You: Do rich people pay more tax? Seems to depend on who you listen to.
Yes, for two reasons. And no for two more reasons.
You: You´re arguing with yourself publicly?
Perhaps, but a straightforward answer to this question doesn’t exist. You´ll be ready to have this debate with others soon.
Why the rich pay more tax
Often the rich have high incomes. Since income taxes are based on a percentage of one’s income, those with higher taxable incomes will pay more. This is just basic math. If you multiply a specific tax rate by a bigger taxable income, the product is bigger, and so is the tax bill.
The federal tax system is progressive. This means that the tax rates themselves increase as taxable income rises. Therefore, when you do the simple math above, both numbers (the taxable income and the tax rate) are higher for high-income earners than for those who make less. As a result, the higher wage earner’s tax bill increases dramatically.
Why the rich do NOT pay more taxes
Remember, it is not gross income but taxable income (income after subtracting your deductions) that determines your income tax. Rich people are more likely to have higher deductions due to their corresponding larger mortgages, state income taxes, and property taxes. These large deductions significantly reduce the amount of wealthy people must pay.
Like it sounds, federal income tax is based on income-not wealth. If you´re worth a million dollars yet have little taxable income, you might not pay it at all. Take the extreme example (and one I’ve seen first-hand) of a multi-millionaire family where neither parent is employed nor does anything to generate significant income. Combined with an enormous mortgage deduction, they might pay no federal income tax.
Furthermore, high income does not mean you´re Tax income rich any more than a comparably lower income means you´re poor. Becoming comfortable (and even rich) is influenced much more by your financial habits more than your income level. Don´t believe it?
You: I’m not convinced yet.
I know you’ve heard stories about celebrities who make piles of money yet wind up later in life with little money or even in bankruptcy. While celebrities get all the press, this tragic story is a sad reality for many others too-not just entertainers and professional athletes.
If you spend 100 percent or more of your income, no matter how high that income is, you will find it difficult to become wealthy. The opposite is also true. If you save enough money for a long period of time, you can be quite wealthy without ever earning a high income.
The conclusion is simple: some people never paid high taxes but are now rich, while some folks once paid a ton of taxes and are no longer wealthy.
Ultimately, there are just too many factors to permit a blanket answer to the question “Do the rich pay more in taxes?” It’s like obtaining a true understanding of how much money the Jones’ really have. While it’s likely a rich household pays more income tax than a poor one, you cannot be sure.
Pay less tax yourself
The important thing is to pay the least amount of tax (legally, of course) and to pay it as late as (again, legally) possible. Don’t get a huge refund and don’t save a couple hundred bucks in tax prep fees at the expense of missing a $1,000 deduction. Tax preparers can help, but if you’re filling out a 1040-EZ, you won’t miss the deduction, so save your money and do it yourself!
Michael B. Rubin, CPA, CFP, MBA is the author of Beyond Paycheck to Paycheck: A Conversation About Income, Wealth, and the Steps in Between.