This is just one of the stories in our “I’ve Always Asked Myself” series, where we answer all your questions about the business world, regardless of its size. Have you ever wondered if recycling is worth it? Or how to store brands stack against famous brands? Discover more of the series here.
Auditor Patrick Green of Santa Barbara, Calif., Asked:
I’ve always wondered why we have tax brackets instead of a continuous tax system. Why does someone who earns $ 40,000 a year pay the same tax rate as someone who earns $ 80,000 a year? Do we really not have the ability to calculate the tax continuously?
Over a century ago, the modern American tax system, with seven brackets, was born.
The lowest bracket applied a marginal tax rate of 1% on income up to $ 20,000 in 1913, while the highest bracket had a marginal tax rate of 7% on income over $ 20,000. $ 500,000 (equivalent to approximately $ 14 million in today’s dollars).
Although we have brackets, our tax system is really a hybrid of both a bracket structure and a “continuous” or progressive structure, in which the rate “continues to increase with income,” explained Billy Fauller, Former IRS Revenue Officer.
By “continuous,” Green was asking if we could have a different and higher rate for every dollar of additional income. But the constant change in tax rates would be difficult for the IRS to manage.
David Gamage, professor of law at Indiana University at Bloomington, explained that our bracket system is a legacy of the pre-computer age.
“If we were to redo our income tax assuming everyone has computer software to do their taxes – if instead of asking the IRS to create tax forms every year, the IRS would create a software package – then it would be possible to have a pricing structure, ”Gamage explained.
He added that the agency’s historical practice has been to create look-up tables, noting that a continuous rate structure requires a mathematical formula. It wouldn’t have been possible in a pre-computer world, unless you expected people to do algebra.
It would be difficult to have a continuous system because the agency’s own systems are outdated, Fauller said.
“They would roll back the whole system, ushering in a new one,” added Fauller, who now works as a senior member at Inside Out Tax Resolution Services. “They would need to modernize their technology and infrastructure. “
Gamage said that in reality the range is just the marginal rate, or the rate you pay on an additional dollar of income.
“And your income less than that is subject to lower rates, and there are credits and deductions,” he said. “We don’t have a continuous system, but neither do we have a single tax rate system. ”
For example, let’s say you are a single filer and earn $ 40,126. Your first $ 9,875 is taxed at 10%, the amount you earn between $ 9,876 and $ 40,125 is taxed at 12% and any dollar you earn over $ 40,125 (but less than $ 85,526) is taxed at 22%.
While we don’t have individual tax rates that increase with every dollar of income, the system has had times when the number of brackets has fluctuated.
If we wanted to create other media, the IRS could take care of it, according to Dennis J. Ventry, a law professor at the University of California at Davis. We currently have seven, although we have had over 50 at times.
“There was a totally bogus argument in the post-war period that, like, all of these brackets created complexity in the tax system,” Ventry said. “The IRS would determine the blended rate for where you fell and tell you what your tax liability was.”
Politicians haven’t necessarily pushed for a continuous system, but some progressive lawmakers have proposed an increase in the tax rate for those earning higher incomes. US Representative Alexandria Ocasio-Cortez, a Democrat from New York, pitched the idea of a maximum rate of 70% on income over $ 10 million.
To make the tax system fairer, Ventry said, we should add tax brackets – but at the top.
Ventry said “it’s crazy” that someone earning more than $ 518,000 a year technically pays the same marginal tax rate – 37% – as billionaire Jeff Bezos. Or, he added, even a partner at a large law firm, who could make between $ 5 million and $ 10 million.
He said a lot of that income comes from salary income, but when you go up, a lot of that income is also capital gains income (the profits from selling an asset, like stocks). ). This has a maximum tax rate of 20% for assets held over a year.
“This is the problem in terms of too few supports,” he said.