Couple tax questions

[Zkribbler]

For today only, I am a Republican.

While calculating my income, I forgot to add in my taxable interest. So I had to recalculated. The extra $3,500 in interest caused my federal taxes to increase by almost $1,000. It took me a moment to realize that I'm probably in the highest bracket, but dang! When I said, "Tax the Rich!" I wasn't talking about me!!

[KrazyHorse]

Even worse, that tax is on interest on income which has already been taxed.

There is absolutely no reason to disincentivize savers in that manner.

[Kidlicious]

Even worse, that tax is on interest on income which has already been taxed.

There is absolutely no reason to disincentivize savers in that manner.

It's better than disincentivizing workers.

[KrazyHorse]

If you don't understand how it also disincentivizes workers then you're retarded.

[KrazyHorse]

Wait, I already knew that you're retarded.

[Zkribbler]

I don't see why unearned income should be taxed at a lower rate than earned income.

My own dream is to tax wealth, not income. That way, ancient blue-haired ladies could not sit idly by on the piles of inherited wealth. I'd rather tax them that folks working 9-5. But there's just too many ways to secret wealth; it's not practicable.

[duke o' york]

Even worse, that tax is on interest on income which has already been taxed.

There is absolutely no reason to disincentivize savers in that manner.

But when completing your tax return you're supposed to add back the tax taken off interest and then take it back off at the end at the same rate, so it isn't taxed twice. You might need to reclaim any interest tax if you've paid it twice.

[KrazyHorse]

I don't see why unearned income should be taxed at a lower rate than earned income.

Let's say you have two workers. They each have the option of working overtime for 50 dollars an hour. Say they are both solidly in the 25% marginal tax bracket and nothing we're discussing will affect that. Worker A wants extra money to buy a 40" flatscreen TV, which costs 1500$. Worker B wants to save the extra money for 5 years, earning interest along the way, to buy a 50" flatscreen TV which costs 2000$ (let's leave this constant over time to make things easier to calculate). Money can be put in savings and earn 6% interest (annual compounding).

With no tax anywhere in the system both workers have to work 30 hours to buy their TV. This is because 2000$ 5 years from now has a present value of 1500$.

With a 25% tax rate Worker A has to work 40 hours to buy his TV. In any reasonable system we wouldn't want to penalize Worker B relative to Worker A. What happens in a system where interest is taxed annually? If Worker A works 40 hours then he makes 2000$, 1500$ after taxes. He puts the money in savings. The first year he earns 90$, and is taxed 22.50$ of that. The next year he makes 94.05 and is taxed 23.51 of that. After 5 years he has 1870$ after taxes. In fact, to have earned enough to buy his TV after 5 years he would have had to have worked 42.8 hours, not 40 hours.

By taxing interest as income the government has chosen to reduce the rate of return Worker B earns on his AFTER-TAX income from 6% to 4.5%. It encourages people to spend today rather than save for tomorrow.

[KrazyHorse]

But when completing your tax return you're supposed to add back the tax taken off interest and then take it back off at the end at the same rate, so it isn't taxed twice. You might need to reclaim any interest tax if you've paid it twice.

You completely misunderstand me. Taxing interest as income introduces a second tax wedge between workers who choose to save money and those who pay them, compared to the single tax wedge introduced between workers who choose to spend and those who pay them.

In the example above, Worker B pays an effective tax rate of 30% on his overtime earnings while worker A only pays 25%, simply because worker B chooses to save for tomorrow.

[duke o' york]

I sincerely hope not. You should only be taxed once on your income, no matter whence it comes, and in the UK the tax on interest on savings income is far less than that on normal income. If this isn't the case in the US then you can stay at mine until you find somewhere to live, and be taxed properly.

[Zkribbler]

By taxing interest as income the government has chosen to reduce the rate of return Worker B earns on his AFTER-TAX income from 6% to 4.5%. It encourages people to spend today rather than save for tomorrow.

One of my favorite Andy Capp cartoons is where he turns over and goes back to sleep on the couch rather than looking for a job after concluding that there's little difference between not having a job and having a job earning an income that the government won't let you keep.

[KrazyHorse]

You should only be taxed once on your income, no matter whence it comes, and in the UK the tax on interest on savings income is far less than that on normal income

If interest income is taxed AT ALL then there is a tax disadvantage to saving compared to spending.

What makes it worse is that in the US interest income is taxed as ordinary income, and this tax is applied every year (meaning that it is a compounding tax). Capital gains are less tax disadvantaged (the tax does not compound at all between purchase and sale of securities, and if an asset is held longer than a year it is taxed at a lower rate which IIRC is 15%).

In my example the compounding effect of the tax was not particularly important because the money was only saved for 5 years at 6% return. However, imagine somebody earns an extra 1000$ and has the choice between spending now and saving for 30 years in different vehicles. The following gives the total effective tax rate on that 1000$ assuming a 6% return over 30 years and a 25% marginal rate the whole way:

Spending now: 25%
Interest-bearing account: 51%
Stock bought and held for 30 years: 34%
Tax-advantaged retirement account (either Roth or normal): 25%

[KrazyHorse]

One of my favorite Andy Capp cartoons is where he turns over and goes back to sleep on the couch rather than looking for a job after concluding that there's little difference between not having a job and having a job earning an income that the government won't let you keep.

Yes, that's why I'm opposed to high marginal tax rates on people who choose to save.

[duke o' york]

In the UK, your interest income is taxed at the lowest rate (10%) until it goes above the limit of normal income tax for the lowest rate, at which point it goes above the usual rate for 10% tax. It is always taxed at the very lowest rate however, as does dividend tax, which is why company directors always choose to be paid in dividends up to the tax rate at which they'll have to pay the highest rate.

[KrazyHorse]

IIRC dividends in the US are also taxed as ordinary income. Thus if your earned income for a given year places you in the 25% bracket then any dividends will be taxed at 25% (until they push you into a higher bracket, that is).