Jan

26

Effective Federal Tax Rate: Effects of Social Security Tax

January 26, 2007 |

Our politicians like to discuss levels of taxation in terms of the Tax Brackets. These brackets usually apply to income tax levels after the allowed deductions have been taken into account. What it doesn’t include is other methods of taxation that the Federal Government may impose on its subjects, like the Social Security and Medicare taxes. In this article I not only attempt to make people aware of the increased effect of this extra tax, but also aware of another hard fact: Social Security tax makes the tax levels more linear than politicians want you to think — people of all income levels end up paying a flatter tax than you may expect.

Blueprint for Financial Prosperity was kind enough to publish tables that combine the IRS 2006 published federal tax brackets and the effect social security tax has on them. For simplicity purposes he published them for single taxpayers, and I will base all of my assumptions in this article on Single taxpayers with only one income source: employment wages. If we took into consideration income taxation from investments, rental properties, and other investment methods the Social Security Tax would appear as an even heavier burden on the lower income sectors of society. Doing such analysis would be, however, beyond the scope of this blog article.

Take a look at the data provided by BFP and notice that the burden of Social Security tax is very heavier on the lower income levels. When placed into comparison, suddenly an innocent 10% tax bracket almost doubles. And due to the effect of Social Security Tax income and benefit caps, higher tax brackets don’t even worry about it. See the accompanying chart to understand the curve flattening effect — approaching a level point for all taxpayers, regardless of level of income into a flatter tax. The graph has one flaw — it still show tax brackets, not tax paid, two different numbers.

 

 

 

 

 

 

Salaried Income Federal Tax Bracket Effective Tax w SS Tax
$0 and $7,550 10.00% 17.65%
$7,550 and $30,650 15.00% 22.65%
$30,650 and $74,200 25.00% 32.65%
$74,200 and $94,200 28.00% 35.65%
$94,200 and $154,800 28.00% 29.45%
$154,800 and $336,550 33.00% 34.45%
above $336,550 35.00% 36.45%

 

Effects of Social Security Tax on Federal Taxation Now lets take a look at the following table and chart. On it we compare single payers with single income from employment wages at different levels: from mere $10,000 to above $300,000 a year. Notice how the red line (% of tax paid after taking into account personal deduction, standard deduction, social security and tax brackets) is flatter than you would have expected. After an income level of $75,000 it just hovers around 30%, almost creating a flat tax.

 

 

 

 

 

Income Federal Tax Bracket % Tax Paid With 10% 401k
10000 10.00% 17.65% 7.56%
25000 15.00% 20.75% 14.97%
50000 25.00% 24.97% 19.90%
75000 28.00% 27.72% 23.32%
100000 28.00% 29.63% 25.31%
150000 33.00% 29.57% 25.75%
200000 35.00% 30.57% 27.30%
250000 35.00% 31.36% 28.73%
300000 35.00% 31.88% 29.69%
350000 35.00% 32.26% 30.37%

 

Effective Taxation Rates by Level of Income\ On the chart you might also have noticed the yellow line — the effective tax rate for those people that contribute 10% of their income (up to limits of $15,000) to their 401k plans (or traditional IRAs at lower income levels). When such thing happens the Effective Tax rate does approaches the “intended” tax bracket rate. Maybe Uncle Sam is trying to tell you something: save for retirement.These are times when Social Security is a topic of political discussion. By looking at hard numbers we can try to remove politics from it and see its effect on people and society. Increasing the social security tax rates will burden even more our lower income people and will create an ever flatter curve. Not doing something to fix social security now will create bigger issues to solve that will make society do hard decisions: like increasing retirement age or increasing social security tax, burdening people even more.

 


Comments

3 Comments so far

  1. Bill Woessner on January 26, 2007 1:33 pm

    In principle, I agree with what you’re saying. Social Security is a regressive tax and Medicare is a flat tax. When you take them together with the income tax, they have a flattening effect. Agreed 100%. But you can’t really look at our tax system without considering the whole.

    The income tax is not as strictly progressive as you make it out to be. Thanks to the convoluted system of deductions and credits, many high wage earners end up paying very little in taxes. My wife and I are a prime example. Nearly HALF of our gross income is not taxed because of one deduction or another. For 2006, I estimate our federal income tax rate at 5.8%. Not what you’d expect from a doctor and a mathematician with no children.

    And then there’s Warren Buffet. He recently did a tax rate exercise in his own office. All he did was ask his office staff to compute individual tax rates. He discovered, quite to his amazement, that his tax rate is substantially lower than anyone in his office. This is Warren Buffet: the 2nd richest man in the world. So much for progressive income taxes…

    Then there are excise taxes. I don’t know of all the federal excise taxes, but I know that, at the very least, gasoline and cigarettes are taxed. I firmly believe (though I have no evidence to back it up) that these are HIGHLY regressive taxes. The poor can’t live where they work, so they commute and end up paying more gasoline taxes. I believe the poor are also more likely to smoke, though again, I have no numbers on the matter.

    If you consider ALL the taxes that individuals pay, I wouldn’t be surprised to find that our tax system is actually regressive. I don’t know of any studies on the matter, but I would be interested to find some. Our tax system is an abomination. We need to throw it out and start from scratch. If we actually design it, instead of letting it evolve on the whims of legislators, I’m sure we could build a fair and simple tax system.

  2. Long or Short Capital on January 29, 2007 8:51 am

    Carnival of the Capitalists 01-29-07

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  3. car games online - Uttaruk.com » Carnival of the Capitalists 01-29-07 on January 29, 2007 9:43 am

    [...] Moneyandfinance talks about the Social Security tax in the context of tax brackets: By looking at hard numbers we can try to remove politics from it and see its effect on people and society. Increasing the social security tax rates will burden even more our lower income people and will create an ever flatter curve. Not doing something to fix social security now will create bigger issues to solve that will make society do hard decisions: like increasing retirement age or increasing social security tax, burdening people even more. [...]

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