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25 January 2011

Comments

Todd Juvinall

I have always wondered how it is the progressive tax, where you are taxed more for making more, and so beloved by the "progressives" ends up causing the top 5% of people paying 40% of the tax load and the "progressives" still complain. I would think their goals were met.

George Rebane

With a marginal income tax rate of 40% and a 10% sales tax, the earner will pay an effective tax of (0.4+0.1)/(1-0.4) or over 83% tax for everything he buys. And we wonder why these people are trying to do everything they can to get out from under such a tax burden?!

Todd Juvinall

That is why Walmart is so huge. Save a buck.

Wayne Hullett

Sales tax paid is a deductible item on your income tax return. By how much does that change your result if you include the tax savings due to the deduction?

George Rebane

Good point Dr Hullett. Not all taxpayers can and/or do deduct sales tax from their income taxes - e.g. the 'rich' when buying big things like cars and boats. And with the current fiscal state of the states and the country overall, I think such remaining deductions will soon disappear. However, we can provide for sales tax deductions in the formula by appropriately adjusting (reducing) the aggregate income tax rate TI to compute the overall tax burden.

In the case where you do get the full amount of sales tax, P*TS, refunded, the formula for earnings then becomes E*(1-TI) + P*TS = P*(1+TS), and yields the amount earned to price ratio of E/P = 1/(1-TI). Subtracting one from both sides gives the total tax burden on the purchase as E/P – 1 = TI/(1-TI), or the same as if we would have entered TS = 0 into the original formula I gave in the post. This is what we would have expected. Again using our numerical example, the total tax burden in this case would then be 0.2/(1-0.2) = 0.25 = 25%, instead of the previous 37.5% with the non-deductible sales tax. We note that we still have to earn 25% more than we pay for the purchase, which is 5% more than the income tax rate TI = 20% that we pay on our earnings. Tricky business.

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