Are U.S. tax policies leading to income inequality?

Taxing fairness

It’s that time of year again.  Time to file your annual income tax return.  Most people are excited because the government will write them a refund check.  For many, it is the one time that people see a large infusion of cash… and immediately go out and spend their refund check on something nice for themselves.  Some go on a cruise; others spend the money on a new piece of furniture.  Still others pay down bills they had let slip in the past year.  In any case, we behave as if the federal government has given us some sort of gift from heaven.

We hardly notice many of the withholding amounts on our paycheck any more.  I will never forget my first formal paycheck when I learned that I would not get to keep almost 20% of my minimum wage check when I was a teenager.  As a dad, I had to council my daughter as she had the same experience with her first paycheck.  After that initial shock, we seem to forget we are even paying taxes.  It is probably a beneficial coping mechanism that we have all developed in order to live happy lives.

However, when we fret about taxes, we seem to focus on federal income taxes.  The reality is that we pay much more than just federal income taxes.  I think that federal income taxes seem to be the most noticeable because we file a tax refund each year which highlights our large federal tax bill.  If you are one of the lucky ones, you may get some of your paid federal income taxes returned to you in the form of a rebate check.

I am writing this blog to enlighten the reader on the total tax bill.  I am not necessarily advocating for lower or higher tax rates.  However, I think that you ought to at least understand what you are paying in your total tax bill.

If you are a working stiff, you probably notice a lot of your tax bill on your periodic paycheck stub.

Payroll Taxes

So, although you may focus on your high federal income tax withheld from your paycheck, you are paying many other taxes that may go unnoticed.  In fact, you will never see the entire social security (FICA) and medicare taxes on your paycheck, because your employer pays half of these amounts directly to the federal government.  Nevertheless, the average middle class worker is paying 45% of their income in taxes.

That alone may be a shock to some.  Now, let’s consider other taxes that you pay on a daily basis as you purchase goods and services in our economy and probably don’t ever realize.

Sales Taxes

On average, most consumers are paying 11% of their remaining income on sales taxes of one sort or another.

We’re not done yet.  In addition to payroll taxes and sales taxes, most people pay a property tax.  Even if you do not own property, your landlord has to pay property taxes and so you are paying these taxes indirectly.  Property taxes amount to 5% of the average middle class income in most cases.

If you have any savings that you try to invest, you will also pay capital gains taxes.  The good news is that capital gains are taxed at a much lower rate than your payroll taxes, so I have ignored capital gains in this post.

So let’s add this all up.  If you are paid $100,000, you will be taxed 45% right off the bat so your take-home pay immediately drops to $65,000.  You then pay 11% of this remaining amount in sales taxes as you spend your take-home pay, meaning that you end up with $57,580.  You then pay $5,000 in property taxes for a net paycheck of $52,580.  This means that you are paying a total of 47.4% in total tax payments.

In the U.S., our state, local and federal government spend 35% of Gross Domestic Product (GDP).  So, although, you are paying 47.4% of your personal GDP in taxes, the government doesn’t seem to need all of this tax revenue.

Ok.  You are now wondering, “If I am actually paying 47.4% of my income in taxes; and the government is only spending 35% of GDP; and we are amassing debt at a rate of 3% per year, where are all my tax dollars going?”

First of all, you are getting a refund check back because you will typically find tax deductions from federal and state income taxes which will normally reduce your tax payments from 47.4% of income to 42.4% of income.

Second of all, a lot of the GDP is comprised of financial revenue which is not taxed at the same rate as payroll taxes.  So, if you are one of the lucky few that does not make your money the old fashioned way, your income taxes will be much less.  The capital gains rate had been 15% for some time and just recently was raised to 20% in 2013.  Although this rate seems high, it is still much lower than the 45% payroll tax rate that working people pay through payroll withholding taxes.

Other Payroll Deductions

So, you’re probably not happy with the taxes that are being taken out of your paycheck already.  However, it gets worse.  Almost all employers withhold additional amounts of income for health insurance, disability insurance, and other items.  With the advent of the Affordable Care Act (ACA or Obamacare); employers are now forced to withhold amounts for health insurance.

So What?

Many people know that we have a wealth gap.  Or at least they suspect that this is the case.  Others understand that wages for middle class and lower-income earners have not kept pace with high-income earners.  This is true.  However, it is important to understand that politicians that continue to promise to close this gap, merely add more taxes to payroll withholding and expand this gap further.

Payroll withholding taxes and high consumption taxes negatively impact our economy.  It makes it more and more difficult for people to earn a living as a worker; and more beneficial for investors to look for passive income avenues rather than hiring workers.  Some employers have simply taken their business overseas where employment is easier to do.

A few 2016 Democratic presidential politicians have promoted higher taxes on short-term investment.  And, I believe this is a step in the right direction.   A few 2016 Republican presidential politicians have promoted low or no taxes on corporate income.  I also support this idea.  Candidates have also promised simplification of our federal tax code.  I support this idea as well.  But we also need to be aware of all of the local taxes that are levied as well in our efforts to simplify.


So, here’s what you ought to do whether considering a presidential candidate; or hounding other elected representatives:

  1. Simplification of tax code; no deductions.
  2. No difference between payroll and investment income tax rates.
  3. Increase import taxes to parity with domestic taxes.
  4. Eliminate double corporate income taxation.

All of these initiatives are necessary to get our American economy and a robust labor market back on track.