This is a guest post by Michael Rubin. Michael Rubin, CPA, CFP, is the author of Beyond Paycheck to Paycheck (a book I recently reviewed) and the blog of the same name features a unique easy-reading conversational style, one you’ll find in this post.
You can see Michael live in New York, Philadelphia, Los Angeles, Chicago and other cities (for free!) as part of his Beyond Paycheck to Paycheck seminar tour at ING DIRECT’s cafes. See his upcoming tour schedule here.
Who Pays More Taxes? Rich or Poor?
You: Do rich people pay more tax? Seems to depend on who you listen to.
Yes, for two reasons. And no for two more reasons.
You: You’re arguing with yourself publicly?
Perhaps, but a straightforward answer to this question doesn’t exist. You´ll be ready to have this debate with others soon.
Why the Rich Pay More Tax
Often the rich have high incomes. Since income taxes are based on a percentage of one’s income, those with higher taxable incomes will pay more. This is just basic math. If you multiply a specific tax rate by a bigger taxable income, the product is bigger, and so is the tax bill.
The federal tax system is progressive. This means that the tax rates themselves increase as taxable income rises. Therefore, when you do the simple math above, both numbers (the taxable income and the tax rate) are higher for high-income earners than for those who make less. As a result, the higher wage earner’s tax bill increases dramatically.
Why the Rich do NOT Pay More Tax
Remember, it is not gross income but taxable income (income after subtracting your deductions) that determines your income tax. Rich people are more likely to have higher deductions due to their corresponding larger mortgages, state income taxes, and property taxes. These large deductions significantly reduce the amount of wealthy people must pay.
Like it sounds, federal income tax is based on income-not wealth. If you´re worth a million dollars yet have little taxable income, you might not pay it at all. Take the extreme example (and one I’ve seen first-hand) of a multi-millionaire family where neither parent is employed nor does anything to generate significant income. Combined with an enormous mortgage deduction, they might pay no federal income tax.
Furthermore, high income does not mean you´re rich any more than a comparably lower income means you´re poor. Becoming comfortable (and even rich) is influenced much more by your financial habits more than your income level. Don´t believe it?
You: I’m not convinced yet.
I know you’ve heard stories about celebrities who make piles of money yet wind up later in life with little money or even in bankruptcy. While celebrities get all the press, this tragic story is a sad reality for many others too-not just entertainers and professional athletes.
If you spend 100 percent or more of your income, no matter how high that income is, you will find it difficult to become wealthy. The opposite is also true. If you save enough money for a long period of time, you can be quite wealthy without ever earning a high income.
The conclusion is simple: some people never paid high taxes but are now rich, while some folks once paid a ton of taxes and are no longer wealthy.
Ultimately, there are just too many factors to permit a blanket answer to the question “Do the rich pay more in taxes?” It’s like obtaining a true understanding of how much money the Jones’ really have. While it’s likely a rich household pays more income tax than a poor one, you cannot be sure.
Pay Less Tax Yourself
The important thing is to pay the least amount of tax (legally, of course) and to pay it as late as (again, legally) possible.
- Don’t save a couple hundred bucks in tax prep fees at the expense of missing a $1,000 deduction. Tax preparers can help, but if you’re filling out a 1040-EZ, you won’t miss the deduction, so save your money and do it yourself!
- Don’t get a huge refund every year. No sense in giving an interest-free loan to the government. In fact, one of the easiest ways to increase your savings is to cut out spending that doesn’t impact your lifestyle. No one enjoys excessive tax withholdings. Learn how to convert your income tax withholdings into 401(k) contributions for the price of an income tax refund by using this calculator.
Michael B. Rubin is the author of Beyond Paycheck to Paycheck, the blog of the same name and a professional speaker. You can see Michael live in New York, Philadelphia, Los Angeles, Chicago and other cities (for free!) as part of his Beyond Paycheck to Paycheck seminar tour at ING DIRECT’s cafes. See his upcoming tour schedule here.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
Taxes are a fact... We all know the familar saying about death and taxes. What astonishes me is the number of people who whine about taxes, and are so familiar with the different taxation levels, and the difference between long term and short term, and regressive and progressive, but do not follow their own advice.
Whether you have $1 million in the market or $1000 in the market, the same rules apply. Why don't people put money in the stock market? Why do people not put money in VULs? Why do people ignore taxation?
You will pay more on taxes than you will on ANYTHING else in your lifetime. The best strategy for gaining wealth is managing taxes.
Taxes are always a contentious issue. I a live in Switzerland where tax is a motivation for many a clebrity to live. But the average working family here pays uch the same as anywhere else ad we have huge insurance and pension bills. A rich celebrity would pay 6 times that rental value of their property and 1% wealth tax under the forfeiture rules.
This may seem outrageous but the wealthy do contribute to the economy and we have one of the healthiest in the world...
I disagree with Drew about the flat tax - especially one as high as 17%. While it may even out the 'upper-middle class', and the 'somewhat-wealthy', the fact is that most Americans make well under $50k a year, and the extra taxes they pay at the store would seriously widen the gap between rich and poor (not to mention have a serious impact on corporate growth, thus hurting those rich who live off of dividends). Joe Citizen who makes $36k welding in Texas will have to save up 17% longer for that new TV that he's gonna need to buy before 2009, instead of buying it with his $3500 tax return (and yes, tax returns are a blessing for us lower-income families, since we get relatively big credits, not just deductions). And what about military servicemembers? Most Enlisted servicemembers with families tend to make between $35-$45k a year (mostly on the lower end), and up to half of that is non-taxable allowances (our housing, subsistence, and locational cost-of-living allowances). A flat sales tax would completely destroy the spending ability of almost every enlisted servicemember. I know the tax system is screwed up, but this is not the way to fix it.
