By Jerry Lynch, CFP, CLU, ChFC
I have been watching a lot of the “March on Wall St” and for the most part, I’m not really sure what the participants of “Occupy Wall Street” are protesting other than the rich should pay more in taxes and rants about corporate greed. Even as I read into their website, I still do not really comprehend their issues.
I often listen to people discuss taxes on individuals and corporations, and for the most part, it is totally inaccurate. Many of the people “Marching on Wall St” are saying things that make no sense, so I do think we need a little clarification. Let’s take a few moments to explain some very basic points on taxes and understand what is true and what is false. Here are some common assumptions:
People making millions of dollars pay very little tax.
False. A single executive, ball player or rock star making $2 million a year would pay a federal tax of $673,989. If I include state income tax in let’s say New Jersey, that person would pay about $164,000 in state income taxes. This is a total of $811,539 in state and federal taxes. This does not include sales, property or FICA tax and this is about a 45 percent average tax rate without these additional taxes. This is a very fair amount and they are paying their fair share. An individual making $70,000 would pay about $8,300 in federal and state income taxes or a 12 percent average tax rate. A few points to be highlighted here:
The average tax rate (%) is almost 4 times higher for the millionaire.
The average total tax paid in dollars is about 98 times more for a millionaire than for the person making $70,000.
A millionaire is generally paying more in property taxes, sending their kids to private schools, and not using the roads and benefits living in the US any more than any other person in the state.
If you think this is erroneous, check my numbers:
47 percent of the population is paying no federal income taxes in 2009.
True. This is because of tax credits and deductions available to low and moderate income tax payers as part of the stimulus programs. In addition, people in a 10 percent or 15 percent tax bracket qualify for tax free capital gains and qualified dividend income (i.e. ATT stock dividend). Many of these are short-term programs and have gone away or will go away shortly. My point here is that while it happened that 47 percent of the people paid no income tax in 2009, this will not be continued, nor should it, long term.
U.S. businesses do not pay their fair share of taxes.
False. Businesses in the U.S. generally are “flow through” organizations (such as S Corp’s and LLC’s ) or taxable entities (such as C corps). In a flow through organization, a business owner gets taxed on the income of the business, even if she/he does not get the income (i.e., it stays in the business to pay bills). C Corporations pay some of the highest tax rates in the world averaging up to 38 percent, plus there are still state and local taxes that many other countries do not have. Wikipedia Corporate Taxes
The top 1 percent of families in the U.S. averaged a 17 percent tax rate.
True – but you need to understand why. Very wealthy people make their money in four ways:
Earned income -- basically a salary where you get taxed up to 35 percent plus state tax.
Capital Gains -- these are investments that you held for more than 1 year and when you sell them you get taxed at a capital gains rate, which is currently 15 percent.
Qualified Dividends -- which are stock dividends that are currently taxed at 15 percent.
Municipal Bonds -- which are tax free interest both on a federal and state basis.
Most very wealthy people do not receive income like you and me, which is earned income and gets taxed at the highest current rates. Many people get upset at loopholes that reduce their taxable income by giving them tax credits and tax free income but please, understand these points:
Tax credits are generally given to get people to do things that we as a society, want to incentivize. For example, they may give tax credits for investing in inner city development for housing, hiring new employees, investing in your company or building a factory. Without these incentives, you would have less affordable housing and fewer inner city jobs.
Tax-free muni bonds generally pay a lower interest rate because they are federally and state tax free. This allows local municipalities and cities that allow them to build up their infrastructure at a much lower cost. These bonds can fund school systems, sewer, roads, etc. By having higher net worth investors in these, it helps us all lower the cost of developing our communities.
You cannot vilify someone using tax incentives that help our society or they will just say, fine, I will invest in taxable investments, and your local government costs go up as they have to pay higher interest rates. By investing in these projects that provide them tax benefits, it helps all our communities by substantially financing our local projects and it also brings in jobs. A win win!
About 1 year ago, the New York Knicks were trying to get LeBron James to come and play in New York and he ended up settling for the Miami Heat. By choosing Florida, a state that has no income tax vs. New York, which has a 6.85 percent tax, LeBron saved about $1 million in income taxes annually! I am confident this was a contributing factor in him going to Miami … all things being equal! Now, think like a business owner. If Florida is cheaper than New York, some companies will move to Florida. How about this: What if Mexico, Brazil or India is a lot cheaper than Florida, do you move?
Right now our corporate income taxes are some of the highest in the world, and just like LeBron — who took this cost into consideration — every business executive has to take all costs, including taxes, into consideration. Right now many U.S. corporations have billions of dollars overseas that they cannot get back here without paying a large amount of taxes on it, forcing them to leave the funds overseas. Taxes are a cost, as is labor and materials. To be competitive in a world market, any business owner or executive always needs to look at the bottom line, and if they can do it cheaper or better another way or in another place. That is not being unfair or unpatriotic; it is the world we live in.
A tax system needs to be fair, it needs to be proportional and everyone needs to participate. For the super wealthy, I do think we need an Alternate Minimum Tax type system that pushes them up to a minimum rate of 25 percent if your income exceeds a certain amount (let’s say $2 million annually). So for the executive above that was averaging a 45 percent tax, he would not be impacted; however Warren Buffett’s tax rate would rise from 17 percent to 25 percent. On the middle and lower classes, everyone needs to pay something as well; this leads to a more equitable system.
Now I am confident that people can point to GE and say they paid no taxes in 2010. Well first of all, that is not correct. They did pay taxes (GE Washington Post Article). Second, my biggest problem is that with misinformation comes bad law. For example, the Alternate Minimum Tax came up in 1969 as people were outraged about a treasury story that said 155 wealthy families paid no income tax. Because this law was written incorrectly, almost 20 million non “super wealthy” people get caught in it every year.
So yes, some changes need to be made I agree; however, what the Occupy Wall Street people are protesting makes no sense. As the saying goes … “Socialism works until you run out of money” (Churchill).
Jerry Lynch is president of JFL Consulting and has more than 23 years in insurance and financial planning. He has been a regular guest on CNBC, WABC and does regular articles for the Star Ledger. He can be reached at firstname.lastname@example.org.