ChrisWeigant.com

Explaining Taxes

[ Posted Monday, April 18th, 2011 – 17:30 PDT ]

Imagine, this tax day, that you had to explain the concept of how America taxes itself to a visitor from another planet. Picture, if you will, a conversation with modern-day alien Gulliver, who is exploring new words and asking questions about our civilization in order to tell wild tales to the folks back home.

The concept of taxes, of course, is pretty easy to explain. Except when you look at it too closely. Or have to explain it to our imaginary visitor from Mars. Here's my modest attempt at outlining the concept of taxes to an interplanetary Gulliver:

 

A "tax" is money that the government collects within its borders in order to pay for everything that government does. Today is the day when Americans are supposed to have sent in their income taxes. We work for money, or an "income," and the government takes a portion of this as a tax.

Our income tax is what is called a "progressive tax," which means that those who make more money pay a higher tax rate. If you make very little money, you pay no income tax at all. If you make a decent amount of money, you pay a fraction of it to the government. If you make a lot of money, the fraction you pay is theoretically higher. This system is designed this way because those who have enough money not to worry about putting food on the table each day can afford to pay more to the government.

That is the theory, at least.

All money you make during the year is considered "income," no matter how you make it. If you work at a job for wages, that is income. If you win the lottery, that is income. If you find a twenty-dollar bill on the street, you're supposed to declare it as income, too.

There is one exception to this, however -- if you buy and sell pieces of companies (called "stocks") and make a profit, this is called "capital gains" and not "income." This is how the very wealthy make a lot of their money, by what's called "investing" it. This is a more-advanced form of gambling than going to Las Vegas, basically. You take some of your money and you buy a stock. If the stock starts selling for more money, you can then sell it and make a profit. You are making a bet that the company will do better in the future. Sometimes you lose the bet, and you wind up losing money. Sometimes the bet pays off in a big way.

If you took a thousand dollars and successfully gambled it in a casino, and walked out with one hundred thousand dollars, you would have to pay income tax on $99,000 of it. If you took the same $1,000 and bought stocks with it, and then sold the stocks for $100,000, then the money you make is not considered income, but capital gains. Winning the money in Vegas means you have to pay the normal income tax rate on it, but winning the money on Wall Street means you will pay about half the income tax rate.

That's right -- half.

Now, if you work for a wage and you take the money you earn and go out and buy something with it (a beer, a car, whatever), you have to pay a "sales tax" on the purchase price. This tax varies depending on what you buy, and where you buy it. But when the wealthy buy and sell pieces of companies, they do not have to pay a tax on the purchase price. Why? I'm not sure, that's just the way it is set up.

Companies are taxed, too, but they are taxed differently than citizens. When a person makes money, they are taxed on a portion of the total income. There are ways that you can avoid some of these taxes, if you have enough money. If you buy a house, for instance, you don't have to pay income taxes on the interest you pay a bank on your mortgage. There are actually dozens of ways to lower your tax rate, but most of them are so obscure that very few people even know about them. But businesses are not taxed on income at all -- they're taxed only on "profit." Anything which is a "business expense" is not taxed at all. People aren't allowed to "write off" their expenses in this fashion, but businesses are. And there are thousands of ways businesses can claim that the money they make isn't really profit at all. This means that a corporation which brags on its annual report that they made billions of dollars in profit can make that profit disappear when filling out their tax form.

What this means is that people who earn wages pay a certain percentage of their income in taxes, but giant corporations pay little or no taxes at all. Every single year there are stories about companies which make tens of billions of dollars, but pay zero in taxes. Every single year.

The tax laws are written by what we call Congress -- the legislative branch of our government. The people in Congress get elected by the citizens. To get elected to Congress costs a lot of money, because campaigning isn't cheap. So they have to raise money to get elected. The money they raise comes from people who want Congress to do something for them. These people hire other people called "lobbyists" who bribe members of Congress with campaign funds. Well, we don't call it a "bribe" even though that's what it is, because it makes it sound unethical and dirty. It is unethical and dirty, but we all pretend that the money given to politicians has nothing to do with the way they vote -- on tax issues, for instance. I'm not sure why everyone pretends in this fashion, but we all do, for the most part.

Say you are a company that builds widgets. You join together with other widget-makers, and form a business group. You all pay money to this group, and the group takes that money and gives it to a bunch of lobbyists. These lobbyists take the money, and bribe as many members of Congress as possible. Then when the tax laws are drawn up, the politicians which you have bribed write into the tax code "widget makers don't have to pay taxes." Of course, this would be too obvious, so the way this gets written into the tax code takes eight hundred words of closely-packed text which never even mentions the word "widget" -- but defines the tax break in such a way that the only people who can claim it are you and your fellow widget-makers. Nobody else even notices those eight hundred words, so they don't complain about you getting such a sweet deal.

