Here’s the Real Way to Structure a Middle-Class Tax Cut (The GOP Isn’t Doing This)

2017-09-28 – Now that the GOP efforts to “repeal and replace” Obamacare has been stopped for the fourth time, the party of Trump is now turning its attention to tax reform. (In this blog, I’m going to talk about individual taxes only. I’m not going to get too deep into the numbers, but any calculations are based on a married couple filing jointly and not itemizing and are only approximate.) (UPDATE: I wrote this when I only had basic information about the proposal. As I get more details, I have more questions about how much of a cut people in the middle will be getting, but I’m not going to change this. The numbers here are probably more favorable to the GOP plan than it deserves. But the basic point is still true. The rich are getting the best deal here. The very best.)

The Republicans are now calling their proposal a “middle-class tax cut.” But before we get to the middle class part, let’s look at the tax cut for the rich. The figures I’m giving below are in round numbers and does not take into account tax deductions that rich people use that often reduce their taxes even more. Here is what high earners can expect in tax reduction if the top tax rate is dropped from the current 39.6% to 35%.

Taxable Income Tax Reduction
$500,000 $4,600
$1,000,000 $27,600
$5,000,000 $211,600
$10,000,000 $441,600

 

Now, before I go on, I want to acknowledge that 39.6% seems high, but this is a “marginal tax rate.” This rate is not paid on your entire income. It is only paid on the top tier of your income. Lower tiers pay lower rates. Politicians like to scare you by telling you your marginal rate. Your “effective tax rate” (the amount you actually pay) is always lower than the marginal tax rate—often a lot lower. (See below, for details on this point.)

The middle-class part of the tax cut is largely due to an increase in the standard deduction. For a married couple, this is $12,700 in 2017. The Republicans propose to double this, which would definitely reduce taxes for the middle class, but they are also proposing to RAISE the tax rate for the lowest bracket from 10% to 12%. Combine this with the decrease in the top marginal rate and you get the following:

Adjusted Gross Income Tax Reduction % Reduction*
 $20,000  $730 4%
 $50,000  $ 3,397 7%
 $100,000  $ 2,673 3%
 $150,000  $ 2,802 2%
 $250,000  $ 3,381 1%
 $500,000  $ 4,836 1%
 $1,000,000  $27,836 3%
 $10,000,000  $441,836 4%

* As a percentage of adjusted gross income.

So the middle class might get a reduction (this would not necessarily apply if you itemize your deductions), but the richest of the rich are getting a pretty good deal too. So I wouldn’t say that this would be a middle-class tax cut. Everyone would get a cut, but the upper-middle would actually get the least of it.

(There are also other items in the GOP proposal. Some would work similar to the standard deduction and focus benefits more at the lower end of the income scale and there are other items that would give additional benefit to the high end of the income scale. I am leaving those out because I don’t think they change the point I’m making here.)

Now, I don’t think that individual tax reform is the most pressing issue for the country—unless you are looking to boost the top rate. But if you really wanted to give a middle-class tax cut (not a disguised give-away to the very rich), you could take one part of the GOP plan—the doubling of the standard deduction—and skip the changes in the tax rates. That would have the following effect:

Adjusted Gross Income Tax Reduction % Reduction*
$20000  $730 4%
 $ 50,000  $ 3,770 8%
 $100,000  $ 3,046 3%
 $150,000  $ 3,175 2%
 $250,000  $ 3,754 2%
 $500,000  $ 5,029 1%
 $ 1,000,000  $ 5,029 1%
 $10,000,000  $ 5,029 0%

* As a percentage of adjusted gross income.

Doubling the standard deduction and nothing else would actually target tax relief to the middle class, unlike the GOP proposal.

Do you think they’d go for it? Not. A. Chance.

They don’t represent the middle class. The represent the very, very top. Whatever they give to the middle class is a cover for massive giveaways to their elite constituency.

* * *

ABOUT MARGINAL TAX RATES

As I said above, the concept of marginal tax rates often confuses the politics. So I just want to show you the difference between the marginal tax rate and the percentage you actually pay (called the “effective tax rate”). The effective tax rate is always less.

Adjusted Gross Income Marginal Tax Rate
(from IRS Tax Rates)
Percent You Actually Pay
(“Effective Tax Rate”)
$20,000 10% 4%
$50,000 15% 9%
$100,000 25% 13%
$150,000 25% 17%
$250,000 33% 21%
$500,000 39.6% 28%
$1,000,000 39.6% 34%
$10,000,000 39.6% 39%

 

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