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A consumer's guide to taxes: how much do we really pay?

For most Americans, tallying all the various taxes to which we are subject is a hopeless--and depressing--task

MOST AMERICANS complain that taxes are taking a larger bite out of their incomes than ever before. During the month of April, tax-filing time, they complain most bitterly. Yet, do workers know how much they really pay in combined Federal, state, and local taxes each year?

In 1960, middle-income Americans paid less than 30% of their earnings in local, state, and Federal taxes; today, that figure is up to 40%. Moreover, many middle- and upper-income families living in the states that have the highest rates, such as New York and California, pay nearly half their incomes in taxes. High taxes reflect the growth of government, at all levels, in the U.S. since World War II.

The following is a new and easily understood method of measuring the impact of taxes on the finances of American workers. Calculating how much extra middle-income workers must earn to purchase various goods and services--a new car, computer, annual college tuition for their children, or a year's supply of gasoline--after taxes are taken into account is a good measure of their impact. The main reason people work is to earn money to buy the things they want, but much of American workers' income is consumed by taxes. The question is, how much? Let us take as a standard example the purchase of a new car with a sticker price of $10,000. Because of taxes, the average worker will pay significantly more than $10,000 to purchase that automobile.

In an average-tax state, a middle-income worker with earnings of $34,000 must pay $17,038 to purchase a $10,000 car--$10,000 to buy it and $7,038 for sales tax and the income and payroll taxes on the earnings used to pay for the vehicle. He or she must work three and one-half months to buy the car, then two and one-half additional months to pay the taxes on the income used to purchase it. For self-employed middle-income workers, the true cost of that auto is $18,320, because they are subject to a 14.1% self-employment tax, to cover the employee and employer shares of Social Security and Medicare (FICA), on their incomes.

In a high-tax state, such as California, the pre-tax cost of the automobile is $18,776 for a wage earner and $20,186 for a self-employed worker. In a low-tax state, such as New Hampshire, it runs $15,540 and $16.-708, respectively. In the five states with the highest taxes, wage earners have to lay out roughly $2,000 more to purchase a $10,000 car than they do in the five states with the lowest rates.

Taxes also affect the true price of a variety of other products and services. In an average-tax state, the amount of earnings needed to pay for a $1,500 computer is $2,556; a self-employed worker will need $2,748. To pay $8,000 tuition at a private college requires $13,107 and $14,092, respectively. The typical driver spends $479 a year on gasoline, excluding taxes. The income needed to purchase it, after accounting for all taxes, including the Federal and state gasoline levies, is $1,065. Self-employed workers must earn $1,145 to purchase the same amount of fuel.

As such examples demonstrate, taxes take a much larger chunk out of Americans' incomes than generally is realized--which leads to these rules of thumb on taxes: * In high-tax states, the true price of goods and services is roughly twice the retail price at the store. To figure how much income is needed to purchase an item, multiply its price by two. * The rule of two applies to self-employed workers in most states. Half of their earnings are consumed by taxes. * In low-tax states, the true price of goods and services, including all taxes, is one and one-half times the stated price. To figure how much income goes to purchase an item, multiply the price tag by 1.5.

Calculating the tax burden

The purpose of this article is to provide practical and understandable examples of how much middle-income workers actually pay in taxes for goods and services by showing how much extra a person must expend for major purchases. All of the following examples examine the taxes paid by a married couple with taxable income between $34,000 and $53,400.

There are four types of taxes that raise the "true" price of a product. Ignored are the impact of business taxes, which ultimately are borne by workers and the owners of capital, and the employer portion of FICA payroll taxes.

Income tax paid on the worker's earnings. On taxable income between $34,000 and $53,400 per year, a 28% marginal Federal tax rate is paid on all additional earnings.

Payroll tax. For most workers, this constitutes a 7.65% levy on earnings on top of the income tax. Self-employed workers must pay a self-employment tax that raises their effective payroll tax rate to 14.1%.

State income tax. Rates vary widely, from a low of zero in 10 states to a high of 12% in North Dakota.

State and local sales taxes also vary from state to state and even among localities within states. The highest combined state and local sales tax rate is 10% in Louisiana, but many states have no sales tax.

What is the amount a middle-income worker spends to purchase a car in a state where taxes are typical? In Michigan, he or she pays a 4.6% income tax on taxable income. For simplicity, the personal, standard, and itemized deductions, except the state income tax deduction, are ignored in all analyses. Michigan also imposes a four percent nondeductible sales tax on the retail purchase of most products.

