People Find Marginal Tax Rates Perplexing

by Courtney C Horne @FireezDragon

I was talking to a guy at a protest outside a $50k a plate Mitt fundraiser and he asked what I thought about France’s new wealth tax. He called it a 75% tax on people earning over a million a year. I explained that they only pay 75% on the income they make over the million.

This is the most recent time I have encountered confusion around marginal tax rates but it certainly is far from the first.

I decided to write a highly simplified explanation of how a marginal tax rate works so when you want to explain it to people you have an easy example for them to follow.

Let’s pretend there is a land called Slothilvania (Why Slothilvania? Some really weird right-winger commented on a picture of me from the Romney protest that my feet made me look part sloth and I think it is really funny.) In Slothilvania, there are two tax rates. There is a 25% rate up to $500k and a 50% rate above that. Things are very simple in Slothilvania taxes, not a lot of deductions and write offs, so you basically pay that percent no matter what.

Let’s imagine you make $500,000 a year because you are a very successful Slothilvanian. Well then you pay $125,000. Next year you are even more successful with your career and you make $501,000. Do you pay 50% of all of that thus making less than the year before? No. You pay 25% of that first $500,000 and 50% of the additional $1000 only. So $500k you pay $125k, $501k you pay $125.5k. The rich don’t pay a higher rate on all their income, just the income in the higher bracket. While seemingly simple, it is commonly misunderstood and it is an important thing to understand and to explain to the people crying “class war.”  (I will say that the guy at the Mitt protest wasn’t crying “class war,” he just didn’t seem clear on the new French wealth tax.)

Now things in the U.S. are a lot more complex than in the hypothetical land of Slothilvania. Capital gains is taxed at a lower rate and there are a ton of other write offs and strategies to reduce the taxes you pay. I am sure Mitt could explain a whole host of those methods. The basic idea of how a marginal tax rate works holds though. That means if the Bush tax cuts for incomes over $250k aren’t extended a higher rate only applies to the income above that line.