The Truth about Taxes

Lots of talk these days about raising taxes and cutting spending. Republicans say they'll control spending and won't raise your taxes. Democrats won't let social programs be cut but want taxes on the top 2% raised. What's true?

For most people, our Federal Taxes consist of some or all of these:
  • Income Taxes (taxed for working)
  • Payroll Taxes (for Social Security and Medicare)
  • Capital Gains Taxes (gains on the sale of assets like stocks or a home)
  • Dividend Taxes (earnings on stocks)
  • Estate Taxes (only matters if you're an heir or a corpse)
  • Other taxes on miscellaneous income from interest earnings, rents and royalties, pensions, etc.
Let's look at each of these and how they impact your taxes vs. the taxes others are paying. In each case, I've used the averages provided by the IRS for the most recent year available.


Long considered the most progressive tax, income taxes are graduated so those with higher income pay a larger share than those with less income. The current rates range from 10% for the lowest wage earners to 35% for those earning over $373,650. In addition to the tax rates though are the obvious and less obvious deductions and credits that reduce the tax you would pay. Let's look at three examples:

Poor Jimmy (PJ) works at a minimum wage job in Oregon ($8.40 per hour). He is lucky and works 40 hours each week for 52 weeks. He is especially lucky that he is paid for 8 holidays too. PJ earns $17,000 (rounded) in a year.

His income taxes are simple. He takes the standard deduction of $5700 and the personal exemption of $3650. That leaves him with $7650 of taxable income. He pays the lowest rate of 10%.

PJ's 2010 Federal Income Tax Paid: $765 or 5% of his year's income

Wage Taker Freddy (WTF) has a comfortable salaried job and earns $63,000 (national average). WTF also takes the standard deduction and the personal exemption (two-thirds of Americans use the standard deduction). He has $53,650 of taxable income and pays 25% in income taxes.

WTF's 2010 Federal Income Tax Paid: $9600 or 15.2% of his year's income

Richie Rich (RR) is doing well and earns $500,000 at his important job. RR itemizes (87% of those earning over $100,000 itemize). The average itemized deduction for those earning over $200,000 is over $110,000 (half of their income). RR claims deductions of $200,000 (low estimate based on IRS figures). He takes the personal exemption also. RR's taxable income is $296,350 and he pays 33% on a small portion of his income.

RR's 2010 Federal Income Tax Paid: $82,938 or 16.6% of his year's income


But of course, we all pay more than just income tax to the federal government. For most of us, payroll taxes (deducted off the top of our paychecks) are among the highest. Currently, we all pay 6.2% of gross income (no deductions, sorry) for Social Security and 1.45% for Medicare. The Social Security tax is levied only on the first $106,800 of income but Medicare taxes are the same for all.

PJ's 2010 FICA taxes paid: $1300.50 or 7.65% of his year's income

WTF's 2010 FICA taxes paid: $4819.50 or 7.65% of his year's incomeRR's 2010 FICA taxes paid: $13,872 or 2.8% of his year's income

  • PJ is paying 12.65% of his $17,000 earnings
  • WTF is paying 22.9% of his $63,000 earnings
  • RR is paying 19.36% of his $500,000 earnings


Capital gains are your earnings on investments, such as real estate, stocks and bonds. These are taxed at a much lower rate than wages because, well, we like people who invest their money more than the schmucks who go off to work every day to earn from the sweat of their brow. Oops. A little editorializing there.

The capital gains tax rate on long-term (more than a year) investments is 5% if you earn less than $34,000 per year and 15% if you earn more. Let's have a look.

At $17,000 a year income, PJ has no money to invest. He has no capital gains income and no capital gains taxes.

At $63,000 a year income, WTF earns the average for his tax bracket of $840 in capital gains and pays 15% or $126 in tax on that income.

At $500,000 a year income, RR earns the average in capital gains for his income level of $138,000 and pays 15% or $21,000 in tax on that income.

  • PJ's total income is still $17,000 and his total tax burden is 12.65%
  • WTF's total income is now $63,840 and his total tax burden is 22.8%
  • RR's total income is now $638,000 and his total tax burden is 18.46%


Dividends are earnings on investments you still hold. Again, PJ can't afford to make investments and has zero dividend earnings and zero in dividend taxes. We'll use average figures from the IRS for WTF and RR. The current tax rate for dividends is 15%, also well under the income tax rate. (Side note: some decry this as double taxation since corporations are taxed on their profits and then shareholders again when they receive dividends. However, SS corporations already can "pass through" those profits to shareholders without paying any taxes on them.)
  • PJ earned zero in dividends and paid no dividend taxes
  • WTF earned $4,847 in total dividends and paid $727 in taxes on them
  • RR earned $65,388 in total dividends and paid $9808 in taxes on them
  • PJ's earnings still sit at $17,000 with a tax burden of 12.65%
  • WTF's earnings are now at $68,687 with a federal tax burden of 22.2%
  • RR's earnings are up to $703,388 with a federal tax burden of 18.1%


Perhaps before venturing into estate taxes, this would be an appropriate time to thank WTF for his sacrifice for his country.

Estate taxes are paid when an individual dies and leaves a substantial inheritance to his or her heirs. Currently, the estate tax is at ZERO. Indeed, our tax policy is encouraging inheritance and discouraging work.

Unfortunately, I can find no data on who inherits and how much since the IRS isn't collecting the information through tax returns. Without any hard data, it's still reasonable to assume that most of the top 2% of earners either have or will inherit substantially from their similarly wealthy parents. This is lifetime assets with no tax obligation. Suffice it to say that those inheriting big estates -- valued in excess of $1 million -- are the prime beneficiaries of the tax grace from Uncle Sam.


There are some other income sources not included here: interest income, rents and royalties, pensions, and so on. If you've read this far, you're probably thankful I'm leaving those off and allowing you to get back to your business.


Tax policy is a way of encouraging some kinds of behavior and discouraging other. So far, we can see that gambling in the markets, buying real estate and having rich relatives are encouraged. Earning your keep from a job is discouraged. Yet America's one boast to the rest of the world is the amazing productivity of our workers. Is this the road we want to be traveling?


  1. I should add that if you factor in state and local taxes, the burden on PJ increases substantially. Sales taxes in particular are very regressive. This is because all of PJ's money is spent in the market; much of WTF's is but little of RR's is.

  2. For those who read this post earlier and notice some differences in calculations, my apologies for a couple of errors recently corrected.

  3. According to this recent article, 47% of American households don't pay any federal income tax.

  4. Not sure how to reconcile that with the actual IRS figures I used. But a joint return of $50,000 would be equivalent to two wage earners earning $25,000 each, not much over minimum wage. In the example in the article, with 2 children there is no income tax owing. Of course, there's no escaping the 7.65% payroll tax this family will pay on all income (but which income from investments does not pay). Income distribution could play a part also. The top 20% receive 50% of aggregate income ( Add income from investments and this number soars much higher.

  5. Just an FYI. Unless you have some very funky deductions you couldn't have 50% of your income as deductions, because you would hit AMT. The high number is for $200k or more and it's not a percent, so it difficult to tell what the real percent is. (I think the max is 24%) What we need is higher capital gains taxes. Those mostly effect the very wealthy.

  6. Agreed. The average of $110k deductions for upper incomes come from here: It is difficult to determine percent or to tease out the averages for those at the lower end of that income group.


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