The 102% Tax Rate and Other Perils Measuring Tax Rates

Over at the Tax Policy Center’s blog, TaxVox, my colleague Roberton Williams examines the pitfalls that afflict some efforts to measure a person’s tax rate:

Investment manager James Ross last week told New York Times columnist James Stewart that his combined federal, state, and local tax rate was 102 percent.  No doubt, Ross did pay a lot of tax to the feds and the two New Yorks, city and state. But did he really pay more than all of his income in tax?

No, he did not.

As Stewart made clear past the wildly misleading headline (“At 102%, His Tax Rate Takes the Cake”), Ross’s tax bills totaled 102 percent of his taxable income, a measure that omits all exclusions, exemptions, and deductions. Using that reduced measure of income inflates Ross’s effective tax rate far above the share of his total income he paid in taxes.

Deeper into his column, Stewart explains that Ross’s tax bill was just 20 percent of his adjusted gross income (AGI), a more inclusive measure that does not subtract out exemptions and deductions. Because he took advantage of many preferences, Ross’s taxable income was only a fifth of his AGI, resulting in that inflated 102 percent tax rate. But even AGI doesn’t include all income. Among other things, it leaves out tax-exempt interest on municipal bonds, contributions to retirement accounts, and the earnings of those accounts. Ross almost surely paid less than 20 percent of his total income in taxes

Stewart’s article demonstrates the common confusion about effective tax rates, or ETRs. There are many ETRs, depending on which taxes you count and against what income you measure them. Including more taxes drives up ETRs. Using a broader measure of income drives them down. And interpreting what a specific ETR means requires a clear understanding of both the tax and income measures used.

In short, you need to be careful with both the numerator and the denominator when measuring someone’s tax rate. And you need to be doubly careful when comparing tax rates across individuals or groups.

TPC released a short report today that illustrates that point for taxpayers of different income levels. Rachel Johnson, Joe Rosenberg, and Bob Williams show how including different taxes and using different income measures (AGI versus a broader measure of cash income) can have big effects on ETRs.

As Bob concludes his blog post:

The bottom line is you can use these numbers to tell many different stories, some more valid than others, depending on the taxes you include and the income measure you use. The broadest measure of income provides the most meaningful gauge of the relative impact of taxes on households. Narrower measures can yield absurd results—James Ross didn’t pay 102 percent of his income in taxes—and ignore important differences in households’ ability to pay.

3 thoughts on “The 102% Tax Rate and Other Perils Measuring Tax Rates”

  1. Doesn’t this imply that his marginal rate is 102% or pretty close to it for any additional income that he wants to earn for non-tax-preferred consumption?

    So he might be willing to work enough for an extra $1k to give to charity (so it won’t be taxed), but he’d be a fool to work for $1k more to spend on himself, since he’d pay it all in taxes and then some and end up worse off.

  2. Hi Jonathan – All we really know is that his average tax rate is 102% when compared to taxable income and 20% when compared to his adjusted gross income. I can’t see any way for his marginal rate to be up in the 100% range. I checked with my colleagues, and they note that the NY state top tax rate was 8.97%, the top NYC rate was 3.876%, and the top federal rate was 35%. And then there’s the 2.9% (employee + employer) Medicare tax. Add those all up, and you end up at around 51%. And that’s assuming that his tax position is such that he’s lost all ability to get the benefit of deducting state and local taxes from his federal return (which would subtract a bit more than 4 percentage points).

  3. But isn’t this required by definition of marginal tax rate?

    $X increase in taxable income creates $Y amount of new tax liability. Marginal rate = Y/X. when X = 1.

    If his marginal rate never was above 100% at any point, how did his tax bill grow as large as his taxable income in the first place?

    Unless, for some reason, the article was talking about his *total* taxes from all sources, including property tax, sales, tax, etc which are not a percentage of income. But I don’t see any indication that the article was using that measure.

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