Ok, Folks In a Debate on Taxes – Think Effective Rate, Not Statutory Rate

Don’t you hate double talk?

Yeah, so do I.

Without taking a position on who has the best tax plan, the Dems or the Republicans, I want to point out that when we compare income tax rates, we have to look at effective tax rates, i.e. the rates that people actually pay, not statutory tax rates, which is the rate on taxable income based on tax regulations.

After deductions and tax credits, etc. a 35% statutory tax rate, might be reduced to a much lower, effective tax rate on actual “earned income” or “earned + investment income”.

For example, an individual that earns say $25 – $30 million of income might actually pay an “effective” tax rate of only 14%. It depends on the nature of the income received, earned income v. capital gains on investment income, and on the types of deductions and tax credits and other tax planning strategies used to reduce actual tax payments required.

In a recent blog post, the Economist magazine reported on a study conducted by KPMG, the business advisory firm, indicating that, in the United States, the effective tax rate on income for individuals in among the lowest of the 15 or so countries examined.  The rate includes income taxes and employee social security taxes (http://www.economist.com/blogs/graphicdetail/2012/10/focus-4).

Additionally, while it is true that the U.S. has the 2nd highest statutory corporate income tax rate among industrialized nations (@35%), trailing only Japan (@39%), the U.S. effective tax rate is lower and not significantly different from most other industrial economies (http://www.nytimes.com/2011/05/03/business/economy/03rates.html?_r=0).

And, as we know, many corporations are able to avoid paying corporate income taxes by taking advantage of legal “tax planning” strategies, similar to those employed by wealthy individuals.

Ultimately, my point is that the issue of income taxes, individual or corporate, cannot be reduced to simple sound bites.  It’s a complex issue that requires a complex explanation.

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About docjonz

I am an Associate Professor of accounting at Hofstra University in Hempstead, NY. Additionally, I have more than 30 years of professional accounting experience in various capacities including auditing, accounting standard setting and corporate accounting policy.
This entry was posted in Income taxes, Tax policy and tagged , . Bookmark the permalink.

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