Fact-checking Romney-Ryan: Does the math add up?

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Tax Stats

In my recent column “Lower Taxes, Fewer Deductions: Are Romney and Ryan Dodging the Specifics?” I wrote:

Does the math add up? We have a great deal of tax data. Imagine you are the average taxpayer with an AGI between $1 and $1.5 million. Your AGI is $1.2 million. You have $170,000 in itemized deductions for a taxable income of $1.03 million. Taxed at the 2012 rates, you pay an effective tax rate of 32%, or about $329,640. But you have a marginal tax rate of 35%.

Now imagine we eliminate all of your deductions but reduce your top rate down to 28%. Your taxable income would now be the full $1.2 million. Your tax owed would be almost an identical $336,000. But your marginal tax rate would be reduced 20% from 35% down to 28%. (I’m assuming a 25% rate for the amount under $217,450 and a 28% rate above that.)

The math works simply by eliminating only below-the-line deductions to AGI. Those in the lower tax brackets could keep many of these deductions and still have their marginal tax rates reduced by 20%.

This data comes from the IRS statistics of all tax returns from the latest 2009 tax year. I used the statistics for returns with an adjusted gross income (AGI) between $1,000,000 and $1,500,000. And I rounded off the numbers for an example in the column. Here are the specifics from the data for All Returns: Adjusted Gross Income, Exemptions, Deductions, and Tax Items for 2009. The data for returns in the AGI range $1,000,000 to $1,500,000 was:

(a) Total Number of returns: 108,096

(b) Total Adjusted gross income less deficit: $130,149,237,000

(c) Average AGI of $1,204,015 (b/a)

(d) Total Number of returns with itemized deductions: 104,559

(e) Total Amount of itemized deductions: $18,101,201,000

(f) Average Itemized deductions: $173,111 (e/d)

(g) Total number of returns with taxable income: 107,527

(h) Total Amount of Taxable Income: $111,652,589,000

(i) Average Amount of Taxable Income: $1,038,368 (h/g)

Using the 2012 Tax Tables, federal income tax on $1,038,368 of Taxable Income would be $105,062 + 35% of the amount over $388,350 or $332,568 in tax owed.

Now imagine that all deductions are denied and we use just two rates: 25% and 28% for anything exceeding $217,450. Using this 20% lower top marginal tax rate, federal income tax on $1,204,015 would be $54,362 + 28% of the amount over $217,450 or $330,600 in tax owed.

Hence at least for this bracket, Romney and Ryan are correct: Flatting and reducing the top rates by 20% and eliminating deductions collects the same amount of tax. Hence the conclusion of the math:

But why bother if the effective tax rate is the same? The answer is that decisions are not made at the effective tax rate. All decisions are made at the margin. Currently another dollar earned by small business owners is earned at a marginal rate of 35% federal tax and a much higher total rate.

The math adds up using just below the line deductions for those in the top tax brackets. Those in the lower tax brackets could keep many of these deductions and still have their marginal tax rates reduced by 20%. And additional revenue could be substituted by using above the line deductions or tax credits.

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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. Favorite number: e (2.7182818…)