5 Things to Know About Taxes

Happy tax day! If you haven't filed yet, run. You've got a few more hours to get your returns to Uncle Sam. For those of us all squared away, here are five things you should know about federal taxes.

1. Many don't pay their fair share 
The IRS Oversight Board reports that 13% of us say it's OK to cheat on our taxes. At least as many actually do. The "tax gap" -- the amount the Internal Revenue Service fails to collect because of tax cheaters -- is $300 billion a year. Eighty percent of that figure is from individuals underreporting their income. Non-filers account for the rest.

This is serious money. $300 billion is enough to pay for the Department of Justice, the Department of Energy, and all the interest on the national debt combined. It also works out to about $1,000 per U.S. citizen.

The IRS has a lucrative whistleblower program for turning in cheaters, paying tipsters 15%-30% of the amount recouped. The paydays can be huge. An accountant recently blew the whistle on his employer's tax scheme, netting the IRS $20 million in back taxes. Just last week, it sent the tipster a check for $3.24 million (after taxes, of course).        

Know a cheater? Turn 'em in here.

2. It's true: The rich are paying more and the poor are paying less
That's what the numbers show:

Source: Congressional Budget Office.

In 1979, the highest income quintile paid 56% of all federal taxes, while the lowest paid 2.1%. In 2006, the highest quintile paid 69% of the tab; the lowest, 0.8%.

This causes all kinds of class warfare. It is worth noting, though, that income growth for upper earners has far outstripped that of average and lower-income folks. And even though top earners pay most of the tax burden, their tax rates are often a fraction of those making considerably less.

Good example: Warren Buffett noted in 2007 that he paid a 17.7% tax rate on his $46 million income, while rank-and-file underlings at Berkshire Hathaway (NYSE: BRK-B  ) paid as much as 39.7%. Why? Two reasons. One, payroll taxes (which cover Social Security and Medicare) only apply to the first $106,800 of income. So Buffett making $46 million pays the same dollar amount of payroll taxes as someone making $106,800. Two, most of Buffett's income comes from capital gains and dividends, typically taxed at a maximum 15%. Regular income can be taxed at over twice that rate.

Buffett even once made a bet with a roomful of wealthy businessmen. "I'm willing to bet anyone in this room $1 million that [their tax] rates are less than the secretary has to pay."

Any takers?

3. The system used to work better than it does now 
At least that's one interpretation of this chart.

Source: Joint Committee on Taxation and author's calculations.

Felix Salmon of Reuters makes a few points about a similar chart:

  • "Federal taxes are the lowest in 60 years, which gives you a pretty good idea of why America's long-term debt ratios are a big problem. If the taxes reverted to somewhere near their historical mean, the problem would be solved at a stroke."
  • "Income taxes, in particular, both personal and corporate, are low and falling. That trend is not sustainable."
  • "Employment taxes, by contrast -- the regressive bit of the fiscal structure -- are bearing a large and increasing share of the brunt. Any time that somebody starts complaining about how the poor don't pay income tax, point them to this chart. Income taxes are just one part of the pie, and everybody with a job pays employment taxes."

Also, large companies like General Electric (NYSE: GE  ) often pay a far lower tax bill than the advertised 35% rate -- a point that should become clear when you notice how far corporate taxes as a percentage of GDP have fallen over the past half-century.

4. Deductions and write-offs reduce tax revenue by an amount almost capable of balancing the budget
A total of over a $1 trillion annually. Here are the top 10:

Deduction

Cost, in lost tax revenue (2008)

Health insurance $131 billion
Retirement contributions $118 billion
Mortgage interest $89 billion
Depreciation of machinery $56 billion
State and local taxes $49 billion
Charitable contributions $47 billion
Income from foreign corporations $32 billion
Capital gains on real estate $30 billion
Property tax $29 billion
Child credit $28 billion

Source: Tax Policy Center.

Some of these deductions are good, well thought-out policies. Others make little sense. At any rate, we shouldn't pretend that so-called spending in the tax code is different from many other forms of government spending, particularly cash subsidies -- a point conservative Harvard economist Greg Mankiw made last year in this essay.

5. To: John D.
Love: Uncle Sam  
In 1935, President Franklin Roosevelt set a special 79% tax rate on those earning more than $5 million a year. For three years straight, only one man in America made that much coin: John D. Rockefeller.

