Tax Code Complexity

On October 30, 2016, in response to a WSJ article claiming that the “rich” pay more than their fair share of federal income taxes I did a write-up for another blog analyzing the distribution of federal income taxation using 2014 data. That write-up is re-printed later in this post; but first I would like to highlight a good op-ed in today’s WSJ that complements the analysis I conducted last October.

The author of this morning’s WSJ op-ed provides the following statistics: There are about two million taxable corporations and 151 million individual taxpayers, which includes 27 million “who report sole-proprietor or farm business income with their individual returns.” Of the 151 million, there are also nine million S-corporations and partnerships. The author’s point with regard to tax code complexity is that the compliance burdens on individuals and small businesses must be reduced. I agree, but my October analysis takes it a step further…

When the political Left looks to “tax the rich” in order to relieve the economic plight of the Middle Class, it is looking to tax the exact economic machine that the Middle Class depends upon. While “only” 9 million out of 151 million individual taxpayers are S-corps and partnerships, as my analysis shows (below) almost 50% of tax returns with “Adjusted Gross Income” (AGI) of at least $500,000 are S-corps and partnerships. In 2014, the average AGI per S-corp/partnership tax return was approximately $735,000, while the average AGI per non-S-corp/partnership tax return was approximately $2.3 million. (Edit on 9/15/17: This last sentence is in reference to tax returns with an AGI above $500,000, which was not clear in the original write-up.)

Moral of the story: The political Right is insane to claim the “rich” are unfairly taxed; while the political Left is insane to want to tax the “rich” who represent the small business engine of the country.

The following section is a reprint of my October 2016 write-up.

* * * * * * * * * * * *

October 2016 Write-up

The political ‘right’ likes to say that the “top 1% pay nearly half of federal income taxes”. I admit I have fallen victim to this highly uninformed/manipulative ‘analysis’ – but no longer…

As the following graphic demonstrates, in 2015 the top 20% paid 83.9% of federal income taxes. But conveniently left out of the Right’s analysis is the fact that the top 20% earned 51.3% of total US income. When payroll taxes are taken into account – which the write-up attempts to do – the perceived gap closes further. While certainly not as ‘unfair’ as the Left would lead one to believe, I would argue the Right skews the equation more so than the Left…

(Comment on 12/22/17: Not sure what happened to the graphic referred to in the paragraph above, but I can no longer find it.)

Payroll Taxes

2014 Data Table

The gap between the Right’s analysis and reality is driven primarily by payroll taxes. In 2014, up to $117,000 in adjusted gross income (AGI) was subject to a 12.4% Social Security tax – split 50/50 by employee and employer – and up to $200,000 subject to a 2.90% Medicare tax – again, split 50/50. Above $200,000 is subject to a .90% Medicare surcharge paid 100% by the employee. And while the employer portion is technically not taken out of employees’ pay, the reality is that it should be treated as such, IMO.

All in, if you make below $200,000 your baseline Federal tax rate is 15.3%. Not outrageous – but let’s not kid ourselves that the lower end of US AGI generation is not taxed enough.

IRS Taxable Breakdown

IRS Individual Income Tax Data

For all 2014 income tax returns with at least $1 of AGI, the share of total AGI and taxes paid looks as follows:

  • Below $200,000
    • % of Total AGI: 63.3%
    • % of Total Taxes: 58.6%
  • Above $200,000
    • % of Total AGI: 36.7%
    • % of Total Taxes: 41.4%
  • Above $1,000,000
    • % of Total AGI: 15.0%
    • % of Total Taxes: 17.7%

The most tax-advantaged AGI group is $50,000 to $75,000, which earns 12.25% of total AGI and pays 11.2% of total taxes; while the most tax-disadvantaged group is $500,000 to $1,000,000, which earns 6.16% of AGI and pays 7.3% of taxes.

Partnerships & S-Corps

In 2012, small- and medium-sized businesses (SMIDs) employed just under half of the US labor force. I do not know the breakdown, but many SMIDs are structured as partnerships and s-corps under the US tax code, forcing net income and losses thru their owners’ individual tax returns. Again, I do not know the exact breakdown, but many SMID owners retain and reinvest the vast majority of partnership/s-corp earnings, which means taxing the ‘rich’ affects SMID human and physical capital investment.

According to IRS data, in 2014 approximately 49.4% and 58.1% of all tax returns with an AGI greater than $500,000 and $1,000,000 were net income generating partnerships and s-corps.

I’m far from a policy expert, but were I tasked with redesigning the tax code I would focus heavily on making corporate life as easy as possible for SMID owners generating north of $500,000 of AGI. In addition to reducing the regulatory burden, lowering the minimum wage, and closing the “carried interest” loophole to fund SMID tax cuts, making capex investments fully tax deductible and incentivizing long-term retained earnings come to mind.

TPP Analysis

2014 US Tax Analysis

2 thoughts on “Tax Code Complexity

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