The more money you have to bribe politicians with, the better the tax break you can buy for yourself. Ordinary people who earn a wage don't make nearly enough money to buy such preferential treatment, of course. Only the wealthiest of private citizens, and large businesses, can afford this sort of thing. Citizens can form a large group in an effort to bribe their own politicians, but it takes a whole lot of them to balance the bribes which are already pouring in.

But, of course, we have a progressive tax system -- it says so right there on the label. Oh, except for another tax we call "Social Security." This is actually a "regressive tax" because the more money you make, the less you pay. Those who make very little money have to pay the full percentage. Those who make decent money also pay the full percentage. But when you make enough money, then you get to stop paying the tax after a certain point. This means that someone making a million dollars a year pays a tiny, tiny fraction of the percentage that almost everybody else has to pay. Why is this? I'm not sure, that's just the way it is.

So, to review: we have a progressive tax system, so that those who make the most money pay the highest percent in taxes. Except for those who make most of their money buying and selling stocks -- they pay half the percentage everyone else pays. Everyone pays sales taxes, except those buying and selling stocks, who pay no taxes at all on the transaction. Businesses are taxed differently than people, and are allowed to only pay taxes on their profits and not their incomes. Businesses are allowed to report profits to their stockholders, but then report a different number entirely to the government when filling out their taxes. Sometimes very large corporations pay absolutely no taxes at all. If they don't like the tax laws, wealthy people and businesses are allowed to bribe the people who write the laws to create "loopholes" written just for them, which always means they wind up paying lower taxes. Also, if you make enough money, you get to stop paying Social Security taxes after a certain point, even though everyone else pays the same percent.

It's really a very progressive system, isn't it? Well, that's what we all tell ourselves, at any rate. How do they do these things on your planet?

-- Chris Weigant

 

Cross-posted at Business Insider
Cross-posted at The Huffington Post

Follow Chris on Twitter: @ChrisWeigant

 

12 Comments on “Explaining Taxes”

  1. [1] 
    dsws wrote:

    Capital gains are counted as income. They're line 13 on form 1040, and line 22 says "Combine the amounts in the far right column for lines 7 through 21. This is your total income".

    What's not income is *unrealized* capital gains. If you buy something and sell it for more than you paid for it, the difference is income. If you have something that's worth more than it was last year, you could sell it and get some income. But if you don't sell it, you haven't made money on it yet. The problem is that time is money. So taxation delayed is taxation denied.

    "These lobbyists take the money, and bribe as many members of Congress as possible. Then when the tax laws are drawn up, the politicians which you have bribed write into the tax code 'widget makers don't have to pay taxes.'"

    My understanding is that they're not that blatant about it. Rather, they find candidates who are likely to be favorably disposed toward widget makers, and get them elected at no personal gain to the congresscritters. Then they explain the merits of (insert 8000 words of gobbledygook here, that amounts to no taxes for widget makers). Then, when the congresscritters retire, the ones who voted as they were told become consultants or lobbyists, get hired to do legal work that doesn't visibly involve any actual work.

  2. [2] 
    Chris Weigant wrote:

    dsws -

    Ah, but line 13 comes from Schedule D. If you look at "Schedule D Tax Worksheet" (on page D-10 of the Schedule D instructions), you'll find the part where it says "enter the smaller" of what would be your tax if it was all income, and your actual tax because of the lower capital gains rate. You take this smaller number and enter it on line 44 of 1040. Voila! You have just had your taxes generously slashed, because some income is more equal than other income!

    :-)

    -CW

  3. [3] 
    dsws wrote:

    You're right. I must have been sleep-deprived, or maybe I'm going senile or something. Capital gains are indeed specially privileged income that gets taxed at a lower rate than earned income. On the other hand, they can also be an artifact of inflation: if you bought something in 1967 for 60k and you sell it for 400k in 2011, you've got a nominal capital gain of $340 and a real capital gain of zilch.

  4. [4] 
    Michale wrote:

    Ya know, it's funny...

    Obama and the entire Left scream and yell and bitch and moan about how the taxbreak for millionaires is unfair and wrong etc etc etc..

    Yet, Obama doesn't seem to mind taking advantage of the tax breaks....

    Goes back to what I said before..

