How does our current top federal income tax rate (highest individual income tax “bracket”) compare to historical levels?

 

 

CHAPTER 8:  Personal Income Taxes & Hard Times

 

1. To me this section is drier, more boring, than most. So let’s start with a concise and enjoyable Minority Mindset video, on “taxes:”  “Save Money By Avoiding The Idiot Tax (6 Examples),” 6¾ minutes:  https://www.youtube.com/watch?v=jydge9dLYz0.

 

2. In case you’re wondering, two things are true: In addition to personal taxes, this chapter cover unemployment, food stamps and Medicaid only because they can each be unfortunate necessities, and no, we’re not going to pull out huge workbooks and practice calculating personal income taxes line-by-line.  In fact, there’s an online calculator we’re going to use which is good enough to give an idea of how personal income taxes work.  It’s the first thing I made my son go through once he accepted a job offer and could look forward to handling independent budgeting:  http://www.calculator.net/take-home-pay-calculator.html.  Although the website continues to improve its “how to” descriptions and to simplify its format, I’ll still offer my advice on using it.  For “Pay frequency,” I’ll ask you to use “Monthly” regardless of the reality.  By using a monthly income, the calculator will find our monthly take-home pay, and that’s what we want for our monthly budgeting, because the vast majority of bills occur monthly.  “File status” has four choices:  Single, [Married] Filing Jointly or Qualified Widow, Married Filing Separately, and Head of Household.  That choice of filing status (on the third line) affects what you’ll put on the fourth and fifth lines.  If you file as “Single,” then your “Number of children under age 17” is 0 (zero), and your “Number of other dependents” is 1 (one).  Why?  Because that one dependent is yourself.  If you file as “Filing Jointly,” then the “Number of other dependents” is at least two, being you and your spouse.  It could be more.  A “dependent” is any relative for whom you pay more than half of their life expenses, so could be a grandparent or other relative, not just your children.  If you file as “Qualified Widow,” then you have at least one for “Number of children under age 17,” because that’s the “qualified” part, and at least one for “Number of other dependents,” because it includes you.  Filing as “Married Filing Separately” only makes sense for some financial power couple, where each of the two has very high incomes.  (I always picture the television couple the Huxtables for this, but if you want to get more modern you can think of Kim and Kanye.)  “Head of household” means you’re unmarried and have at least one dependent (other than yourself).

“Other income” has the nicknames of “passive income” and “unearned income,” and can be thought of as income from investments.  Those generally have lower tax rates than your job income, (than “earned income”).  [Should they have lower tax rates?  That’s debatable.  The lower tax rates on investment income is why rich people pay lower tax rates than regular people.]  More on investment income taxation in Section 9:  Investments and in Section 10:  Retirement Planning.

“Pretax deductions withheld” includes topics we’ll reach later, but I’ll note here that the federal government partially subsidizes (partially financially sponsors) our health insurance.  The monthly premiums we pay for having health insurance are deducted from our incomes before we pay taxes.  That’s a tax break, as the income which goes to health insurance premiums isn’t taxed.  Just note that, even though people see their health insurance premium on each paycheck, it’s the annual total which gets included in “Pretax deductions withheld.”

With the new tax laws, most people don’t need to bother with “Itemized deductions.”  “Has 2^nd, 3^rd job income?” is for people receiving more than one W-2 form.  If you have more than three such forms, just add them together as if they were fewer jobs.  For example, if you and your spouse each have two jobs, that’d be four in total, so add the third and fourth incomes and enter them as the third.

To simplify grading for this online version of the course, assume you’re in North Carolina.  This website links to Wikipedia for state income tax rates and Wikipedia is incorrect.  The current income tax rate for North Carolina is a flat 5.25%.  No city in North Carolina has an individual income tax, so that will be 0% for all of us.  And for simplicity’s sake, at this point let’s not be what Roadkill was for a couple decades, and say “no” to being “self-employed or an independent contractor.”

Next you click “Calculate” and see your take-home pay per month!  Now you can use this as your take-home pay for your Income & Expenses spreadsheet of Chapter 13, and start seeing how you can arrange your spending.  (Yes, I had my son go through this exercise before he began hunting for an apartment in Boston.  His solution?  Finding two roommates to share a 3-bedroom apartment at a total cost of $4,500 per month.  And NYC would have cost more!)

