Lesson 4

HOW EACH TYPE OF TAX APPLIES TO EACH TYPE OF INCOME: So far, we have established the five "major" types of income (there are others), and the five "major" types of taxes (there are others). How is each type of income taxed? The wage is taxed by all five major types oftaxes, as long as the job is 'above-ground'--- an 'underground economy' job, generating a wage, may only be subject to sales and special taxes. My friend Dave worked as a bouncer in a bar when I was your age. I'd pick him up at 2am- at the end of his shift --for some breakfast, and I saw his boss pay him with four twenty dollar bills (A LOT OF MONEY BACK THEN) and Dave paid no FIT, no FICA, and no SIT on that $80 in take-home pay. The sales tax on the breakfast --- HE WAS BUYING! ---andthe gas tax, and DMV fees on his car were in fact paid, out of that $80 per night in wages. Normally, a worker will pay A) the FIT, B) the FICA tax, C) the SIT, D) the sales tax and E) special taxes and fees, out of her or his wage income. Of course, taxes D and E are paid AS THE HOUSEHOLD SPENDS THE MONEY---theyare not income-based taxes. They do not care what the source of income is. Many people believe that ALL taxes should be some form of D or E.You have to form your own opinion on this matter.It sure would be simpler to learn! Interest (and dividend) income is usually taxed FIT, SIT, sales and special. There is no FICAtaxon interest income, as FICA applies to WAGES ONLY. Capital gain income is taxed at a lower rate for FIT---it is incredibly difficult for a person to calculate the FIT on capital gain incomeusually a person hires a pro or uses software to figure it out, but generally, the FIT on capital gain income is either 15% or 20%, depending on a variety of factors.There is usually little or no FIT on the capital gain 'earned' upon the sale of a house, if it was your primary residence. If you need more details, I urge you to do more research on the matter! Since well over two-thirds of capital gain income goes to families who make over $250,000 in total income,MOST ofthese'capital gain'dollars WOULD HAVE BEEN TAXEDAT 35% or 37% FIT --- THIS IS A HUGE TAX BREAK FOR THE RICHEST 1% OF ALL U.S. HOUSEHOLDS. Many people in our country believe that this is UNFAIR. You have to form your own opinion on the matter. The normal SIT rates apply to capital gain income. This means that our state's tax revenue swings wildly from year to year, depending on the stock market. Our state stands to bring in MUCH LESS REVENUE in 2020 as compared to 2019 owing to MANY factors, including the huge drop in wage income this year, but also due to the fact that households will not be reportingany---or hardly any--- capital gain income for tax year 2020. As of April 2020, the stock market is "down for the year". Who knows? Maybe it will "bounce back" in the last quarter of the year! Sales taxes and special taxes apply to capital gain income IF the family members go out and SPEND THE MONEY. Inheritance income is not taxedFIT or SIT on the first $24 million or sofor a couple, and there is no FIT on the first 12 million or so for an individual. There is no SIT on inheritance income, and the FIT rate of 40% kicks in after the first 12 million or so on the individual and the first 24 million or so on the couple. Thus, well over 95% of all families do not owe any FIT or SIT on money that they inherit. Sales and special taxes will apply to inherited money IF the person goes out and SPENDS some of that money on a car, meal at a restaurant, or most online purchases.Again, theFICA tax applies to wages only, and thus do not apply to inheritance income."Private sector pensions andvariousgovernment (G) payments" vary,in terms of which taxes apply,and I can give you some highlights: a pension from Ford Motor Company will usually be taxed A, C, D and E, just like a state, or federal, or city, or county worker's pension benefits. The social security benefit check, averaging about $1500 a month, will be taxed 'more lightly': if I make under about $30,000 per year TOTAL, then that $1500 a monthbenefitwill have no FIT or SIT taken out (there is no FICA tax on this benefit). Obviously, the federal and state governments decided "ohthis person is old, and low income---let's not tax them FIT or SIT on THAT $1500" -which is interesting. If I make between about $30,000 andabout$50,000, then ONLY ONE HALF of that $1500 a month will be taxed FIT and SIT---which is also interesting. Please remember, this person is most likely old, and retiredno longer earning a wage income. $40,000 a year is not a lot of moneyto live on --- in San Jose or in North Carolina -----but what if this older, retired person is living in a house inSan Jose THAT IS PAID OFF? Recall that little old man who bought his house in 1980? He paid it off in 2010,if he hada normal 30 year mortgage. He may be making only $40,000 in yearly income, yet, heoftenhas assets in excess of $1 million. Would you call him a millionaire? I would. He could sell his house- and 'cashout' -in 90 days(in normal times). Should he getthis kind of'tax break'on his social security benefit? We will discuss this again later. This older person will be chargedthe full sales tax, and pay the full 'special taxes and fees" on restaurant meals,online purchases, andcar registration fees. He will get a big break on property taxes, as we have discussed earlier.Once again, there are many more details involved in "tax incidence'that is, how taxes apply to various types of income. Wages are