A Closer Look at Federal Income Taxes

On or before April 15, 141 million U.S. taxpayers voluntarily shipped to Washington an estimated $1.7 trillion in individual income tax dollars, or about half of all federal revenues, according to the Congressional Budget Office (CBO). Taxpayers grappled with a federal tax code that is 73,954 pages long, which Albert Einstein called, “the hardest thing in the world to understand.”

Today’s federal income tax code is 2,000 times longer than the U.S. Constitution. Originally written by hand on four parchment pages, a pocket-sized printing of the Constitution can run to 17 pages, plus another 17 pages for the 27 Amendments enacted over the last 240 years.

This year, 90% of Americans filed electronically (a record high). 88% of filers took the newly increased standard tax deductions rather than itemize. Still, taxpayers spent an estimated 8.1 billion hours filing out their returns at a cost of $194 billion for professional advice. Charlie Brown’s Snoopy had the right idea when he wrote, “Dear IRS: I am writing to you to cancel my subscription. Please remove my name from your mailing list.”

Additional Taxes Galore

In addition to individual income taxes, the federal government collects revenue from a variety of other sources such as payroll taxes to help finance Social Security, Medicare, and unemployment benefits; corporate taxes which in 2018 were set at 21% at the federal level; federal excise taxes levied on activities, such as gasoline, alcohol, or gambling; estate taxes levied over a certain threshold ($11.18 million in 2018); and gift taxes on transfers of property (or money) above $15,000.

There are state and local income taxes, sales taxes, property taxes, excise taxes, sin taxes (tobacco, liquor, marijuana), windfall profit taxes, gross receipts taxes, value added taxes, carbon taxes, use taxes, death taxes, luxury taxes, soda taxes, franchise taxes, wealth taxes, tariffs, fuel taxes, hotel occupancy taxes, user fees and about 100 others.

The Overall Tax Rate

Adding up just the four income-based categories of taxation (Federal, state/local, Social Security, and Medicare), the average American’s effective tax rate is 29.8%, according to USA Today. This is before any consumption-based taxes are added, such as sales tax, property tax, or other taxes on specific items at the federal, state, city and county level. 

Who Pays Taxes

The Internal Revenue Service, based on the tax year 2016, the latest year for accurate analysis by income percentiles, has determined that:

The top 1% of federal taxpayers accounted for more income taxes paid at 37.3% than the bottom 90% of taxpayers combined at 30.5%. The top 3% of taxpayers paid over half (51%) of all income taxes.

The top 50% of all taxpayers paid 97% of all individual income taxes.

The bottom 50% of all taxpayers paid 3% of total individual income taxes. 44 million Americans paid no federal income taxes at all. 26 million households took advantage of the Earned Income Tax Credit in 2016 resulting in federal outlays totaling $61 billion.

In terms of dollars paid, the wealthy pay the most because as John Dillinger quipped when asked, “Why do you rob banks?” replied “Because that that’s where the money is.”

Montecito Medium

Some 4,690 federal tax returns were filed in ZIP code 93108 (Montecito). Interestingly, 1,040 (22%) of those returns reported Adjusted Gross Income (AGI), or taxable income, of less than $25,000. Almost half of Montecito filers reported incomes of less than $100,000 per year. 19% of filers reported AGI of between $100,000 and $200,000 while 29% reported AGI above $200,000.

It takes an annual AGI of $480,804 per year to reach the rarified top 1% of individual taxpayers. The average AGI of billionaires who claim residence in Montecito was reported to be $433,060, making the Median Household Income in Montecito a relatively modest $112,833.

Middle class income in the U.S. is defined as an annual household income between $34,061 and $136,244 per year. Some 13.4% of US workers (23,294,106) reported $100,000 or more in income. Many were two income households. Single income workers clocking 40 or more hours a week averaged an income of $61,385. For those working 30+ hours weekly, the average income was $41,169. The average income for the U.S. was $55,880. A mere1.6% of U.S. workers reported incomes of $250,000 or more. 

2018 Pain in Montecito

The December 2017 Tax Reform bill capped the State and Local Tax (SALT) deduction at $10,000. That hurts taxpayers in California, New York, and other states with high property taxes and high income taxes. Personally, I find it ironic that Californians who advocate higher taxes for the wealthy are now screaming that the wealthy have to pay more than their fare share due to a limited SALT deduction. I am one who paid more – much more – as the price for the pleasure of living in a blue high-tax state like California

A Pinion Here, A Pinion There

Those on the right contend that the best way for the nation to deal with income inequality is to increase the size of the economic pie. Increase disposable income by cutting taxes, growing the economy, creating higher paying jobs and putting more people to work. A rising tide lifts all boats.

Those on the left contend that the better and fairer solution to the apparent wealth difference is to increase the taxes on higher earners and distribute the proceeds to the poor, using greater entitlements to reduce the gap. This nation has tried both approaches with mixed results.

When I was a kid growing up, my father taught me an important life lesson. He posed this question: “What happens when you have three pinion nuts in one hand, and two pinion nuts in the other?” The correct answer is: “You have a difference of a pinion.”