 

3. You could be thinking “Hey, I’ve gotta do taxes for real, this website isn’t good enough for the IRS” and that’s true. My advice is to get your taxes done by a professional (person or company) for free.  Here are two articles describing who can and how they can:  https://www.cnbc.com/2021/01/25/many-americans-can-file-their-taxes-for-free-heres-how-to-do-it.html and https://www.rollingstone.com/product-recommendations/electronics/how-to-file-taxes-online-1131951/ .   Please, don’t make me sad, don’t go somewhere that will do your taxes for you only to then hand you a check which represents your taking a loan, complete with interest rate, from the tax preparer.  For the truly financially desperate I understand that check might represent the opportunity to not go hungry, but realize that you’d get a lot more money if you had your taxes completed for free and then waited for the refund to come directly to you.  (I word it this way because most people overpay taxes in advance per paycheck and then receive a tax refund.  Ideally, you’d have withholding exactly equal to your tax bill, so at tax time you’d neither pay nor receive some of your own prepayments back.)

 

4. In the accounting world, “personal income taxes” is actually called “individual income taxes,” even though it so often represents an entire family. So when you hear either term, know that they refer to the same thing.

In theory, a personal income tax rate that’s flat, like North Carolina’s, is great due to its simplicity.  And in theory, states which don’t have individual income taxes at all, such as Texas, Florida and Alaska, sound great.  But when you look more closely, the trickiness of the trade-offs can be seen.  Here are the top places states spend money, according to (https://en.wikipedia.org/wiki/Government_spending_in_the_United_States):  “State and local government spending is typically spent in 6 broad categories: elementary and secondary education, higher education, health, welfare, police and safety, and transportation.  Over the last few decades, funding for education at the state level has fallen, while funding for health has more than doubled.”  Those are worthy places to spend money.  But if there’s no state-level individual income taxation, where can the money come from?  Here’s the answer:  https://www.urban.org/policy-centers/cross-center-initiatives/state-and-local-finance-initiative/projects/state-and-local-backgrounders/property-taxes.  “Charges,” (fees for doing state-level things, such as obtaining a driver’s license) and property taxes (annual taxes on the value of your land, house, and in some states such as North Carolina, your vehicles) are the largest two sources.  Second are the pair of sales taxes and [state-level] individual income taxes, with “selective sales taxes” being smaller, and “corporate income taxes” being the smallest.  If a state doesn’t have individual income taxes, then it must raise its funds from the other taxes.  It’s all a matter of trade-offs, so who benefits more under which system?  Let’s look at a low-income person versus a high-income person to explore the issue of state taxation, including a flat tax (every $1 of income is taxed the same) versus a progressive set of income tax rates (at first your income is taxed at a low rate, but as your income rises during the year, your higher-level dollars are taxed at higher rates).

