Why an understanding of taxes is important

Dear James, Daniel and Emily

The News Media cannot be counted on to explain things to you. Nor can they be counted on to really examine what the often sweeping generalizations made by politicians mean. This election has been an excellent example, and I have learned just how ignorant even really smart people are about taxes. So here are some basics plus a broad simplified analysis of the impact the candidates policies will have.

First some basics:

1. On your tax form there is a number referred to as Adjusted Gross Income, or AGI. AGI is computed adding up all of your income.
2. Then you subtract personal exemptions (you, your spouse, kids).
3. Then you subtract your deductions (standard or itemized), arriving at taxable income. That's what your tax rate is based on.
4. Then you throw in additional taxes from capital gains etc.
5. Then subtract credits to find out tax liability,
6. Then subtract withholding, and refundable credits, that's how you get to what you owe or get refunded.

Your taxes, the amount you owe, is based on Taxable income (line 43 on form 1040). That's why it pays to have kids, and buy a house and itemize the hell out your taxes when possible. Because there are only 2 places you can reduce that number: personal exemptions (being married with kids) and itemizing your deductions. Understanding that is one of the few things people get right. It's why home ownership is so crucial, it totally changes your tax liability.

Now here is what all this really means:

For a married couple with 2 kids, filing with the standard deduction, in order to even reach taxable income, they have make more than 23,900$

Once you reach actual taxable income here's your table (income range, tax rate, and then what this family can make before they move to the next tax rate)

0-15,650 10% rate (which means up to 39550)
15651-63700 15% rate (which means up to 87600)
63701-128500 25% rate (which means up to 154400)
128501-195850 28% rate (which means up to 219750)
195851-349700 33% rate
349700 and above: 35% rate

Now all of this above assumes people who don't own a house, itemize business expenses, education and child care credits/expenses, state taxes etc. which honestly is pretty rare. So the actual income numbers that someone can have from regular income are actually somewhat higher than these numbers. Of course that is balanced by the capital gains taxes so for most people I would call that a wash.

The Median household income in this country is roughly 48,000$ (I don't have the exact number in my head). That means that for at least half of the people in this country they are in the 15% or 10% range.

Here's the best break down I can get from the 2 campaign sites as far as specifics on tax policy that would affect the majority of Americans:

Obama:
1. Another Tax free rebate for people below the median income level (I am guessing at the income level based on the rebate in the spring)

2. Create a tax credit of 500-1000$ that again the majority of Americans would be eligible for. This would eliminate taxes for a percentage of lower income people (for my hypothetical family of 4 that would mean they could make up to 10K more a year in taxable income without having to pay taxes on it)

3. Obama did say over the weekend that he would be willing to keep the top tax rate capped at 35% for now, until the economy improves. This is not policy per se, which is why it is not on his web site.

McCain:
1. On the web site there is nothing concrete beyond making the 35% rate the maximum rate.

2. McCain did mention in his speech last week, and on other cases that he wants to double the personal exemptions for dependents. Which would have a huge effect. However, in this article it is explained that this would result in a roughly 24 billion dollars loss in revenue. So I really don't think there is a chance in hell it passes, because I don't think he can realistically come up with more than 24 billion dollars worth of budget cuts.

Plus there is this report that shows the real effect of the Obama and McCain tax policies.

So the bottom line is this: know what people really mean when they talk about cutting or raising taxes, it makes it harder to be misled. Because it is easy to be misled, especially in a presidential campaign like this.