    If the Left is so against such breaks, why do they take advantage of them??

    Michale.....

  5. [5] 
    nypoet22 wrote:

    If the Left is so against such breaks, why do they take advantage of them??

    that oft-repeated maxim by the cons, much like the "if you want higher taxes, why not donate extra money to the government," is a phony conflict. it's like saying if most baseball owners want a salary cap, why do so many teams keep paying their players more money?

    there is simply no conflict between a: doing the best you can for yourself within an unfair system, and b: wanting a fairer system, even if it wouldn't be to your personal benefit.

    further, it frequently comes as a disingenuous retort from people who actively promote keeping the system as unfair as possible, explicitly for their own benefit. the way i see things, that type is the more hypocritical of the two.

  6. [6] 
    Michale wrote:

    there is simply no conflict between a: doing the best you can for yourself within an unfair system, and b: wanting a fairer system, even if it wouldn't be to your personal benefit.

    So, when ya'all were castigating the Right for taking stimulus dollars while at the same time they were fighting against the stimulus in Congress, ya'all were being disingenuous?? :D

    Michale.....

  7. [7] 
    Michale wrote:

    Maybe it's just me, but I see it hypocritical in the extreme to attack a system as unfair and wrong, yet use that exact same system to become enrich one's own life and standing..

    The GOP had a somewhat valid argument in the stimulus issue. They fought against Porkulus but still used the dollars to the benefit of their constituents..

    Democrats who rail against the tax system for the rich, yet use that same tax system to make themselves, personally, richer have no such philanthropic argument to make.

    Michale.....

  8. [8] 
    nypoet22 wrote:

    The GOP had a somewhat valid argument in the stimulus issue.

    that's actually a good point, although i think the hypocrisy meter on this issue is a bit lower for the president or the former speaker, because doing the job of representing constituents is a different role from caring for one's family and personal finances. to some extent it's true though, opposing stimulus funds but using them once they're offered is not particularly hypocritical either. you want a system with fewer earmarks, but if you lose the battle on the system, it's irresponsible to intentionally put yourself at a disadvantage based solely on ideology.

    just like a sports team in a league with no salary cap, there's no point falling on the blade of your ideology. when the policy battle is over, the practical thing to do is accept things as they are and do the best you can for your own.

  9. [9] 
    Michale wrote:

    NY,

    it's irresponsible to intentionally put yourself at a disadvantage based solely on ideology.

    I disagree...

    Consider a person that is facing death from a degenerative disease... There is a medical treatment that can save her but it's formulated from the research of a war criminal that used human beings to experiment on...

    This person refuses treatment out of principle..

    Granted with my example, the stakes are higher, but the principle is the same..

    If a person thinks a particular system is unfair and wrong but then takes specific and willful actions to personally benefit from that system, that is the epitome of hypocrisy...

    Having said all that, I *do* see your point and pretty much agree with it..

    I just think it's wrong and hypocritical for Democrats to get all 'holier than thou' over the tax system if they continue to take advantage of it to enrich themselves personally...

    Michale.....

  10. [10] 
    Michale wrote:

    I disagree...

    Having said all that, I *do* see your point and pretty much agree with it..

    OK, this is a little inconsistent, even for me... :D

    Michale....

  11. [11] 
    nypoet22 wrote:

    OK, this is a little inconsistent, even for me... :D

    i think what you mean is that it's an issue with nuances. the president has his daughters to think of. the republican senators have to consider the immediate needs of their constituents. yes, in an ideal world we would all stick by our fundamental beliefs 100%. but the ideology of either matter doesn't stand up too well against the reality of the near-and-dear who depend on you to make their lives better.

  12. [12] 
    Michale wrote:

    i think what you mean is that it's an issue with nuances. the president has his daughters to think of. the republican senators have to consider the immediate needs of their constituents. yes, in an ideal world we would all stick by our fundamental beliefs 100%. but the ideology of either matter doesn't stand up too well against the reality of the near-and-dear who depend on you to make their lives better.

    Thanx, Joshua... I HATE being inconsistent, especially so blatantly.

    It was kind of you to give me an out. :D

    And you are dead on ballz accurate (it's an industry term) In a perfect world, we would all abide by our principles.

    But then again, in a perfect world, Fate would ALLOW us to abide by our principles..

    I don't begrudge Obama et al for doing the best that the system allows them to do for themselves and their families..

    What bothers me is that it gives the appearance of just paying lip service to real change...

    That when the rubber meets the road, they like the status quo just fine..

    Michale.....

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