1. The flat-tax states: A low-income person spends 100% of their income.  100% of their income is taxed under a flat income tax system, and most of their income is spent on things for which sales taxes also apply.  (I searched into whether we pay sales taxes on our utility bills, like on electricity bills, and it’ll take me a while to recover.  Suffice it to say that policies vary widely across the states.)  And if that low-income person has a vehicle or house, then they pay a flat tax rate every year on the value of those items.  (As far as I can tell, the property tax rates on vehicles and real estate are flat tax rates throughout the country, for places which have vehicle property taxes.)  There are two categories of high-income people.  Those who spend it all, and those who save for retirement.  I’m going to use those who save for retirement as my example.  Why?  Because they enjoy the choice of whether to save for retirement.  A high-income person doesn’t spend all of their income.  They save for retirement.  A high-income person pays the flat tax rate on all their “realized” income, but they don’t pay taxes on their “unrealized” income, which refers to gains due to stock price increases on stocks they haven’t yet sold.  (Until stock is sold, it’s gain or loss amount is hypothetical, so those potential gains or losses don’t affect taxes.)  Also, there are no sales taxes on buying standard investments, such as stocks, bonds, or real estate.  Finally, just like the low-income person, the high-income person pays the flat property tax rate on the values of their vehicles and real estate.  This means that overall, a high-income person pays the flat income tax rate on whatever income they’ve realized, (which usually isn’t all of their income), but doesn’t pay a sales tax on all of their income.  And they pay the flat property tax rates on the values of whatever vehicles and real estate they own.  The overall conclusion is that taxation per $1 of income is less on the high-income person than it is on the low-income person.  Flat taxes favor high-income people.  That lower tax on higher incomes is called “regressive taxation.”
2. The progressive federal taxation: The opposite, “progressive taxation,” is when there are higher tax rates on higher incomes.  This is how our federal income taxes work.  But don’t take my word for it, instead let’s see it.  On the take-home pay calculator, compare inputs of ($30,000 income, single, no young dependents, 1 other dependent, no other income, $6,000 in annual health insurance premiums, 5.25% state income tax) to inputs of ($300,000 income, single, no young dependents, 1 other dependent, no other income, $6,000 in annual health insurance premiums, 5.25% state income tax).  The take-home pays are $1,642.88 and $16,335.91.  Wait a second, the person with ten times the income pays less than ten times the income taxes?!?  That’s not progressive, that’s regressive!  Maybe this is caused by an individual income of $300,000 not having to pay FICA taxes (taxes for Social Security and Medicare) on income over $142,800 (for 2021).  Let’s try this again, except with incomes of $25,000 and $125,000, ceteris paribus.  These result in monthly take-home pay amounts of $1,314.58 and $7,175.08.  As $7,175.08 is greater than five times $1,314.58, what we’re seeing is progressive taxation.  What we’ve found is that federal individual income taxation is progressive until the limit of FICA taxes are reached, but then federal individual income taxation is regressive when comparing those under the FICA limit versus those with incomes higher than the FICA limit.  The reason FICA taxes are capped is because Social Security and Medicare benefits are capped.  However as you can imagine, many politicians disagree with the resulting regressive taxation.

 

5. How does our current top federal income tax rate (highest individual income tax “bracket”) compare to historical levels? Here’s a website with a graph you can scroll down to:  https://bradfordtaxinstitute.com/Free_Resources/Federal-Income-Tax-Rates.aspx.  From 1934 through 1986, our federal individual income tax rates were far more progressive (“low-income friendly”) than they’ve been since 1986.  Will President Biden raise tax rates?  He’ll surely try.  Is that a bad thing?  Not, in his words, for anyone making less than $400,000 per year, but probably yes for such high-income people.  And what do high-income people think of that?  Several prominent high-income people have lobbied in favor of it:  https://www.businessinsider.com/billionaires-asking-for-wealth-tax-americans-disney-soros-buffett-dalio and https://www.theguardian.com/us-news/2020/jul/13/first-thing-some-of-the-worlds-richest-people-want-to-pay-higher-taxes?CMP=oth_b-aplnews_d-1 . (As you can imagine, there are very many online articles concerning President Biden’s tax plans, featuring many conflicting conclusions.  As we have real lives, I think we shouldn’t waste our time speculating.  Let’s just see what gets proposed, and then what happens to that proposal.)

 

6. As you’ve seen, states don’t count on corporate income taxes much. These days, neither does the federal government.  Instead, the “payroll taxes” have been climbing.  Payroll taxes are used for Social Security, part of Medicare, unemployment insurance, and pensions for federal employees.  Here’s a graph of relative federal revenue sources over time:  https://www.taxpolicycenter.org/briefing-book/what-are-sources-revenue-federal-government.  Our federal government needs its revenue, so corporate taxation has a direct affect on individual income taxation.  This general review of taxation has been a theoretical one.  What does reality look like, John Oliver?  “Corporate Taxes:  Last Week Tonight with John Oliver (HBO),” 16 mins:   https://www.youtube.com/watch?v=RKjk0ECXjiQ.  And did the tax break on bringing home overseas corporate profits work?  Yes and no:  https://www.federalreserve.gov/econres/notes/feds-notes/us-corporations-repatriation-of-offshore-profits-20190806.htm.  Yes, although close to a trillion dollars was repatriated, the only noticeable affect of this was “stock buybacks,” just as predicted in the John Oliver piece (based on the 2004 overseas profits repatriation tax break).  But sometimes progress is achieved:  https://www.cnn.com/2021/06/05/business/g7-biden-global-tax-intl-gbr/index.html.  Where the G-7 leads, other countries usually follow.

