Tuesday, November 20, 2012

What Is The Real Difference Between High-Income Earners and Low-Income Earners?

Income Disparity is not as big as you may think
Not as much as you would think, believe it or not.

Everyone is talking about 'taxing the rich!', 'redistributing the wealth!' and 'income inequality!' as if it is something from a fairy tale or something. If you didn't know better, you would think you were reading history from the French Revolution ('Off with their heads!) or the writings of Leon Trosky and the others who brought 'income-equality' (as in 'low' income for everyone but the rulers) in Soviet Russia for almost a century.

Let's take a very close look at the reality of the situation on the ground in real terms, how about it?

Does everyone know what a FICA tax is?  I have been lecturing at various universities over the past couple of years and hardly any student knows what a payroll or FICA tax is.

The FICA tax is the 'Federal Income Contributions Act' which is about as deliberate of a misnomer and  deceptive advertising as ever was one.  Since when did paying taxes ever become known as a 'contribution' anyway?

The thought here is that since you receive a benefit down the road, if you live long enough, you are making a 'contribution' to your future retirement needs. As we have seen in many previous posts, you are making no such 'contribution' to any such trust fund because:
A) They are all broke today
B) You are paying current benefits for current retirees, nothing more, nothing less
C) The only way you will get what you think your future SS and Medicare benefits should be is if your children and grandchildren pay far higher taxes than you do today
D) If you are under the age of 50, you can fully expect and count on receiving far, far less than you will ever 'contribute' in FICA taxes in SS and Medicare benefits when you retire.  Just the time-value of money and the lack of truly invested principal in any form guarantees that you will be underwater in terms of the benefits you will ever receive from either major entitlement program.
Anyway, with regards to the current debate over 'income-equality', let's take a close look at the real post-tax difference between a high-income self-employed individual and a person making $60,000 per year to support a family of four.

Let's assume the high-income person, as defined by the President, OMB, CBO and the Census Bureau makes $180,000 per year in a two-income family.  One spouse is in business for himself as an insurance agent and the other spouse is an independent researcher at a local university.

After family deductions and mortgage interest and charitable deductions, the net taxable income falls to $150,000.

So far, so good it seems for the higher-income family, huh?

Right off the top, this high income family can expect to pay $23,550 in payroll taxes since it is 15.7% of your earned income for self-employed people. All non-deductible from any other taxes they may pay.

Add to that approximately another $17,000 of federal income taxes and their take-home income is down to about $110,000.

State taxes will claim another $10,000 so now they are down to $100,000.  Local and property taxes, depending the number of cars they own, for example, could claim another couple of thousand or so.

So the higher-income self-employed couple is down to around $95,000 of disposable income when all is said and done after sales taxes and every other tax is added in each year.

Over $55,000 in taxes paid at some level or roughly what the average American household makes in income each year. Paid for by 1 couple.

Not bad.  It is far better than anyone in the middle-or-lower income categories, right?

But by how much?  And does the difference justify all of the polemics and class warfare we see out there coming from President Obama and the political left?

Consider a couple making $60,000 as employees at two companies, both making exactly $30,000/year in salary. For one thing, they immediately only have to pay half as much in FICA taxes as the self-employed couple because that is the law.  The reason is that the corporations they work for have to pay a matching percentage from the employer side to get to the 15.7% rate for FICA taxes.

Let's assume their mortgage interest and charitable contributions amount to $10,000/year.  Now they are down to $50,000 in income to spend.

That would mean that this couple has about $3850 total withheld from their paychecks during the year.  They may not fall low enough to not pay any federal income taxes each year but they are not close from it.  Let's say they pay $1250 in state taxes to get to a round $45,000 of disposable income for the year.

So with all of the discussion about rich versus poor, big versus small, fat cats versus the small guy, in many cases we are talking about a difference of $50,000 in income per year for American citizens.

Or about the income earned by an average American household, once again.

$50,000 is a lot of money, don't get us wrong.  We would rather have $50,000 more to spend on education,  vacations, clothes and cars than not have it, to be sure.

But we are not talking about the routine disparity in income in America as being $1 million+ or $10 billion+ per year amongst perhaps 98% of all American families.  The whole debate is driven by perceptions not reality.

Not all the rich people in America live or act like the Kardashian family on cable. (Thank God!)

Plus, we could tax the rich people out the wazoo and guess what would happen?
  1. They would find legal tax shelters and pay the same next year as this year.
  2. They would move to the Cayman Islands or somewhere that doesn't tax them as much and declare legal residence there.
  3. We would not balance our federal budget.  Not even come close.
  4. Or they would just quit investing in more business in America and just retire and enjoy life.
None of us should want any wealthy person to pull up stakes and just sit back and 'enjoy life'!  We want them to keep working their tails off and taking risks right and left with their money!  We should all be begging and encouraging them to make more investments so we can all get a job working at their new business!

We want them to be like those talented, somewhat crazy football coaches who win a national title at one school, retire to 'spend more time with the family' (which they never do) and then take the next job to lead another team to the national championship. Or the Super Bowl.

That is what great business people and entrepreneurs do.  They were put here on earth not to just make money for themselves but to provide jobs and help create wealth for the rest of us!

Sometimes they will fail.  But we would still get paid salary and benefits out of their capital (and the money they can borrow from banks that you and I can't) until the business failed.  And then, we should hope they would try again.

That is where we think this current debate over 'income-disparity' is so messed up.  We want everyone to have the chance to work for themselves or someone else and move up the income ladder, not drag everyone above them down to our level. 

We want wealthy people to keep investing in business in America.  We want them to become the next Apple.  If someone had gone to work at Apple just 10 years ago and had stock benefits in their compensation that included about $10,000 in value then, they would have over $660,000 in their nest egg today, give or take a few thousand dollars on any given day.

Now, let's stop all this class warfare and figure out ways to stop spending so much money on everything, balance our budgets and let this great American money-making, job-creating machine get back to work putting us back to work as well.

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