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.

A Sunday Numeracy Quiz

My Sunday reading turned up three examples of glaring numeracy errors. I make plenty of my own errors, so I have sympathy for the perpetrators. But I did want to highlight them as examples of what can happen when quantitative thinking runs off the rails. And the need to remain mathematically vigilant in your daily life.

So please take this short numeracy quiz. My answers after the fold.

1. How much has teen drinking declined?

In today’s New York Times Magazine, Tara Parker-Pope makes the case that teenagers are more conservative than their parents were. For example, the fraction of high-school seniors who reported that they had recently consumed alcohol fell from 72% in 1980 to 40% in 2011.

I have no beef with those statistics (or that trend), but I do wonder about the chart used to illustrate it. Do you see anything wrong in this visual?

2. What’s a fair way for students to hedge their bets on today’s Super Bowl?

A few pages later (in the ink-and-paper edition), the NYT’s Ethicist, Ariel Kaminer receives a letter from a parent whose child was offered a bet on the Super Bowl … by their school. Leaving aside the propriety of book-making in the class room, what do you think of this wager?

My school charged a dollar for students to bet, or “predict,” which team would win the Super Bowl. It was $1 for one team, and if you won, you would get a candy bar. If you bet $3, you could choose both teams and guarantee your candy bar. Is this legal or even morally right?

3. How much does federal compensation exceed private compensation?

In Friday’s Wall Street Journal, finally, Steve Moore makes the case that federal workers are overpaid. What’s wrong in the following excerpt? (ht: Brad DeLong)

Federal workers on balance still receive much better benefits and pay packages than comparable private sector workers, the Congressional Budget Office reports. The report says that on average the compensation paid to federal workers is nearly 50% higher than in the private sector, though even that figure understates the premium paid to federal bureaucrats.

CBO found that federal salaries were slightly higher (2%) on average, while benefits — including health insurance, retirement and paid vacation — are much more generous (48% higher) than what same-skilled private sector workers get.

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