Thursday, April 12, 2007

Schansberg on the Seven Myths about Taxes for April 15th

Seven Myths about Taxes for April 15th

1.) “I didn’t pay any taxes this year!” This irritating myth, often uttered around in early April, stems from a confusion between one’s tax burden throughout the year—and any additional taxes one must pay by April 15th if they didn’t pay enough earlier in the year. “I didn’t pay” usually means “I didn’t have to pay any more to Uncle Sam on Tax Day”.

2.) “No, I really didn’t have a tax burden this year!” That’s certainly possible. Many lower-income and lower-middle class folk don’t pay federal income taxes—especially if they have children. Federal income taxes are paid almost exclusively by those in the upper half of earned income. But that’s at the Federal level. What about state and local income taxes? In Indiana and Kentucky, many hard-working people in the lower income brackets have to cough up money to support state government—including many below the poverty line.

3.) “No, I didn’t pay any state or local income taxes either.” Well, you don’t make much money then! In any case, you still paid a significant tax on your income—through the payroll taxes for Social Security and Medicare. No wage income is exempted and there are no deductions, so the 15.3% flat tax is applied to every dollar you earn (up to a cap of nearly $94,200 in 2006). About 80% of wage earners lose more to this tax on income than its far more famous cousin, “the income tax”.

4.) “OK, but the employer pays half of that tax, right?” Not quite. Firms are often able to shift the burden of taxation. Who do you think pays the tax on gasoline? The tax is imposed on firms and they cut a check to the government, but they easily pass on that burden to consumers through higher prices. In a similar manner, firms pass on the cost of the Social Security tax to workers through lower wages.

5.) “Well, at least the corporations are paying their share.” Yes and no. Again, companies will pass the burden to consumers as much as the market allows. Beyond that, a corporation is made up of people—so the extent to which the burden remains with the firm, it will be shared by workers and owners/shareholders. Many taxes start with corporations but are transmitted to consumers, workers, and shareholders: sales taxes on most items and special taxes on everything from cigarettes to liquor, from telephones to recreational vehicles. And don’t forget about tariffs—taxes on all sorts of foreign-produced goods.

6.) “Well, taxes could be worse.” Yes—and they probably will be. Whatever one thinks of current taxes, things are actually worse because of government debt and unfunded mandates. Debt must be repaid—and government debt must be repaid through higher future taxes. Unfunded mandates like Social Security and Medicare (tens of trillions of dollars in promised payments) must be paid through future taxes—or defaulted upon. So, save up now—and support politicians who courageously address these difficult topics!

7.) “Of all tax reforms, the flat income tax would be the worst since it’s regressive.” Nope. The flat income tax has a number of merits, including the elimination of “loopholes” and greatly reducing the amount of time spent filling out forms. Beyond that, a flat tax is at least proportional—the same marginal tax rate is applied above some exempted income level. Or using the common definition, a flat tax is progressive; the average tax rate would rise as income increases.

Assume a tax system with a 20% marginal tax rate applied to all income earned above $30,000. Someone earning $30,000 would pay no taxes—a 0% average tax rate. Someone earning $40,000 would have $10,000 in taxable income (above the $30,000 of exempted income), pay $2,000 in taxes, and face a 5% average tax rate. Someone earning $100,000 would have $70,000 in taxable income, pay $14,000 in taxes, and face a 14% average tax rate.

Imagine how much easier life could be with a less complex and burdensome tax system. Or maybe you should let your imagination roam after you finish filling out your 1040s this year. It might be too frustrating to think about until your task is done.

D. Eric Schansberg

Professor of Economics, Indiana University (New Albany)

Adjunct Scholar, Indiana Policy Review

Author, Turn Neither to the Right nor to the Left: A Thinking Christian’s Guide to Politics and Public Policy

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