by far the most heavily taxed type of income, whereas inheritance income is the least heavily taxed type of income. All this is a matter of the federal, state, and city and county tax legislation that has been passed over the last several decades. Hard to believe that way back in 1912, there was no FIT and no FICA. Of course,back then,there was no social security, noMedicare, noMedicaid. Next, we need to look at the tax 'incidence', or "bite" on a typicalU.S. household'snext $1,000 pay raise, or bonus, or extra income from overtime, oradditional $1,000 from a 'side-gig'---an extra job. Let's put this person in this situation: she is single, no children,earning$61,000 per year. She earns a $1,000 pay raise, thus, her income is 'moving' by +$1,000, from $61,000 to $62,000. She may end up paying about 50% in overall, combined taxes on the $1,000 gain in income AND IT MAY CHANGE HER BEHAVIOR IN WAYS THAT HURT OUR ECONOMY (in theory). Now, the brackets will vary depending on the situation. A worker could find herself in lower brackets, or in higher brackets. Here goes: her $1,000 may be taxed 22% FIT, as she is 'rich enough" to have 'entered" the 22% FIT bracket. PLEASE REMEMBER THAT HER OVERALL FIT MAY BE ABOUT 8% for the entire year, but THE FIT ON THIS RAISE may be 22%. The FICA tax that she must pay LOOKS LIKE IT IS 7.65%---but it is actually 15.3% -- HER share, AND HER EMPLOYER'S SHARE. It is a fiction that she does not pay 'both halves'--- she pays both parts of this tax! The SIT on her raise could be 6% or 8% or 9.3% depending on several factors. Let's put it at 8%. Okay: BEFORE SHE EVEN SEES HER PAYCHECK, 45.3% of this pay raise of $1,000- that is, about $453 ---should have been deducted from her gross pay by her employer---HER EMPLOYER COLLECTSMANY OFTHE TAXES FOR THE VARIOUS LEVELS OF GOVERNMENT---mainly federal, but also state. Now, if she is 'self-employed'---let's say she is a hair stylist---she may have CHECK to these various governmental entities----often four times a year---to pay these taxes. In theory, she would be MUCH MORE AWARE of these taxes that you and I(well, we are aware of them NOW, obviouslywe are studying them!). So, in theory, she "sees" about $547 'after taxes' --- about $10 a week. DON'T SPEND IT ALL IN ONE PLACE! She may not even notice it, but in theory, she may 'celebrate' her big raise (that was a joke) by increasing her spending levels. EVEN IF SHE DOES NOT, inflation of 3% (historical average)will "eat away" at this pay raise. Over the course of a year, the $3,000 she spends every month on the "basket" of products and services in Jan 2019 will rise to cost about $3,090 by Jan 2020for "the same" basket of products and services-----so----THE PAY RAISE IS NOT EVEN A PAY RAISE---over the course of a year. Please note that this pay raise is less than 2%---if it is the only raise she gets this year. Yet, BEFORE INFLATION HAS HAD A CHANCE TO EATAWAY AT THE RAISE, it is a true pay raise. What will she do with the extra money? If she goes out and buys "extra" products and services, quite often they will be online purchases, restaurant meals (takeout is counted), consumer electronics---things that are subject to the sales tax. Let's say she spends an 'extra" $400 on these items. The sales tax incidence will be almost 10% of this $400 in extraspending, or about $40. Now, this last one is depressing: over the course of the next 12 months, 'special taxes and fees' are bound to go up---with or without her pay raise. Gas taxes may risethey have, in fact. DMV fees may risethey have, in fact. Our state has raised BOTH in the past several months. Over the next 12 months, this person will pay more in property taxes. If she owns a condo, the property tax may rise from $3,000 last year to $3,060 next year. If she pays rent to a landlord, it is QUITE LIKELY her landlord will raise her rent at some point in any 12 month time period. Not always, but usually, especially if she lives in a popular metro are like Seattle or Austin or the Bay Area (in normal times). This rise in special taxes and fees is not causally linked to her pay raise---they do not happen OWING TO her pay raise--but they happen over the same 12 month period. It is appropriate to "take" the rise in these taxes and fees "out" of her pay raise. If we do that, then we end up with OVER ONE HALF OF HER $1,000 PAY RAISE GOING OUT IN TAXESand fees. Now, if she is a part-time worker,she may bein the 12% FIT bracket and maybe the 6% SIT bracket, then it may not be so badmaybe "only" 40% or so of her pay raise is taxed. I will argue to you that THIS IS TOO HIGH--- THE COMBINED OVERALL TAX BURDEN, OR TAX INCIDENCE,ON THE AVERAGE AMERICAN WORKER'SNEXT PAY RAISE IS TOO HIGH.

1. Please list, describe and explain each one of the five major types of taxes as discussed in Lectures 3,4, and 5: What is the FIT? What is the FICA tax? What is the State Income tax? What is the sales tax? What are the various types of "special taxes and fees" that a family may pay? 2. How does each type of tax contribute to the US. economy? 3.. Please rank each type of tax from #1, 'contributes the most' to our economy, to #5, 'contributes the least' to our economy, and please defend your ranking system. 4. What are three harmful effects of the combined tax on the typical U.S. worker's next $1,000 pay raise? 5. What would you do to make the current system of taxation more fair? Why? Please discuss at least one SPECIFIC proposal that would improve the current tax system, in your opinion