Manipulating the Margins

People in this country seem to have a very difficult time understanding marginal tax rates. I have seen this since working near Cleveland after high school, when a co-worker explained how it wasn't smart to work overtime because it would put me into a higher tax bracket. With the higher tax rate, I would supposedly loose more in taxes than I would earn in over time. And I have seen the same confusion among a lot of smart, educated people who really ought to know better.

Just to pick a simple (and imaginary) example, let's suppose that the tax stucture is this:

• <$20,000- 0%
• $20,000 to $40,000- 5%
• $40,000 to $100,000- 10%

Now at first glance, you might suppose that a person earning $100,000 would be $10,000, but you would be wrong. Such a person would pay nothing on the first 20K, 5% on the next 20K ($1000) and 10% on the next 60K ($6000) for a total tax of $7000. In other words, the listed tax rate applies only to income above the lower margin. This is an issue that the rubblekins are exploiting to whine about how terribly unfair Obama 's proposed surcharge tax on the very wealthy (to offset the costs of health care reform) is to those earners.

Jonathon Schwartz at A Tiny Revolution provides some powerfully snarky schoolin' to a right-wing, Columbia MBA, media figure, trying to explain exactly this same idea: it's not the gross tax rate being talked about, it's the marginal rates.

Here's how the proposed surcharge would actually work. There would be:

• an additional 1% tax on income between $350,000 and $500,000. Thus, if someone makes $500,000 per year, they would pay an extra 1% of $150,000, or $1,500.

• an additional 1.5% tax on income between $500,000 and $1,000,000. Thus, if someone makes $1,000,000 per year, they would pay an extra 1.5% of $500,000, or $7,500.

So under this proposed law, someone making a million dollars per year wouldn't pay $54,000 more in taxes. They'd pay $9,000 (ie, $1,500 + $7,500), or 0.9%.

(Now, it is true that someone making $10 million per year would pay an additional $495,000. That would consist of the extra $9,000 on the first million plus 5.4% ($486,000) on the next $9 million.)

I guess they don't teach about marginal rates and arithmetic in the Columbia MBA program. Which is kind of funny, as they certainly taught the former in the introductory econ classes here at this little backwater state school, and pretty much expected you to have mastered the latter.