# Monthly Archives: January 2012

# San Rafael

Robert has to say that San Rafael has it going on. It has an El Farolito and an Arizmendi Bakery. On the same block!

# Birthday Gift Ideas

# San Rafael

Robert has to say that San Rafael has it going on. It has an El Farolito and an Arizmendi Bakery. On the same block!

# Birthday Gift Ideas

# Capital Gains Rate

There’s been much discussion lately about the rate at which capital gains are currently taxed under federal tax law. The rate is currently 15%, which is lower than the rate at which other income is taxed. This is making folks focus on the tax avoidance strategies of people who make most of their money on investments, like professional investors and other wealthy people who don’t need to work for their money. The example is usually given that millionaires, who make their money passively through investments, enjoy a lower tax rate than their secretaries who work for a living and pay payroll taxes. The optics of the situation are terrible. Many people are saying that we should move to a capital gains rate that is the same as the rate on other types of income. Robert shares this view, as he stated in his November 7 blog post.

All the politics and the real and important perceptions aside, it is good to talk for a moment about the reason the capital gains rate is lower than the general rate. Congress did not wake up one day and say, “We want to bestow a huge tax benefit on investors, so we’ll tax their income at a much lower rate than everyone else.” It’s not that easy. The reason the capital gains tax rate is lower than the general rate is to remedy the pernicious effect of inflation on investment income.

# Out and About

# Out and About

# Effective Tax Rate

Robert has decided to announce his federal income tax rate paid in the years 2008, 2009, 2010. He does this because it is a good way to discuss the somewhat confusing question of what a person actually pays in federal taxes as a percentage of income. A question that Robert is sure most American’s cannot answer about their own tax returns, which is one of the biggest problems in US society today.

There are at least three ways to answer the question “How much federal income tax did you pay this year as a percentage of your total income?”

First, one could answer the question by giving one’s “marginal tax rate.” This is the answer that perhaps many (unthinking) Americans would give to the question stated above. The problem is that it is a nonsense answer. The marginal tax rate for a given tax return is the rate at which the last dollar earned by the taxpayer during the year is taxed. It IS NOT an answer to the question “How much federal income tax did you pay this year as a percentage of your total income?”

Second, one could answer the question by giving one’s so-called “effective tax rate.” The term “effective tax rate” does not, as far as Robert knows, have a universally recognized definition. He believes that what most people mean when they say “effective tax rate” is the amount of tax an individual or firm pays when all government credits are applied, ** divided by income that has been reduced by government allowed deductions**. Robert believes that using a person’s effective tax rate is certainly a better way to answer the above question than answering with a marginal tax rate (which is nonsense), but the effective tax rate measure is also a poor way to answer because when calculating the effective tax rate one subtracts from income all government allowed policy deductions (such as exemption deductions, charitable deductions, retirement account contribution deductions, and mortgage interest deductions). By giving this answer, one understates income and thus overstates the percentage of one’s income paid in tax.

One might most straightforwardly and honestly answer the question above by giving the amount of tax one pays without application of credits, divided by base income ** without government policy deductions (such as exemption deductions and mortgage interest deductions)**. Stated another way, using this approach, one measures taxes as a percentage of net income, where net income is gross income less the allowable and customarily measured costs of generating that gross income. For employees, who earn wages, gross income and net income are generally the same amount. This definition recognizes that to give an intellectually honest answer to the question above, one must not reduce the amount of one’s base income by the amount of policy deductions, which are, after all, ways the government reduces taxes. Robert will call the tax rate determined using this method the “True Tax Rate.”

So, using the definitions above, here are Robert’s, and thus the Pierce Family’s, federal tax rate numbers:

2008

Marginal Tax Rate: 28%

Effective Tax Rate: 22.0%

True Tax Rate: 17.5%

2009

Marginal Tax Rate: 28%

Effective Tax Rate: 23.4%

True Tax Rate: 18.2%

2010

Marginal Tax Rate: 15%

Effective Tax Rate: 17.7%

True Tax Rate: 8.2%

Here’s a link to the Tax Policy Center page that tells the same story (see second table down). Note that the definition of “Effective Tax Rate” used by the Tax Policy Center appears to be the same as what Robert defines as “True Tax Rate.”

http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=456

# Effective Tax Rate

Robert has decided to announce his federal income tax rate paid in the years 2008, 2009, 2010. He does this because it is a good way to discuss the somewhat confusing question of what a person actually pays in federal taxes as a percentage of income. A question that Robert is sure most American’s cannot answer about their own tax returns, which is one of the biggest problems in US society today.

There are at least three ways to answer the question “How much federal income tax did you pay this year as a percentage of your total income?”

First, one could answer the question by giving one’s “marginal tax rate.” This is the answer that perhaps many (unthinking) Americans would give to the question stated above. The problem is that it is a nonsense answer. The marginal tax rate for a given tax return is the rate at which the last dollar earned by the taxpayer during the year is taxed. It IS NOT an answer to the question “How much federal income tax did you pay this year as a percentage of your total income?”

Second, one could answer the question by giving one’s so-called “effective tax rate.” The term “effective tax rate” does not, as far as Robert knows, have a universally recognized definition. He believes that what most people mean when they say “effective tax rate” is the amount of tax an individual or firm pays when all government credits are applied, ** divided by income that has been reduced by government allowed deductions**. Robert believes that using a person’s effective tax rate is certainly a better way to answer the above question than answering with a marginal tax rate (which is nonsense), but the effective tax rate measure is also a poor way to answer because when calculating the effective tax rate one subtracts from income all government allowed policy deductions (such as exemption deductions, charitable deductions, retirement account contribution deductions, and mortgage interest deductions). By giving this answer, one understates income and thus overstates the percentage of one’s income paid in tax.

One might most straightforwardly and honestly answer the question above by giving the amount of tax one pays without application of credits, divided by base income ** without government policy deductions (such as exemption deductions and mortgage interest deductions)**. Stated another way, using this approach, one measures taxes as a percentage of net income, where net income is gross income less the allowable and customarily measured costs of generating that gross income. For employees, who earn wages, gross income and net income are generally the same amount. This definition recognizes that to give an intellectually honest answer to the question above, one must not reduce the amount of one’s base income by the amount of policy deductions, which are, after all, ways the government reduces taxes. Robert will call the tax rate determined using this method the “True Tax Rate.”

So, using the definitions above, here are Robert’s, and thus the Pierce Family’s, federal tax rate numbers:

2008

Marginal Tax Rate: 28%

Effective Tax Rate: 22.0%

True Tax Rate: 17.5%

2009

Marginal Tax Rate: 28%

Effective Tax Rate: 23.4%

True Tax Rate: 18.2%

2010

Marginal Tax Rate: 15%

Effective Tax Rate: 17.7%

True Tax Rate: 8.2%

Here’s a link to the Tax Policy Center page that tells the same story (see second table down). Note that the definition of “Effective Tax Rate” used by the Tax Policy Center appears to be the same as what Robert defines as “True Tax Rate.”

http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=456