The rich are frequently criticized for not contributing their fair portion of taxes. However, when examining income taxes, it becomes evident that the wealthy actually contribute more than their fair share.
Here’s a chart displaying the proportion of income taxes paid by different income groups from 2001 to 2021. In 2001, the top 1% (considered wealthy) contributed approximately 33% of all income taxes. By 2021, this group contributed around 46% of all income taxes!
You might wonder, “Isn’t it natural for the wealthy to contribute a significant portion of income taxes? After all, they earn the highest incomes!” However, when we discuss fairness, true equity would entail the wealthy paying the same proportion of all income taxes as the proportion of all income they earn.
The Rich Shouldn’t Be Vilified For Their Portion Of Income Taxes
In 2021, the top 1% of income earners in America accounted for “only” 26% of the country’s total income, yet they shouldered 46% of the total tax burden. This indicates that the wealthy paid 15% more than what would be considered their equitable share.
Consequently, perhaps we should reassess our tendency to vilify the rich specifically concerning income taxes. On average, their tax rate stood at 24%.
We operate under a progressive income tax system, where the marginal federal income tax rate increases with income levels. Here’s a quick overview of the 2024 income tax brackets to refresh your memory: The lowest federal marginal income tax bracket starts at 10% and gradually rises to 37%. Additionally, there are state income taxes for residents of states that impose such taxes.
Likely Under A Lot Of Stress If You Earn A Top 1% Income
If you find yourself in the top federal marginal income tax bracket, chances are you’re dedicating a considerable amount of time and effort to your work and are likely under a significant amount of stress.
I’ve encountered numerous households earning between $500,000 and $1 million dollars in W2 income. These individuals include doctors, bankers, lawyers, small business owners, executives, and entrepreneurs, many of whom work 50-80 hours per week, leaving little time for leisure.
While their high income serves as a reward for their hard work, they often find themselves heavily taxed for their efforts. After working 12-hour-days for 20 consecutive days, you might not be pleased with forking over more to the government than you get to keep!
During my years working in investment banking, I was among those individuals. Despite the substantial income, I found myself facing chronic stress and experiencing physical discomfort, including back, leg, and jaw pain, which ultimately affected my overall happiness.
What About The Bottom 50% Of Income Earners And Their Taxes?
The bottom 50% of income earners collectively earned just 10% of the total income in 2021, yet they only contributed 2% of the total income taxes, with an average tax rate of 3%. That’s quite a favorable ratio!
Ultimately, I made the decision to leave my finance job and join the bottom 50% income for the sake of my health and happiness. Initially, the drastic reduction in income, approximately 85% less during the first 12 months, was a significant adjustment. However, thanks to hedonic adaptation, I gradually became accustomed to the change.
Moreover, after experiencing relief from chronic physical pain within six months, I realized that sacrificing the higher income was well worth it. The health benefits of early retirement were priceless.
Looking back, I found being a bottom 50% income earner to be enjoyable. Not only did I pay a reasonable amount of income taxes, but I also gained a newfound sense of freedom.
Instead of rushing to catch a flight on Sunday afternoon for a brief client meeting in Denver, I could leisurely spend my time lounging in Golden Gate Park, indulging in a good book.
The Ideal Federal Marginal Income Tax Rate: 24%
As time passed and with the help of a bull market, I gradually accumulated more passive income and online earnings. Through this process, I found that the optimal federal marginal income tax rate to pay was around 24%.
At a 24% tax rate, you’re contributing a substantial amount to the country’s development without feeling excessively burdened. Simultaneously, you’re earning enough to sustain a comfortable lifestyle.
For the tax year 2024, individuals within the income range of $100,526 to $191,950, and married couples earning between $201,051 and $383,900, fall into the 24% marginal income tax bracket. These income thresholds are typically adjusted annually to accommodate inflation.
Maintaining an upper-middle-class lifestyle with an income of $300,000 per year is quite enjoyable. Moreover, it allows you to steer clear of the 8% jump in federal marginal income tax that comes with entering the next tax bracket of 32%.
Wealth Is What You Want To Minimize Income Taxes
It may not be readily apparent, but the top 0.1%, the truly affluent, don’t amass their wealth primarily through income. Instead, they accrue their fortunes from owning equity in businesses, including their own.
As long as they refrain from selling any assets, they can avoid paying capital gains taxes. To access their wealth, the ultra-rich often borrow from their assets to finance their lifestyles.
As of 2024, the estate tax threshold stands at $13,610,000 per person, or $27,220,000 per married couple. Essentially, this means that an individual or a married couple can pass on this amount of wealth without incurring an estate tax, typically set at 40%.
Various strategies exist to manage estate taxes at these thresholds, such as a GRAT, dynasty trusts, and other methods. However, the most straightforward approach to avoid estate taxes upon death is to gradually spend down your wealth or gift as much of it away while you’re still alive.
Get Busy Building Passive Income To Replace Active Income
If you amass sufficient wealth, your distributions and asset sales will be subject to lower capital gains tax rates if held for more than a year. Your qualified stock dividend income will likely be taxed at a lower rate as well.This serves as another incentive to strive for wealth accumulation.
The most significant contrast lies between the W2 federal marginal income tax rate and the long-term capital gains tax rate, which stand at 32% and 15%, respectively. Ideally, you accumulate enough capital to substitute for an income in the 32% bracket, enabling you to earn passive investment income and incur only a 15% tax rate.
This is what I’m shooting for after blowing up my passive income in October 2023 after buying a new home. I suspect I will need three-to-five years to recuperate my $150,000 passive income decline.
About Half The Working Population Doesn’t Pay Income Taxes
We often point fingers at the rich for various societal issues, but what about the approximately 47% of working Americans who pay zero income taxes? While they do contribute through sales taxes, FICA taxes, and other levies, so do those who pay income taxes.
It’s worth considering how much stronger our nation could be if those who currently don’t pay income taxes contributed even a modest amount, like $500 a year. If so, more people would care about our country as everybody would have skin in the game.
With approximately 167 million employed Americans today, if just 78 million of those who don’t pay income taxes contributed $500 each annually, it would generate $39 billion. Doubling that to $1,000 per person would yield $78 billion, which could be allocated to addressing homelessness, providing jobs for unemployed veterans, and other critical needs.
While the rich already shoulder a significant portion of income taxes, they also face hefty estate taxes upon their passing. Instead of fixating on the wealthy, perhaps we should focus on ways to increase our own tax-efficient income and build wealth.
Reader Questions
Do you think the rich pay their fair share? If not, how much more should they pay? How much of your income are you paying in taxes? Do you think you’re paying your fair share? Should we try to increase the breadth of income tax payers in our country?
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