Numbers Have Meaning Too: The Marginal Tax Rate Myth

I caught this gem on the Huffington Post which led me to the original article on USA Today about Math For Grownups, a book by author Laura Laing.

Math for Grownups

Does this mean there are no stickers or coloring sections? Boo.

That raise actually might not be as good as it looks. The extra money is nice, but it could very well bump you into the next tax bracket, possibly leaving you with less money than you had before the raise. Better benefits, such as medical, can save you money while keeping you in the same tax bracket.

This has since be updated on the site, but can you see the problem? I’ve had to explain this to people myself, and my math skills are “meh” to middling at best. The writer of the article, Gregory Connolly, to his shame (for the next 24 hours or so before the Internet forgets this) passes along an irritatingly common misconception about income tax brackets.

The way “marginal tax rates” work is that you don’t get the higher rate applied to your total salary, only that portion that goes over the cutoff. This is explained quite well by the Center for Economic and Policy Research.

Suppose that the tax bracket for income under $200k is 25 percent, and for income over $200k is 33 percent. If you get a raise that pushes your income from $195,000 to $205,000 then you only pay the higher 33 percent tax rate on the $5,000 that is above the $200k threshold not your whole income. Therefore, there is no (as in none, nada, not any) way that getting more money, and being pushed into a higher tax bracket will leave you with less money after taxes.

This common misconception usually gets parroted by conservatives, though I’ll admit most of the ones I know are educated on this point. In fact, despite having mediocre results in terms of personal finance, even I’ve had to hammer this very simple fact into the heads of some anti-tax idealogues on social networking sites and in person. On one memorable occasion an individual consistently attempted to use his personal experience with families that make over $200,000 annually to bolster this claim. Basically, he said something along the lines that he pretty much knew everyone in his town who made that much. This concerned me that so many people would be going over their income and taxation histories with this guy who wasn’t a CPA, bookkeeper or a tax official of any kind by trade. Also, I didn’t believe a word of it.

To her credit, Laura Laing, the author of the book, does address the clarification in the comments section of the USA Today story:

This issue is covered correctly in Math for Grownups. But I’m so glad that you pointed out this very common misunderstanding. The example from the book considers whether or not non-taxable perks and more paid time off might be a better deal than the raise itself. Folks may assume that a raise is the best option–however, there are many ways to negotiate with employers so that more money is kept in your pocket!

I’m a little uncertain as to what kind of perks could make up for a $6,000 raise that pretty much adds up to $4,575 after putting in the increased tax being paid. Among the examples she listed: an extra week of vacation, a cappuccino maker for the break room and a VIP parking spot. I guess it all depends on what you value and how you evaluate it, but frankly, I prefer the extra $380 a month that I could be put towards interest bearing savings, or divert a part of it for a slightly larger monthly entertainment budget.

In any case, making more money is generally good. I think that’s something on which most people agree.

NOTE: Oh, also, Math for Grownups is available as an e-book for free until September 10th, 2011 (this Saturday). I just did the 1-click thing on Amazon to download it, so we’ll see how the rest of the book goes.

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