When all income, payroll, and sales taxes are taken into account, how much money does the typical middle-income Michigan wage earner have to lay out for a $10,000 automobile? The sales tax adds $400 to the retail cost, raising the price to $10,400. To earn that amount in take-home pay, the worker will have to make $17,038 because the government will take $7,038 from his or her paycheck in payroll and state and Federal income taxes.

Self-employed workers are keenly aware that they have additional taxes taken directly out of their incomes because they pay a self-employment tax, which is equal to the employer and the employee shares of FICA payroll taxes. The 14.1% rate on earnings up to $53,400 means that they must pay $1,282 to purchase the same car, raising its true price to $18,320.

The above example shows the tax liability in a typical state, but others vary widely in the level and mixture of taxes they impose on their residents. The one with the highest, California, charges an 8.25% sales tax on most items and imposes a 9.3% marginal income tax rate on middle-income workers, whereas Alaska and New Hampshire have neither a state income tax nor a sales tax.

In California, a middle-income worker must spend an additional $8,776 to be able to purchase a $10,000 car. If self-employed, he or she must earn $20,186 to do so. That worker must pay more than double the sticker price of the car if all taxes are taken into account. In other words, in the high-tax states, self-employed workers spend more of their income to pay the taxes on the auto than on the car itself. That Californian must pay $3,000 more to purchase the car than someone living in New Hampshire or Alaska.

There is evidence that people try to avoid working and purchasing goods and services in high-tax states. For instance, to avoid high income taxes, businesses and individuals tend to move from high-tax to low-tax states. That was clearly the case in the 1980s, when low-income-tax states saw business and population growth, while high-income-tax ones experienced little or none. Moreover, to avoid high sales taxes, many consumers shop for major items in low-sales-tax states. Portland, Ore., with no sales tax, has twice the annual retail sales of Seattle, Wash., which has an eight percent sales tax. This is despite the fact that Portland has a much smaller population.

Taxes raise the true cost of all goods and services, not just cars. The retail price of a new IBM personal computer is roughly $1,500. What is needed to purchase that computer after taking into account all taxes is $2,556 for a wage earner and $2,748 for a self-employed worker in Michigan.

Many parents, who spend years sacrificing and saving money to help finance their children's college tuition, are paying much more than they may suspect. Although there is no sales tax on college tuition, they must pay income and payroll taxes on the money they use to send their child to college. To cover the $8,000 tuition, Michigan parents must earn $13,107 if they are wage earners and $14,092 if they are self-employed.

A typical car owners uses 504 gallons of gasoline a year, according to the Federal Highway Administration. The pre-tax price of that gasoline (premium unleaded) is $479. Yet, gas is different from most other products in that it is subject to special Federal and state excise taxes in addition to normal sales taxes. The per gallon pump price includes those taxes. In a typical state, the combined state and Federal gasoline tax is roughly 34 cents a gallon. The income needed to purchase the year's supply of gasoline, after all taxes are accounted for, is $1,065. Self-employed workers must earn $1,145 to purchase the same amount of gas.

There are several easy-to-remember rules of thumb for determining how taxes affect your financial condition and consumer behavior. The rule of two on taxes also applies to most self-employed workers. To pay all taxes, those in business for themselves must earn twice the retail price of goods and services. Half the income self-employed workers earn pays for the goods and services they purchase, and half goes for Federal, state, and local taxes. That means their marginal tax rate is more than 50%.

In low-tax states, the true price of goods and services is approximately one and one-half times the list cost, thus constituting a marginal tax rate of 33%.

There is an old saying that describes the feelings of workers in difficult economic times: My take-home pay won't take me home. One reason for the squeeze on workers is the rising tax burden at all levels of government. Since 1990, the Federal government has enacted a five-year $200,-000,000,000 tax increase and the states have added $40,000,000,000 in new taxes to the total. After a brief respite in the early 1980s, taxes are climbing again. By one calculation, Americans work from January to the end of the first week in May just to pay their tab to the government.

For most, tallying all the various taxes that they pay to all levels of government is a hopeless task. Americans pay excise, sales, income, and payroll taxes. In many states, middle-income workers are devoting over half their income not to the goods and services they want, but to the government tax collector.

The authors are, respectively, a member of the Board of Advisors, Mackinac Center, Midland, Mich., and director of fiscal policy studies, Cato Institute, Washington, D.C.
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Author:Nastas, George; Moore, Stephen
Publication:USA Today (Magazine)
Date:May 1, 1993
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