinton-era rate. The couple advised they intend to monitor their revenues to ensure they do not go more than $250k, and may even shut down their businesses part-way through the year in order to ensure they retain the minimum after-tax dollars they require to maintain their lifestyle.

This chiropractor and her husband are professionals and small business owners, but the statements attributed to them are wholly ignorant of how marginal taxes work and how they will change if President Obama’s proposal is implemented.

First, income taxes on small businesses apply to income, not revenues. Income is what is left over after you pay rent, utilities, wages/salaries, benefits and all other business expenses (including state and local taxes).

Second, and more importantly, an increase in marginal rates on income more than $250k does not apply to income below $250k, no matter how much you make above $250k. So it will never be the case that, making $1, $1k, $10k, $100k, $1M or any amount more than $250k will result in a lower amount of after-tax dollars retained by the taxpayer. The couple’s concern — that they might earn too much and be left with less to live on — is wholly imaginary.

The President wants to retain the current tax rates for income under $250k. Democrats also wish to extend the payroll tax holiday.

For years, Republicans have executed a hostage strategy, refusing to allow votes on any bill extending the payroll tax holiday or retaining the current low rates for income under $250k, unless the bill also continues low rates for income over $250k. If they continue this hostage strategy, Republicans will force all taxpayers to pay more beginning Jan. 1, 2013.

The writer is a member of the Democratic Town Committee, which supplies this column.

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