Among the issues most commonly discussed are individuality, the rights of the individual, the limits of legitimate government, morality, history, economics, government policy, science, business, education, health care, energy, and man-made global warming evaluations. My posts are aimed at intelligent and rational individuals, whose comments are very welcome.

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"Observe that the 'haves' are those who have freedom, and that it is freedom that the 'have-nots' have not." Ayn Rand

"The virtue involved in helping those one loves is not 'selflessness' or 'sacrifice', but integrity." Ayn Rand

17 July 2008

Taxes in Montgomery County, Maryland - An Example

The median family income in Montgomery County, Maryland was $103,476 in 2006. Half of the families in the county made more and half made less. This means that such a median family is making much more than the median income in most of the United States. But, it is also true that the cost of living is much higher in Montgomery County and taxes make no adjustment whatsoever for that fact. By the way, median household income in Montgomery County is considerably less, so do not confuse those two sets of numbers, as many commentators do.

Let us assume that this median income family has all of its income from being self-employed. We will discuss the case of income from a separate employer later. This family has approximately the following taxes applied to their income, assuming they are married and filing jointly, have one child younger than 17, and have $15,000 of itemized deductions:

Federal Income Tax Average Rate = 12.00%
Social Security Average Tax Rate = 12.22%
Medicare Average Tax Rate = 2.86%
Maryland Income Tax Average Rate Estimate = 3.73%
Montgomery County Tax Average Rate Estimate = 2.54%

The sum of these average rates on this family's income is 33.35%. More than one-third of their income is going to income taxes! In this calculation, I calculated the social security payment and then found the percent of that relative to the total income of $103,476, which is slightly above the cut-off upper income on which the 12.4% social security tax is levied. For the Medicare tax I did the same thing. The state and county taxes depend further on what part of the itemized deductions are due to state and local taxes, so I made a reasonable typical estimate of that.

Let us look at the case of family income for those not self-employed. The first thing to realize is that the employer figures up the total cost of employing an employee including all taxes paid on the employee, benefits for the employee, facility space for the employee on the job, added insurance costs, added equipment costs, etc. If he did not have to pay 6.2% social security tax and 1.45% Medicare tax on the employee, he would be absolutely as willing to give that money to the employee as to give it to the government. As a result, it is really a fiction that the employer is paying that money rather than the employee. Politicians love this little fraud because it hides, as so many other taxes are hidden, the true cost of taxes from the employee and most voters. This fraud does give the employee one little benefit however. Since the 6.2% + 1.45% = 7.65% of his income never appears in his salary, he does not have to pay federal, state, and local income taxes on that amount, while the self-employed person does. Ain't it a crock. Everyone hates the self-employed!

Suppose the family income earners above are considering whether it is worth their while to work an additional hour or not. If they do, what fraction of the income earned in that hour will go to government instead of to them? This is the same as asking what is the marginal income tax rate for each of the above taxes? Let's assume however that they are still a wee bit below the social security and medicare tax cut-off levels, as very many families will be. Then we have:

Federal Income Tax Marginal Rate = 24.00%
Social Security Tax = 12.40%
Medicare Tax = 2.90%
Maryland Income Tax Marginal Rate = 4.75%
Montgomery County Income Tax Marginal Rate = 3.20%

Thus, the total marginal income tax rate is 47.25%! Just in income taxes alone, $0.4727 out of each additional dollar earned is lost! Or, 28.35 minutes out of each hour worked is stolen! This is a situation a great many productive people are in. They have to really love their work or be really dedicated to achieving a goal requiring additional money to justify working this additional hour. If you wish to increase taxes on such people, are you really sure that you want to so discourage them from working as hard as they do? How many baby boomers might you induce to take early retirement, with the added strain that will put on the social security system and the loss of so much experience? Of course, at such tax rates, it makes a lot of sense for such people to work very hard on trying to earn additional money in ways that will not require them to pay so much in taxes. This tendency for people to work fewer hours as the taxes go up and to work harder to find tax loopholes or even to cheat on taxes, is why increasing tax rates does not always allow the government to collect more in taxes. The economy will grow less and over the years after a tax increase, this results in a large decrease in the taxable income compared to the taxable income which would materialize in those years at lower tax rates.

Of course, these income taxes are not the only taxes paid. You will also pay property taxes on your home and the land it sits on, sales taxes, taxes on utility bills, gasoline taxes, liquor and tobacco product taxes, motel and airport use taxes, fishing license, car registration, car pollution test taxes, dog licenses, marriage licenses, home title registration taxes, and higher costs for all products and services to cover the taxes paid by businesses, and many, many more taxes. So the income you have left after you pay the income taxes, is still going toward paying taxes in many ways. Taking these other taxes into account, the family earning just less than $102,000 will in fact pay out far more than half of each additional dollar of income on average in taxes. How discouraging!

So, stop and think. Are our governments really doing enough for us that we should be willing to give them more than half of all the value we create by working hard? I for one do not think this is anything but a slam dunk question. NO!!!! NO!!!!!!! NO!!!!!!!!!!!!!!!!


Anonymous said...

I feel your pain. It's the same here in New Zealand - what's with a 33% tax rate for a middle-class family and a 12.5% "Goods and Services Tax", "we" also practically pay half our income to the government.

Even low earners, like myself, pay 15%.

It would help the poor so much if the government here would just slash all income tax for the first $20000 of earnings - that is, in New Zealand dollars, which is worth less than the American dollar. But nobody would do it.

