Jeff  Carter

Was reading an article in a left wing paper about the Romney tax return. Once you get through how the author of the article tries to shock you with the numbers, you begin to read the comments.

It is amazing how stupid a lot of people are on taxes, and how the extremely wealthy earned their money. Unfortunately, it’s easy to demagogue the big numbers and the tax rates. But reading what’s behind those numbers is wonky and something that most people don’t have the time or inclination to try and understand. For many, it’s easier to let envy bubble up and push it off rather than figure out how Romney really made his money.

To begin to comprehend, you have to know there are tax rates and there are real tax rates. There is the headline rate that everyone pays, and then there is the effective tax rate which is the true tax on your income.

Because American tax rates are progressive, you don’t pay the same amount of tax on each dollar of income. As you get into higher income brackets, you pay higher tax on each dollar earned. This is called an increase in tax on every marginal dollar. It wouldn’t surprise me if John Kerry paid less than or equal to Romney when it came to effective tax rates.

Here is some quick and dirty math:
Suppose one makes $20,000 in a year and is taxed under the a progressive system. If you make 10g/yr, you pay 10%. Make 20g/yr, pay 25%. This person pays $1000 (10%) of the first $10,000 and 2500 (25%) of the second $10,000. The total tax liability is $3500, which when divided by the $20,000 of income and multiplied 100, is found to have an effective tax rate of 17.5%.

But wait..I thought we were soaking the rich guys by having them pay more? Au contraire. That’s why incentives in the American tax code are so screwed up. We should be flat taxing everyone at 15% with no deductions.

The effective rate is always lower than the headline rate. Even if you are in the 35% tax bracket, you rarely pay that headline rate in tax. Also, because you take deductions for charity, mortgages and all the other sundry items you are allowed to deduct, your actual taxable income is generally less than your headline income. That’s one of the reasons why an AMT is so pernicious.

In Romney’s case, he paid a higher effective tax rate than 60% of all Americans.

When you read the comments, you see the misinformed trolls are out in force.

Jeff Carter

Jeffrey Carter is an independent speculator. He has been trading since 1988. His blog site, Points and Figures was named by Minyanville as one of The 20 Most Influential Blogs in Financial Media.