7.30.2010

Today I learned about Income Tax Brackets

I looked into how tax brackets work and it makes a whole lot more sense than it did before.

Before I had heard on occasion, it must have been repeated on tv or maybe in school, that someone turned down a raise to avoid getting bumped into a higher bracket. Even I had thought for instance if the top of bracket were at $50k and you got a raise to $51k, all of a sudden you went from paying something like 20% to 25% on it that'd be crazy. Turns out, if you know anything, this is completely not how it works.

The way it works is that the top of first bracket is currently $8 375 and the rate is 10%, if you're single. So everyone who makes less than $8 375 pays 10% of whatever and they're done. The top of the next bracket is $34 000. So, if you make $30 000 then you pay 10% on the first $8 375, and then the rate of the second bracket, 15%, on the next (30 000 - 8 375).

If you make more than 34k, say 50k, it then repeats again with you paying the max in the $8 375 bracket and the max in the $34k bracket and then 25% on (50 000 - 34 000) and so on.

I made an Excel to see the numbers. Downloadable here. I concluded that with the way it is, at least these two things are true:
  • As salary increases, pay more in taxes
  • As salary increases, take home pay never decreases
Display the graphs!


This first one is the effective tax rate by income. Click for bigger.


This second one has the pre-tax income across the bottom and the blue line, click for bigger. The after-tax income is the red line and I've also drawn the tax rate again.

Now that I know, breaking the income tax up into brackets like this seems to be vary fair--everyone pays low taxes on the first few chunks and then additional taxes on the additional income. Now when I hear about lowering the highest tax bracket for rich people, which is income past $374k, it feels like that's being way too generous to them. It's only 35%! It doesn't seem unfair that it should be higher like 50 or 60%, post WWII levels, since they've already gotten the first few hundred thousands at reasonable rates.

Today there are six brackets. Historically there were many more brackets. Up through the mid 60's, the highest brackets, $200k+ payed 91% tax. (Via the inflation calculator, $200k in 1964 is equivalent to about $1.37 million in 2009.) Then by the 70's it was in the 70's and it's crept down since then.