Rockefeller wasn't happy with this. "When a man has accumulated a sum of money, accumulated it within the law, the Government has no right to share in its earnings," he once said, according to his biography, Titan.

Fool contributor Morgan Housel owns shares of Berkshire Hathaway. Berkshire Hathaway is a Motley Fool Inside Value pick. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (16) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 18, 2011, at 6:06 PM, xetn wrote:

    There is no such thing as a "fair share" or a "fair tax" because taxes are nothing more than legalized theft.

    One of the many reasons that Hong Kong consistently ranks as the freest place of 183 places around the earth is its very LOW tax rate and they do not tax income anywhere except in Hong Kong. It is also one of the easiest places to start a business.

  • Report this Comment On April 18, 2011, at 6:34 PM, TMFHousel wrote:

    I still don't understand the theft argument you consistently bring up. Taxes are set by politicians. Politicians are voted into office by the people.

  • Report this Comment On April 18, 2011, at 7:05 PM, velcrosalsa wrote:

    Morgan - I take minor issue with the comment that payroll taxes are applied to the first $106,000 of income. I am betting that you actually know that Social Security taxes are on the first $106,800 of WAGES and there is no cap on the wages to which the Medicare tax is applied. Still the point that the rich pay smaller % of their income in payroll taxes is a fair one. To be sure the Social Security benefits the rich get are also a lower percent of income as well

  • Report this Comment On April 18, 2011, at 8:14 PM, TMFHousel wrote:

    velcrosalsa,

    Good observation, and fair points. I should have noted that Medicare taxes (1.45%) applies to all wages.

    This document lays it out:

    http://www.ssa.gov/pubs/10003.html

    Thanks,

    Morgan

  • Report this Comment On April 18, 2011, at 9:28 PM, ynotc wrote:

    "Federal taxes are the lowest in 60 years, which gives you a pretty good idea of why America's long-term debt ratios are a big problem. If the taxes reverted to somewhere near their historical mean, the problem would be solved at a stroke."

    Yes and I am sure that government would then live within thier means. In 2005 our budget was approximately 1/2 of what it is today and no children or old people starved. This is primarily a spending problem

    "I still don't understand the theft argument you consistently bring up. Taxes are set by politicians. Politicians are voted into office by the people."

    1/2 of the taxpayers (voters) do not pay any tax. It would be fair to observe that the people paying the tax do not have a fair representation. It is easy to vote to tax the rich if you don't pay tax.

  • Report this Comment On April 18, 2011, at 9:35 PM, TMFHousel wrote:

    ^ Very, very few pay no taxes. Half pay no income tax, but do pay payroll tax, sales tax, property tax, etc.

  • Report this Comment On April 18, 2011, at 9:53 PM, rd80 wrote:

    Is the lost revenue from not taxing retirement contributions net or just the cost of the deduction?

    This would be a key difference since nearly all of the contributions and income that weren't taxed when earned will be taxed when withdrawn from the tax deferred accounts.

  • Report this Comment On April 18, 2011, at 10:28 PM, BruceHBi wrote:

    In 2000, corporate and individual tax rates were higher and we had a budgetary surplus.The Bush Tax cuts in 2003, with no spending cuts (and several unfunded wars) eliminated the surplus and threw us into the red.

    I know no one wants to hear "tax increase," but if tax levels reverted to the 2000 level, coupled with some serious entitlement reductions, and our problems would be substantially less.

  • Report this Comment On April 18, 2011, at 10:35 PM, CaptainWidget wrote:

    Fact 6: The Federal tax code contains over 66,000 pages and over 7 million words. No one, without special training or hired help, can ever be expected to hit the correct amount of deductions and pay the "proper" tax amount with such lack of clarity in the rules

    Fact 7: The average American citizen pays over 40% of their income to taxes at the federal, state, and local levels. Closer to 50% for the self employed. Anyone who advocates higher taxes is pushing an agenda at the expense of the middle class.

  • Report this Comment On April 19, 2011, at 12:42 AM, badnicolez wrote:

    @BruceHBi - you say, "In 2000, corporate and individual tax rates were higher and we had a budgetary surplus.The Bush Tax cuts in 2003, with no spending cuts (and several unfunded wars) eliminated the surplus and threw us into the red."

