This month marks the 100th birthday of the federal income tax. Ratification of the 16th Amendment in February 1913 gave the government legal authority to tax the incomes of businesses and individuals. Nine months later Congress enacted the Revenue Act of 1913 and the income tax was born.
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Back then, if you were a single taxpayer, a 1% tax kicked in once your income exceeded $3,000 ($4,000 for married/joint). The tax rate gradually increased, hitting a maximum marginal rate of 7% on income above $500,000.
According to the Tax Foundation, if the same income brackets were in effect today (taking into account inflation), regardless of your filing status, your maximum income tax rate would be 1% until your income exceeded $463,826.(1)
Of course, thanks to the recently-enacted American Taxpayer Relief Act of 2012 (ATRA), income of this level means you will be taxed at the highest marginal rate of 39.6%.
Tax rates and income brackets are not the only things that have changed over the past 100 years. The Internal Revenue Code (IRC) has morphed and multiplied over the past 10 decades. In 1913, the entire code was 400 pages long. According to CCH, a leading provider of tax and accounting information and software, today's federal tax code has grown to nearly 74,000 pages!
As she has testified for years, in her annual report to Congress last month, National Taxpayer Advocate Nina Olsen listed the complexity of the tax code as the most serious tax problem Americans face. She has called the very act of having to fill out a tax return each year as creating a “significant, even unconscionable, burden.”
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A year ago, Olsen estimated that American taxpayers- including businesses- spend more than six billion hours a year complying with the tax code. That’s the equivalent of three million full-time workers. This includes keeping records, compiling information and filling out tax forms.
The increasing complexity of the Tax Code is one of the main reasons people cheat on their taxes. It’s also the reason we spend millions each year to get help filling out our returns. According to the most recent study by the IRS, the average taxpayer spent $258 on tax preparation, either by buying software or hiring a professional to complete their return. And that was back in 2007!
The following graphic, which is from the 2012 report by the Taxpayer Advocate, is a great summary of how costly and complex the Tax Code has become:
With passage of ATRA last month, the Tax Code underwent yet another revision. Much has been said about the fact that the tax increases this Act includes “only” affect those who meet Washington’s definition of “high-income.” There has also been ample analysis of how this could impact our already-fragile economy in light of the fact that those who fall into this category tend to be business owners and investors, i.e. those often associated with job creation. (3)
Instead, let’s make this personal. If you’re wondering how/if your tax bill is going to be higher this year, use this online calculator produced through a joint effort by the Urban Institute and Brookings Institution. Think of it as a fiscal dolorimeter, a device that the Oxford dictionary defines as “an instrument for measuring sensitivity to, or levels of, pain.”
You simply choose your filing status (Married/Joint, Single, Head of Household, etc.), choose the income level closest to yours and click on “calculate to see how you might fare. You can also change the values to reflect your own situation.
The biggest increase- except for those who are retired- is due to the increase in the payroll tax. For about the past two years, workers have been paying 4.2%; As of Jan. 1, the Social Security tax has reverted to its former level of 6.2%.(4) “Seventy-seven percent of taxpayers are working and therefor affected by the payroll tax,” says analyst Joe Rosenberg of the Tax Policy Center.
For instance, take a married couple with two children below the age of 13. When you click on “Select Income Level,” let’s assume their earnings put them in the category of “middle-income.” To compare what they paid in 2012 taxes to what they’ll pay this year, choose the third option in the drop-down menu: ”Select Tax Laws” - “2012 Law with AMT Patch vs. ATRA.” Then click on “Go.”
First, you will see the assumptions for income, capital gains, childcare expenses, etc. for this couple. (Again, you can customize them.) When you click “Calculate Tax” you see how this couple’s tax bill will go up almost $1,400 this year. The entire amount is due to the fact that the payroll tax reverts to 6.2%.
Most of the other ATRA-related tax increases affect what Rosenberg describes as “the high end” of the income scale. This includes the new top tax bracket of 39.6%, plus the phase-out of common tax deductions.
Take the married couple with one child in college. Let’s say their income is $413,759, which puts them in the category of very high income.” Their tax bill is going to be $5,416 higher this year. Since both husband and wife work, again, the increase in Social Security tax is the biggest factor, accounting for more than $4,700 of this. In addition, because of their income level, they no longer get the full benefit of their personal exemptions or itemized deductions.
At the risk of making what some might consider a strange suggestion, here goes: This tax season, pause to give thanks. Next year, things could be a lot worse.
1. The complete inflation-adjusted comparison can be found here
2. See this site
3. The non-partisan Tax Foundation has produced dozens of papers. You can access them here
4. Workers in Social Security-covered jobs once again pay 6.2% instead of 4.2%- the reduced rate that was in effect for two years. Employers also contribute 6.2%, for a total of 12.4%.