Charles R. Anderson, Ph.D. said...

Is a Goods and Services Tax the same as a Sales Tax here in America? Do you have any separate local government taxes in New Zealand?

The federal government "Income Tax" for married filing jointly with $20,000 of taxable income is an average tax of 11.1%, to which the 12.4% Social Security Tax and the 2.9% Medicare Tax are added. Then the state of Maryland adds a 4.75% tax and Montgomery County adds a 3.20% tax. So, the overall income tax rate is still 34.35%! Frankly, despite the fact that our system is designed to punish somewhat high income people more than yours is, it is nonetheless the case that high income families pay most of the tax revenue collected by the various governments. This artificially makes it appear that government is a lot less wasteful than it is to most voters. So, it is easy to fool them into voting for politicians promising them one more social program after another, since high income people will be made to pay for most of it. This is the basis for a huge fraud in value offered by governments and the reason that few people pay much attention to how their vote will affect their pocketbooks.

I do not favor further reductions in taxes for the lower income groups until justice is first served by reducing rates for the higher income groups. Of course, practically, there should be such huge reductions in government spending that everyone should get reductions in tax rates, with the biggest percentage decreases going to those who pay the highest rates now. Unless rates are reduced for everyone, no tax reduction package is likely to get the votes to pass Congress.

Charles R. Anderson, Ph.D. said...

The percentages in the above comment were made against the federal taxable income of $20,000, which is why they are so high. I will estimate a case here in which we infer a likely income which yields a taxable income of $20,000 and what deductions are likely to apply. I am only going to do the first iteration on the Maryland and county tax bite as a federal deduction, so the amount of this deduction is by about $460.

This family is too poor to own a home in Montgomery county, so they will be assumed to have no mortgage interest deduction. They do have 3 personal exemptions and they can deduct state and local income taxes paid. So, their total income was about $31,739. The federal income tax average rate is therefore 7.0%. The Maryland income tax average rate is 3.5% and the county rate is 2.5%. Including the constant social security and Medicare rates, the total income tax rate is about 28.3%, which is only a slightly lower average income tax rate compared to that of a family with more than 4 times their taxable income, whose rate was 33.35%.

So, if you are a middle class family and you own a home on which you are making mortgage payments, you can arrange to pay an average income tax rate similar to that of a poor family simply by choosing a sufficiently expensive home. What does not change, unless you upgrade your home, is that fact that your marginal tax rate is much higher.

Anonymous said...

I'm sorry to hear all this. There isn't really a "local tax" here in New Zealand, but our system seems to do the opposite of the American one. It punishes homeowners. You have to pay a "land rate" to the local government if you own a home.

Hey, I totally agree that taxes should be cut for the rich and middle class as well. Ideally, I'd go for a Hong Kong system - 16% flat tax for everyone, nothing else whatsoever. Under this system, I wouldn't even mind paying 1% more, because the standard of living would be so much higher.

But you won't find a politician in New Zealand that favours this. Except maybe Act and the Libertarianz. And I don't like the latter.

"So, if you are a middle class family and you own a home on which you are making mortgage payments, you can arrange to pay an average income tax rate similar to that of a poor family simply by choosing a sufficiently expensive home."

Hey, could this be part of the reason for the "lending crisis"?

Charles R. Anderson, Ph.D. said...

Yes, people are very much tempted to take on as big a mortgage as they can handle to minimize their taxes. This is a contributor to the housing crisis. However, the housing crisis is actually a local phenomena which is much worse where housing is most expensive. Government restrictions on building homes and apartments are a major contributor to high housing costs in most of the more expensive metropolitan areas, so these housing restrictions have contributed to the problem. Then, the federal guarantees of home mortgages through Fanny Mae and Freddy Mac have been another reason for the crisis.

Anonymous said...

"Government restrictions on building homes and apartments are a major contributor to high housing costs in most of the more expensive metropolitan areas, so these housing restrictions have contributed to the problem."

Oh boy, same here, same here...especially in Auckland where I live. The restrictions are nuts.

I hope the level of socialism here in NZ goes down come next election. Same with the US. And I do detest this crony capitalism thing where irresponsible corporations get bailed out by taxpayer dosh - I wonder if there's any way to stop it.

Oh yes, the "Goods and Services Tax" in New Zealand is added to the price of things. I'm not sure if it's the same as the sales tax. But I'm pretty sure it has a similar effect on commerce - Drive it down.

Charles R. Anderson, Ph.D. said...

Fortunately, here in Maryland a recent attempt to apply the newly increased 6% sales tax to services by starting with computer services has been turned back. Temporarily. The National Federation of Independent Businesses was among those who fought it hard and actually forced a law already passed to be rescinded. Also, our sales tax does not apply to food, except some food and beverages considered junk food.

The Democrats now control the governorship and the legislature and they are on a constant quest to grow the government and to increase taxes. The previous governor, Bob Erlich, was the best governor in decades, but the people chose to replace him with a demagogue, Martin O'Malley, who had a proven record of failure as mayor of Baltimore. O'Malley has massively broken his totally insane campaign promises and quickly increased the sales tax from 5% to 6%. He promised to prevent an electricity rate hike for residential customers, but that was always a lie since the electric utility company would have gone under without the long-overdue increase. The system equipment has long been rundown due to inadequate maintenance. It seems that for political reasons, it was that equipment that served the commercial customers long since paying the higher rates deferred for years to residential customers which was least maintained. O'Malley, O'Folly!