    The reality is that in 2000 the tech bubble burst, and in 2001 9/11 happened, both events having major negative impacts on the economy prior to the tax cuts and the Iraq war.

    I'm guessing someone could make a pretty good case that the surpluses were a result of a combination of the tech boom bubble (lots of capital gains paid on all those dot com stocks in the runup) and some government fiscal responsibility brought about by having a politically split WH and congress, but I'm too tired to research the actual numbers right now.

  • Report this Comment On April 19, 2011, at 3:13 AM, CaptainWidget wrote:

    <<I still don't understand the theft argument you consistently bring up. Taxes are set by politicians. Politicians are voted into office by the people.>>

    Politicians have been to known to change their mind in between the "once every 4 years" period in which they're required to talk about their plans for the future. A low taxes pol today will be a high tax advocate as soon as the situation benefits himself.

    And furthermore, I don't even recall voting for anyone who ever advocated raising taxes. 90% of the politicians I've ever voted for advocated complete abolition of the income tax. So...I spoke my voice...why do I still have to pay income taxes your choice recommends? There's no such thing as politicians "we" vote in. "We" is just me vs you, and only one of us gets our pick into office.

  • Report this Comment On April 19, 2011, at 4:34 AM, WyattJunker wrote:

    Politicians are voted into office by some people. Not all people. We have a very divided America whereby the last few elections are decided by a thin majority. That said, no such mandate truly exists for major reconstructive nor radical change. Politicians should understand that unless they get a greater than 10% electoral spread or an unconvincing win, they should cool their heels and just play mascot or game show host and not try to 'change the world' or worse, America.

    I want my politician to not do much. I want them shrinking the size of government. I want them to stop lying and promising stupid voters so much free crap. I just want to be left alone.

    America is not about the tribe, but the individual. As long as we still believe that(less and less of us do), we will be okay. Tribalism is coercive. Tribalism is populism which is socialism which is also communism, aka communal-like, it takes a village, living.

    Its gross.

    Can't I just be left alone? I didn't sign up to be in this disgusting socialist pyramid scheme. Please, just leave me alone. Thanks.

  • Report this Comment On April 19, 2011, at 5:22 AM, dcflipflop wrote:

    Question: is the "Share of Federal Taxes by Income Quintile" graph showing income taxes or all federal taxes?

    Also, it is curious that the upper quintile shoulders so much of the tax burden, especially given your other point about how the rich tend to pay a lower percentage of their income in taxes. I guess this is more supporting evidence for how "top heavy" our wealth is in the USA. Or how we have eroded the middle class.

    Also linked to your article about removing the mortgage interest tax deduction. I like this idea, I think it would have a minimal effect on the middle class, and would actually help keep housing prices on an even keel. I hate the way our housing market still has the "regional bubbles" where the prices are crazy inflated.

  • Report this Comment On April 19, 2011, at 11:10 AM, bbell46356 wrote:

    I don't know where I saw it but it was an article on the Fool stating that the average person currently eligible for social security and/or Medicare is currently expected to draw 2 to 3 times the amount they have paid in as taxes during their lifetimes.

    How can it be so unfair to expect people to pay for their own retirement and health care, especially when the bill only covers 1/3 to 1/2 of the cost.

    The other argument about how so many rich individuals and corporations pay no tax also fails to recognize that we have an income tax, not a wealth tax. Many wealthy individuals and corporations don't pay taxes in years they do not have income. I think this is at least part of the reason GE paid no tax?

    Any change to a system of taxing wealth would result in economic disaster or at best, be another welfare program for accountants and attorneys, the current inheritance tax being a case in point.

    I don't want anyone to starve, but why should someone or some entity that earns their income support anything more than that?

    In the current environment, need or fairness is pretty much overshadowed by reasonably wealthy interest groups looking for hand-outs.

    This has everything to do with special interest politics and very little to do with fairness.

  • Report this Comment On April 20, 2011, at 1:48 PM, mclaugph wrote:

    Enjoyed the article.

  • Report this Comment On April 24, 2011, at 4:01 AM, ershler wrote:

    I think the top chart is misleading because it doesn't show how much each quintile earned as well. I believe showing this data side-by-side would show a much different picture.

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