By the way, I do feel small business owners get the shaft on taxes. If any tax reform is to be done, it should be aiming at helping their situations. Small business is extremely important to our nation, and the government should be making it easier, not harder, to thusly improve our nation's economic situation. However, it is hard to feel sorry for someone complaining that, at $350k a year, they pay proportionately more tax than someone with $2mil. The tax cap has to be somewhere. I don't remember what the exact statistics were, but I believe less than 1 in 10 Americans makes $100k a year, and the number drops quickly as it gets higher, so unfortunately for your tax situation, you are in a very rare situation (but I still wish I had half that income).
I do strongly agree with Jeff Perkins, however. One thing I've learned in the military is that government bodies can, in fact, balance their budget (we're forced to do it every quarter, if not more frequently!). The government should be held more responsible to how they spend our hard-earned (or even not-so-hard-earned-but-still-ours) money. Just like paying off household credit cards and learning not to eat at McD's every day, a government that pays off it's debt and works a little leaner will absolutely be able to work with less taxes.
Actually, what should happen is that the Government should abolish the Federal Reserve and go back to printing and regulating our own currency instead of borrowing it on interest. That way we could abolish the Federal Income Tax completely and institute a smaller corporate revenue tax instead.
Wow. That's a great nutshell description of our tax system. I may just have to find this guy's book.
Sorry ... Darn Spellchecker.
I meant to say in the third paragraph "Many Countries" have implemented this.
Reading these articles almost make me feel dumber. The two sides are what miningoilgasguru said and also what Xasa said. Where you fall is basically where you fall. You either count the "more gross $ spent" or the "highest impact on family" approach on tax dollars.
I personally believe in the flat tax (fair tax, whatever people call it now days). Basically sans food, normal clothing (not designer crap) and necessities, there is no tax. Then you tax other things at like 17% above that. So when you buy that new TV, you pay more, but don't have to fill out your tax forms each year, there is no tax evasion, no worries about illegal immigrants paying their taxes, etc. Yes it means that someone has to work 17% longer to buy that DVD player, but they also don't get 20% taken out of their paycheck to pay for the government.
Oh well, at the end of the day we have what we have, and without someone coming forward and spearheading this new idea, people won't catch on. There are several counties that implement this, and guess what, they are no where as broke or in as much financial mess as we are.
Even if we implement the flat tax on consumables, at the end of the day, the same argument exists from the first paragraph. However, when that person buys that Bentley for 100k and they pay an extra 17k in taxes, that hurts a lot. When that person buys a DVD player for 30 dollars and they pay that extra $5.10 for tax, does not hurt as much. It is one of the truly fair taxes as it does not discriminate, no preferential treatment, and no loopholes. Then you get a truly, balanced, tax.
>>Rich people are more likely to have higher deductions due to their corresponding larger mortgages, state income taxes, and property taxes. These large deductions significantly reduce the amount of wealthy people must pay.
I see - so paying more in taxes (state/property) actually reduces your taxes. Must be that crazy new math.
Great post! I always hear people complaining that the rich pay less in taxes, but they never have any facts to back up this claim. After reading this I feel a little more informed.
The comments above further solidify my opinion that there isn't just one answer to the question "Who pays more taxes?" Despite many political soundbites (especially this year), the answer ultimately depends on what you count as taxable (i.e, income and what kind) and include as tax (income, payroll, state, property, sales, etc.)
I didn't even touch on payroll taxes in the post, taxes which are incredibly regressive, yet cause a self-employed person making $100,000 to pay an additional $15,000 in taxes (where his federal income tax liability might otherwise be nominal). I wouldn't consider someone making $100,000 to be of low income, but he's getting killed with this supposedly regressive tax.
Alternative minimum taxes, state income taxes, and local property taxes all play a role in the total amount we pay - not to mention the amount we pay federally.
If I could convince you of anything, my hope remains, it is that there is no sure answer to a fundamentally basic-sounding question.
Rich people do pay more in tax dollars but I think the poor pay a higher price in terms of the affect taxes have on them. Taxes may hinder the rich in becoming richer but because they already have disposable income, they have money to spend. For the poor, I think taxes in many cases block the poor from spending and more importantly save.
I agree that people with higher income can easily avoid taxes. My husband and I make ~160k a year and our effective tax rate is 9% because of deductions (mortgage, property tax, state tax, charity) and avoidance (maxed out 401k contribution, health care spending account). If we have kids, our tax rate would probably fall below 5% due to another deduction and the use of a dependent care spending account.
Umm...this is softball article. it does nothing to note that the progressive tax system STOPS being progressive after approx. 360,000 per year in income. Meaning that the person making 350k/year is paying proportionally higher taxes then someone earning 2 million.
Further the tax rate on passive incomes (dividends and interest earned etc) is very very low. Meaning that while the rich over all paid more in taxes in dollars. Thier ability to capitialize and generate additional revenue with a reduced tax liability on passive sources means they are not actually paying as much percentage wise.
Warren Buffet has said many times publicly that he pays less in taxers then his Admin Assistant does! Also that the taxation system is "Regressive" for those earning large incomes from passive sources.
Just another "Cute" article, as tackling the befuddling world of USA tax codes is more requireing a book or two!
The rich may have more options but incorporating and living on business expenses has nothing to do with rich, it deals with owning your own business.
The benefits that the rich get as a result of their wealth is in the stock market. Long term capital gains tax and dividend tax are lower than their marginal tax rates so they benefit more from that than people with less wealth (since they invest less).
The reality is that the rich just have more options to pay lex taxes - incorporating, live on business expenses ...