The Truth About Taxes
The Truth About Taxes
Jordan Goodman (Personal Finance Author) gives expert video advice on: How many taxes does the average American pay?; How much of my earned income does the government take?; What does the government do with my money? and more...
How many taxes does the average American pay?
The average American pays all kinds of different taxes. Their going to pay sales taxes, their going to pay property taxes if they own their own home, Federal income tax, many cases state income tax, and some cases even city income tax, like in New York City. There are just lots of taxes because all the different municipalities and government agencies want to get money to support their operations one way or the other. Even though we pay a lot of taxes here, we still pay a lot less than a lot of other countries, particularly in Europe or Canada. They have much higher tax rates than we do. The other big tax that we pay is capital gains and dividends. When you receive a dividend from a corporation that you are a share holder of, or when you sell a stock for profit for capital gain, you pay a tax on that, typically of fifteen percent. In other countries again, they have much higher taxes than we do. So, we like to complain about it a lot, but in fact our taxes are much lower than a lot of other places in the world.
How much of my earned income does the government take?
The percentage of your earned income which the government takes depends on your income level. In general, the higher your income level, the more the government's going to be taking. And in general, the lower income you have, the less you're going to be paying in taxes. And many, many people have no taxes at all; they actually get money from the government, called the Earned Income Credit. The burden of taxation has been shifting more and more to upper-income people over many years, by taking away various kinds of deductions and tax shelters. So now, the top 1 percent of the population pays something like 20 percent of the total taxes due. And that's actually been growing because, by taking away tax deductions and credits, it means that the richer people have no other place to hide; they have to pay some taxes.
What does the government do with my money?
Well the government spends your money in all kinds of ways. One of their biggest expenses is actually interest on national debt. They certainly spend a lot on defense. That is a very large area. Social security and various kinds of social programs. All the other parts of the federal budget are relatively small. The parks department, the justice department, all of those are, as you look at it, are relatively small parts of the pie. The big three would be social security, defense, and interest on the national debt. That is where a lot of your money goes when you pay your federal taxes. At the state level they have got all their state agencies and services that they're providing. They also usually have a lot of debt that they are paying interest on, as well. At the local level typically your taxes are going to support the local government and schools is by far the biggest area where local government is needing money. They have to spend for the teachers and facilities and keeping up the local schools.
Which state has the highest taxes?
There are certain states that have much a higher tax rate than others. A lot of them are in the Northeast -- New York, Pennsylvania, New Jersey, and Massachusetts in general have higher tax rates. In many cases the Western and Southern states have lower tax rates. Some states like Nevada, Washington, and Texas have no income taxes what so ever. And when you have low or no income taxes, it brings a lot of people into that state and makes business flourish. So a lot of people are in Nevada, for example, because it doesn't have any state income taxes. That's a real magnet to bring people into a state like that.
Is the income tax unconstitutional?
Some people say the income tax is unconstitutional. It was not in the original constitution, that is true. But it was put in 1913 by Congress. And the constitution does say that the congress has power to impose taxes on the population. So even though it's not explicitly in the constitution and congress has a right to raise money through taxes and therefore they have created the Internal Revenue Service and do charge taxes that is completely a legal kind of thing. A lot of people will say that they are part of some religion that doesn't believe in paying taxes or they're part of some obscure Indian tribe that's exempt from taxes. People try all kinds of things to avoid paying taxes. But all that is illegal, the tax code has been upheld by the Supreme Court many times and it is constitutional.
Is there a law that says I have to pay my income tax?
There is a law that says you have to pay your income tax. That was passed when the IRS was originally set up back in 1913. People have tried to come up with all kinds of reasons why they're exempt from it: they're part of some religious order; they're part of some foreign country that lives inside the United States, like an Indian tribe. But all these don't wash. You do have to pay taxes, and if you don't pay your taxes, you're going to have very large penalties and interest, and the IRS is very strong about enforcing those. So, it's not an area you want to fool around with, saying, "Taxes are for everybody else, but I don't believe in them." That's not going to work with the IRS.
How many days do I have to work to pay my taxes?
There is something called The Tax Foundation which every year takes a look at the total of the tax burden and sees how many days you have to work before you have payed off your tax liability. Typically it's into about early May for most people. That's been creeping outward a little bit as taxes have gone up for an awful lot of people. It depends on your situation, how much income you earn, and how much you pay in taxes. Typically it's going to take about 5 months of the year to pay off the taxes you owe.
Didn't we fight the Revolutionary War so that we wouldn't have to pay taxes?
Well, we fought the Revolutionary War because we had taxation without representation. King George said we had to pay these taxes and we didn't have any say about it. In theory, anyway, we do have some say about it today in that we do elect our senators, representatives, and president -- all of whom set tax policy. And it does make a difference. A good example would be President Reagan in the 1980s. He cut taxes dramatically and he was very popular for that, and he got elected and re-elected because the populace liked that. We have elected other presidents who have raised taxes, so at least in theory we have some input in the level of taxation that we have to pay, as opposed to when we were just a colony and they imposed taxes whether we liked it or not. We didn't like it and that's what caused the revolution.
What would Thomas Jefferson say about our current tax system?
Well if Thomas Jefferson looked at our current tax system, the first he would say is it's too complicated. It's not done based on equality of opportunity, it's based on lobbying and getting special interest loopholes in the tax bills. A lot of money is spent subsidizing people who probably don't need to be subsidized. So that's something Thomas Jefferson wouldn't like very much. He was all about equality and making it equal for many people across the country. The tax code is certainly not like that. It's bloated with all kinds of favorite loopholes for a lot of special interest so because they don't pay taxes, the rest of their tax burden goes to everybody else. In fact because the U.S. government has deficits, the taxes that are being brought in every year are not enough to cover our expenses. So we have to go into more debt, being put on future generations to cover the lack of taxes that we're getting from the current tax system.
Why do poor people pay a higher percentage of their income in taxes than rich people?
Some people think that lower income people pay higher taxes than higher income people. Now, higher income people can get lower tax rates by taking money in capital gains and dividends, which are currently taxed at a 15% rate. So your regular income tax rate might be as high as 35% or so. So if you're getting regular wage income, that could, in many cases, be taxed at a higher rate than dividends and capital gain, which is taxed at 15%. But overall, wealthier people pay much more of the tax burden than middle and lower income people. But the rates that lower income people may pay are going to be higher if they're getting it in regular wage income, as opposed to capital gains and dividend income.