Wait, how much do they want!? Explaining America's progressive income tax

HarshawnRatanpal · business · feature · 10/03/2020 · edited

If you want to skip some background and just read the explanation, scroll till you see the first bold heading.

You may remember the pandemonium caused by Alexandria-Ocasio Cortez’s sponsorship of the Green New Deal back in 2018. In case you don’t, the congressional proposal was aimed at tackling inequality and climate change¹. When asked in a 60 Minutes interview² about specific tax rates that might pay for it, she referenced how back in the mid-1900s, tax rates might go up “as high as 60 or 70 percent.” And thus spawned a wave of confusion, misinformation, and, as previously stated, pandemonium.

For example, let’s take a brief look at the commentary of Fox and Friends co-host Ainsley Earhardt. In a conversation³ about “WILL DEMS’ RUSH TO THE LEFT HURT THE PARTY?” Earhardt ponders “How do they have so much support though? Because when you hear they’re gonna take 70% of your paycheck, if Alexandria-Ocassio Cortez gets her way, how do they have so much support? That’s a lot of money for people to give back to the government.” This is wrong for two reasons. First of all, it’s a bit disingenuous to say that AOC wants to take 70% of “your” paycheck when she was specifically referring to those with over $10 million. The second reason it’s wrong will be our focus today.

How our federal income taxes work

In the United States, we have what is known as a progressive, or graduated, income tax. That means a couple of things. First of all, it means that tax rates increase as taxable income increases: someone who makes $1 million pays a greater rate of their income than someone who makes $5 thousand. In the United States, people’s income is separated into brackets, or ranges, of different income levels and you pay accordingly. Most people understand that part.

However, the rate that corresponds to your income bracket is not the rate you pay on your entire income. Instead, you pay that tax rate only on money that lies within that bracket’s range. Additionally, you pay the tax rates of all the lesser brackets for income within those ranges. Just as the rich man pays more taxes than the poor man, you pay more taxes on your millionth dollar than you pay on your first. This is a bit complicated to grasp, so let’s see an example.

How to calculate income tax

Here is the federal income tax bracket for 2020⁴

10%: $0-$9,875
12%: $9,876 – $40,125
22%: $40,126 – $85,525
24%: $85,526 – $163,300
32%: $163,301 – $207,350
35%: $207,351 – $518,400
37%: $518,401+

Let’s say you and your buddy got a payday from the amazing website y’all created this year, and your taxable income amounts to $100,000 in 2020.

You pay 10% on your first $9,875: $9,875 x .10 = $987.50

You pay 12% on the next bracket, which, if it ranges from $9,876 – $40,125, includes $30,250. $30,250 x .12 = $3630

You pay 22% on the next bracket, which encompasses the next $45,400. $45,400 x .22 = $9988

Finally, you pay 24% on the next bracket. It ranges from $85,526 - $163,300, but you only made $100,000 total, so you’ll be taxed 24% on $14,475. $14,475 x .24 = $3,474

If you add up the amount we pay in taxes from each bracket, we see how much you paid in income tax this year on your taxable income:

$987.50 + $3,630 + $9,988 + $3,474 = $18,079.50.

This is about 18% of the $100,000 you made, even though, at first glance, it seems like you’d be paying 24% since that's where $100,000 fits on the bracket.

That was a lot of math, and you might be wondering why it even matters. Well, first of all, I just saved you 6 grand. You’re welcome. Also, I’ve heard people spreading uneducated takes in the past about how they don’t want to take a raise because it’ll put them in a higher tax bracket and they’ll actually be losing money; unless they're talking about some kind of specific welfare they benefit from for not making enough, this is false: you will never lose money from federal income tax because of a raise. Take the raise.

And finally, you can avoid making the same mistake as (generous) or falling victim to the misinformation of (not generous) Ainsley Earhardt.

Sources

1: https://www.newscientist.com/article/2193592-green-new-deal-proposal-includes-free-higher-education-and-fair-pay
2: https://www.cbsnews.com/news/alexandria-ocasio-cortez-the-rookie-congresswoman-challenging-the-democratic-establishment-60-minutes-interview-full-transcript-2019-01-06/
3: https://twitter.com/revrrlewis/status/1084820894751645696?lang=en
4: https://smartasset.com/taxes/current-federal-income-tax-brackets#:~:text=The%20U.S.%20currently%20has%20seven,subject%20to%20a%2037%25%20tax.