 

7. Now that we’re covering taxes, we can get much more precise about budgeting. And as you’re headed toward a whole new stage of life, now is the time to consider how to convert your take-home pay expectations for getting real on budgeting.  Here’s a reliable source for the cost of living between cities:  https://www.salary.com/research/cost-of-living.  (Congrats, as of Spring 2021 the website has been simplified so you no longer have to do math.  Be grateful!)  For example, to simplify comparisons, suppose my son is making $100,000 in Boston.  To have the same standard of living in NYC would require $119,491.  (Try this and find that answer.)  But in reality, his company is paying his NYC colleagues the exact same salary that he’s making in Boston.  The equivalent salary in Miami would be $73,894.  If he had been offered a position with the company in Miami, then his salary would go a lot further.  (Sales taxes are just one piece of the overall cost of living calculation, so I’ll skip reviewing sales taxes by location.  But if you’re curious, here’s a reliable source:  https://taxfoundation.org/2021-sales-taxes/.)

 

8. The first note is that bankruptcy laws are generally federal.  Here are two sources with way too much detail for our purposes.  The first covers Chapter 7 bankruptcy, which is the kind of bankruptcy which permits the successfully-declaring person to not repay many of their debts, https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-7-bankruptcy-basics, and the second covers the various types of bankruptcy overall, “How Bankruptcy Works” 6½ minutes:  https://www.youtube.com/watch?v=tpI0XWjIsqI.  That’s a great overview, but do you prefer it to the John Oliver style, “Bankruptcy:  Last Week Tonight with John Oliver (HBO)” 21¼ mins: https://www.youtube.com/watch?v=GzFG0Cdh8D8?  Now let’s relate this material to the real world with three true 2019-2020 bankruptcy stories.

 

9. Story 1: During the Summer of 2020, a great local friend of mine went through bankruptcy.  I’ll call her B.  (I was much more excited about it than she was.)  B had been living with her mother for over ten years.  B’s income is Social Security Disability, and her mother’s income had been Social Security income (and possibly pension payments from her deceased husband, who had a military career).  Early in 2020, B’s mother died.  Suddenly all the living expenses (such as rent, etc.) fell solely on B.  And B had had a history of financially helping relatives, even though B was accruing credit card bills to do so.  B knew that she couldn’t afford even her modest lifestyle without her mother.  B was going to have to explore solutions.  First she researched all the advertised “debt relief” companies out there, and in her opinion (and she’s extremely bright) they were all… unsavory.  Bankrupcty was the only option.  She hired a local bankruptcy attorney, who cost exactly $1,500 for a Chapter 7.  How could she afford that?  The very first recommendation of the attorney was for her to stop making any credit card payments, and to use those savings for his $1,500.  About two months later the process was completed.  Her credit card debts (and credit cards) are gone, but she uses a debit card.  Her $1,000 car is still hers, and she still rents the same place.  She changed from a more expensive television provider to a less expensive one, from a more expensive phone plan to a less expensive one.  They didn’t even want any of her assets, not even any her most valuable assets of her television, sewing machines, and phone.  It doesn’t get much simpler than that.  (I know the hardest part will be the next time a relative begs for money from her, and she has to decline.)

Story 2:  In 2018, a friend of mine in his 40’s, whose nickname was Grimr, married and then had a little boy.  His wife worked in a hospital (at some level just below LPN, if you’re curious).  Grimr was a high-end tattoo artist, and when times were good could make $5,000 in a week.  They wanted to move and start their new family lives somewhere new.  First he accepted a position in Colorado, but Colorado is growing so fast that he literally couldn’t find a place to live and had to back out of the deal.  Then he accepted a position in Tennessee, and finding housing was no problem!  So they put a down payment on a house, began packing and left their jobs.  And that is when, in March of 2019, Grimr had a massive stroke.  His recovery was a roller-coaster of improvements and setbacks, but the conclusion is that he never left medical institutions and died in October of 2019.  His wife was faced with well over $1 million in medical bills, because when they left their jobs they also left their health insurance.  (And Grimr hadn’t had health insurance anyway, as they’d been married fewer than six months, so he couldn’t yet be added to hers).  There’s no way she could pay anything even close to that amount.  I knew she was going to have to declare bankruptcy.  But before that could happen, she remarried.  I was horrified.  Not that she had found someone and rediscovered happiness, but that she’d become financially merged with someone with that huge medical debt on her!  The guy she married is a body mechanic, so that’s steady, but it’s not going to handle her medical debt.  It turns out that she’s still going to declare bankruptcy, and that even if you’re married, you can qualify to declare individual bankruptcy that won’t affect any assets of your spouse (if your overwhelming debts existed prior to the marriage).

