The first thing to understand about the income tax is that it is a progressive tax. That means that the more income you earn the more you pay in taxes. There are a lot of rationales for adopting a progressive tax-rate structure but the most common is called the ability-to-pay argument. Low and middle income tax-payers devote a higher proportion of their income to paying for the necessities of live, such as food, shelter and medical care. They are more likely to be living from paycheck to paycheck then are high-income earners. High-earners can easily afford to cover the necessities of life and still have a large amount left over to spend on luxury items and the like. Therefore, high-earners can afford to pay a higher tax-bill without feeling the same level of economic hardship as low and middle income earners.
President Bush and Congressional Republicans pushed through changes in how dividends, capital gains, and wealthy estates are taxed, but let’s just focus on the changes in the income tax. President Bush changed the income tax-brackets in 2001 and 2003 like so:
President Obama has proposed letting the top two tax-rates on income earned over $200,000 by an individual ($250,000 for a family) reset to the levels under the Clinton Administration. That would mean a change from the current rates of 33 and 35 percent to 36 and 39.6 percent, respectively. So does that mean a family earning $250,001 will have to fork over $90,000 (36 percent of $250,000)? Nope. Annie Lowrey explains why in a post for The Washington Independent:
Pop quiz. Say you make a steady $250,001, every year. How many dollars of additional income tax will you pay if the Obama administration’s tax plan goes through? A thousand dollars? A few thousand? Nope. Three cents.
Here’s how it works. Your taxes below $250,000 remain the same. And on that excess $1, your income tax rate increases from 33 percent to 36 percent. For most earners making between $250,000 and $500,000 a year, the Obama plan would increase income tax liability by just a few hundred dollars — an average of $600, according to the Center for Economic and Policy Research’s Dean Baker.
Slightly left of center think-tank The Center on Budget and Policy Priorities explains further, with one of the neatest metaphors I’ve ever read in policy paper:
This crucial distinction is often overlooked. It is perhaps best explained through a metaphor: the income tax operates as a staircase, not an elevator. This means that people who make $1 million a year do not go directly to the top “floor” (i.e., to the top tax rate, currently 35 percent) but instead take the “stairs,” paying tax on the first increment of taxable income at 10 percent, paying tax on the next increment at 15 percent, and so on until reaching the top rate.
Because of this, the 10 percent bracket — which the 2001 tax law carved out from within the old 15 percent bracket — reduces taxes not only for people whose incomes fall within that bracket, but for every taxpayer whose income exceeds the 10 percent bracket, as well. In fact, taxpayers in higher brackets receive the maximum possible benefit from the 10 percent bracket.
Members of a certain political party often talk as though the totality of a high-earners income will be taxed at the same top rate, when in fact it will be taxed at all the different, lesser, rates on the way up to the top. Whether they do this because they are ignorant or lying is an open question I won’t address here (But I have theories!). Regardless of their motives, because they do this you can count on some opponents in round making the same mistake. If you call them on it, it will totally undermine their credibility on the issue. So do that.
I’m a real wind-bag when I get going about taxes. I’ll stop now and just add some more articles that are worth reading:
Analysis Looks at Effect of Letting Tax Cuts Lapse for Rich - NYTimes.com
A concise summary of Obama's tax-proposal.
"Extending them for the next 10 years would add about $3.8 trillion to a growing national debt that is already the largest since World War II. About $700 billion of that reflects the projected costs of tax cuts for those in the top 2 percent of income-earners."
Tax Cuts May Be Good Politics but Poor Stimulus - NYTimes.com
"The nonpartisan Congressional Budget Office this year analyzed the short-term effects of 11 policy options and found that extending the tax cuts would be the least effective way to spur the economy and reduce unemployment. The report added that tax cuts for high earners would have the smallest “bang for the buck,” because wealthy Americans were more likely to save their money than spend it."
A Gift for the Nation - Ending Tax Cuts for the Wealthy - NYTimes.com
"Because most poor and middle-income families consume their entire income, higher tax rates for those families would indeed deprive the economy of much-needed short-run stimulus. But extending the Bush tax cuts for the wealthiest families would be one of the worst possible ways to stimulate spending. These families typically consume much less than their income. Instead of trying to use up all their savings before they die, most prefer to leave substantial bequests. Letting their tax cuts expire might reduce those bequests, but it will not reduce their current consumption significantly.
It will, however, generate revenue that could be used to bolster spending in a host of ways that would be useful even apart from the stimulus effects. Because state and local government budgets are in shambles, hundreds of teachers, police officers and firefighters are being laid off every week. Federal grants could keep them on the job."
Why the Rich Don’t Need a Tax-Cut Extension - NYTimes.com
"The second argument is that not extending the tax cuts to high-income earners would impose an excessive burden on small businesses. Here, however, we fall into a statistical morass. The administration points out that only 3 percent of all businesses earn enough to have to pay any additional tax. But Republicans reply that those 3 percent of businesses earn 47 percent of the income from this entire sector, meaning that the higher taxes would apply to the bulk of small-business income.
Which is the most relevant number?
To understand these statistics, we need to know how small business is defined. The data come from tax returns, and the definition of a “small” business is one that is organized so that all the profits pass through to the owners, who then report these profits as income on their personal tax returns.
Partnerships and firms structured as S corporations are examples. This category can include businesses as diverse as barbershops, car washes, hedge funds and law firms. Goldman Sachs was in this category before it became a public company. And the fact that 3 percent of the businesses earn nearly half of the money is precisely what many people are concerned about: growing income inequality."
Why Congress Should Let the Bush Tax Cuts Expire - Daniel Gross, Newsweek
One Nation, Two Deficits - Peter Orzag, NYTimes.com
Peter Orzag, Obama's former director of the Office of Management and Budget (OMB), advocates temporarily extending all of the Bush tax-cuts for two years and letting all of them expire (middle-class cuts included). He's concerned about our future deficit.
"In the face of the dueling deficits, the best approach is a compromise: extend the tax cuts for two years and then end them altogether. Ideally only the middle-class tax cuts would be continued for now. Getting a deal in Congress, though, may require keeping the high-income tax cuts, too. And that would still be worth it.”



