Tax Brackets

In coming years California and the country are going to have to confront and settle a number of budget issues that we have been putting off for decades. We have been putting off so many necessary decisions -- deferring maintenance of our infrastructure, pushing pain into the future by borrowing, setting aside the needs of our people by cutting school, police, fire and other budgets, and practicing almost every form of avoidance of reality that we could find.

Well, the karma is coming back on us, all the chickens have come home to roost, we are getting what we gave and we are going to pay for our sins. (Please leave more cliches in the comments.)

The number one budget issues that has to be confronted is taxation.

So, let's talk taxes, beginning with the basics. I have found that many people don't really understand how taxes work, so I want to write a bit about that here. One reason for the lack of understanding of taxes is that there has been quite a bit of deliberate misinformation. By confusing people, the very wealthy and corporate interests have been able to trick people into letting them avoid paying their fair share. Instead we either take on ourselves the bulk of the burden of paying for democracy, or just borrow and put that burden on our children.

One thing that I have found many people do not quite understand is the concept of tax brackets.

Tax brackets

A "progressive" tax is one where the tax rate increases as income increases. A progressive tax structure consists of brackets. You pay a certain tax rate on income up to the next bracket. After that bracket is reached, a higher tax rate applies to income that is earned that is above that amount. Let's say that you pay 5% on income below $10,000 and 7% on income above $10,000. So if you make exactly $10,000 of income the tax is $500. At $10,100 the tax is still that $500 on the amount below $10,000 and $7 on the additional $100, for a total of $507. The key point is that only the amount in the new bracket is taxed at the higher rate.

Many people believe that once you reach a higher bracket you pay the higher tax rate on all the income that falls below that bracket amount as well. I have actually talked to people who think they need to "get their income into a lower bracket" to avoid paying a higher tax rate, because they think that a higher tax rate would apply to all of the income they earned.

Using the example of the earlier paragraph, many people believe that you would pay $707, not $507, on income of $10,100, assuming that the entire $10,100 is taxed at a 7% rate because the total income is above $10,000. This incorrect belief is one result of anti-tax arguments. It is also the basis of many tax-avoidance schemes.

So, to repeat: If you enter a higher tax bracket, you only pay the higher tax rate on the amount of income you earn that is in the new tax bracket, not on all of your income.

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Comments

[oustfan]

5% tax on $10,000 is $500 not $50. A person making $10,100 would pay $507 under your example.

Learn 3rd grade math before giving tax tips.

[Dave Johnson - Huffpost Blogger]

Thanks for catching that. I changed it from $1000 to $10000 at the last minute and didn't change the tax amounts.