 

10. [Personal Advice and the third story] I’ve long had a theory that people have three separate brains/personalities:  Their brain when it comes to money, their brain when it comes to sex, and their brain for everything else.  I’ve had way too many friends whom I could successfully predict in very many ways, suddenly shock me with their money brains or sex brains.  So now I assume these are merely separate, and I’ve found that to be extremely helpful several times.  (And harmless.  So why not continue assuming that?)  I had a friend, a high-ranking professional, who serves as a great example.  She was trustworthy and had a position of enforcing rules in her professional position.  She made great judgment calls with empathy balanced with fairness and justice.  But it turns out she also had a nasty secret.  She didn’t control her spending.  It got so bad that she couldn’t handle making the credit card payments any longer.  And she knew that she might well lose her (lofty) position if she declared bankruptcy, because her employer would no longer be able to trust her to oversee a large budget.  So in desperation she vowed to cut down her spending and to use her company credit card for her personal spending.  With her newfound financial self-discipline, she’d be able to dig herself out of the hole she’d spent years digging.  But is addiction (sure, I’ll call her problem a spending addiction) ever so easily cured?  (Okay, maybe “never” isn’t the case.  I had a friend with a $10,000 per week cocaine problem who suddenly stopped cold turkey.  He’s been clean over 25 years now.)  So her spending continued, and she couldn’t handle her monthly company credit card either.  When those payments were overdue, her employer was contacted by the credit card company.  The gig was up.  The company treasured her so much that they offered to let her keep her position if she could find a way to pay off the company credit card.  But she couldn’t.  The market value of all the things she’d bought didn’t add up to enough, because a $300 dress might only be worth $40 on the used market.  I lost contact with her after that, but I can’t imagine she avoided declaring bankruptcy.  And I don’t know what position she could find after that fall from grace.  One that doesn’t have any budget responsibility, I’d bet.

 

11. Something I left out of the discussion of personal bankruptcy is how there will likely be a tidal wave of personal bankruptcies resulting from the direct medical or indirect economic expenses of covid-19.  The number of 2020 bankruptcies was about 30% lower than the number of 2019 bankruptcies, but the assumption is that this was due to the various economic stimulus packages and stipulations, such as student loan payment freezes, eviction bans and foreclosure moratoriums. (And as opposed to some rumors, medical expenses can cause bankruptcy, and actually are the leading causes of bankruptcies.)  And if you’re a company that extends loans, even a credit card company charging 15%-20% interest, how many returns of -100% can you weather before those still paying the +20% aren’t enough to stay in business?  The only guarantee is that belt-tightening will result, meaning that credit will be harder to get.  That has both good and bad aspects, but it’s harsh for those wanting to qualify for buying a car or a house.  So, build and protect your credit score.

 

12. Bankruptcy can be helpful if you can’t climb out of a financial debt-hole, but if you lose your job you may need immediate help. I asked an expert in this, Tim Kincaid, who said the first thing to do is apply for unemployment:  https://des.nc.gov/apply-unemployment/before-you-apply is where to get started.  (And I’m sorry to hear of your North Carolina unemployment:    https://www.propublica.org/article/how-north-carolina-transformed-itself-into-the-worst-state-to-be-unemployed.  (If you have opinions on these matters, vote!))

 

13. Second, Tim suggests applying at the Department of Social Services for food stamps. Here’s the best place I could find for that purpose:  https://www.freshebt.com/state/north-carolina/.

 

14. Third and finally, Tim suggests that if you have a disability or children, then you might become qualified for Medicaid. (After all, you just lost your employer-based insurance when you lost your job.)  https://www.benefits.gov/benefit/1390 is a recommended site for that process.

 

15. [Optional] To simplify applying for assistance when something financially tragic such as a job loss occurs, there’s an app which can help guide you through these, well, applications:  https://epass.nc.gov/.

 

16. [Optional] Here’s an article about taxes which might not apply to many of you in the course, so I’ll put it here for practical purposes (as opposed to for quiz purposes): https://www.nerdwallet.com/article/taxes/5-sneaky-things-covid-19-might-do-to-your-tax-bill .