The media is spreading all kinds of disinformation about the tax system, in order to drum up economic envy and resentment against Presidential candidate Mitt Romney. During Monday night’s debate, Romney said that he thought his “effective” federal tax rate was somewhere around 15%. The word “effective” is important here, because it’s the word various journalists have chosen to ignore.
It looks like multiple news agencies are all reading from the same script. MSNBC’s article tells readers that Romney’s effective rate of 15% is “a much lower rate than many middle class Americans pay.” The CBS News online article states that Romney’s rate is “the same rate that billionaire investor Warren Buffett has decried as lower than that paid by most middle-class Americans.”
The semantics are important. A person’s effective tax rate is the tax he or she actually pays after taking advantage of all deductions and credits. For most of America’s lower middle class to middle class wage earners, the effective rate is actually lower than zero. In other words, most of the wage earners in the lower half of the income scale actually get de facto welfare checks from the IRS.
This is partly because the tax code is “progressive,” but it’s largely because low-to-moderate income earners can take advantage of tax credits that add up to more than a person’s tax liability. In these millions of cases, the government ends up paying a “tax refund” of money that the worker never paid to the government in the first place.
Take the example of a single woman with three children who works at a low wage job and earns $25,000 per year, about what a person would make working full time with absolutely no overtime, and making nearly twice the national minimum wage. Since the great majority of low-earning Americans have their kids out of wedlock these days, this is a real life example.
Call this woman Ms. Jones. If she takes the standard deduction of $5,800, it lowers her taxable income to around $19,000 for the year. Thanks to the Bush tax cuts, her tax rates are 10% of the first $8,700 and 15% of the rest, which would equal $3,315 for the year.
But here is where the magic of tax credits comes in. The Earned Income Tax Credit for a single person with three children is $5,751. You subtract this number from her tax liability of only $3,315 and get a total of <$2,436>. The government, in other words, has to pay her a net benefit of $2,436 for the year, just for filing her taxes.
Currently 47% of tax filers pay an effective federal income tax rate of zero percent or lower, and the people in this group are the low wage earners, not the high earners.
Under the current system, an American worker actually has to be making pretty good money to pay an effective federal income tax rate of 15%.
As for Romney, he is paying a much lower effective rate than most of America’s highest wage earners. Part of this may be that his income is nowhere near as high these days as it was back when he was earning his great wealth in the first place. The IRS only taxes earnings, they don’t tax the money a person already has in the bank. (Yet.)
People who earn seven or eight figure paychecks end up getting very little relief from the top marginal income tax rate of 35%. The earned income tax credit does not apply to these people. Romney was paying this kind of effective tax rate back in the days when he was running Bain Capital and making big money.
I’m not writing this because I’m a Romney fan. He’s too liberal for my taste, although I would certainly vote for him in a general election against President Obama. The real issue here is the disinformation the news media spreads on issues of taxes and “fairness.”