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Response to Sarah Ibarruri (Original post)

Sun Mar 23, 2014, 02:16 PM

118. Tax Deductions aren't what you think

 

Most tax deductions don't do what most think they do. Keep in mind that our tax system is such a convoluted mess that it defies any real analysis.

Tax deductions only benefit people who pay taxes. While this is obvious, what's not so obvious to some is that lower income people don't pay a lot in taxes to begin with. The progressive tax rates coupled with the deductions that everyone gets means that taxes really don't kick in until about $40,000 to $50,000.

But tax deductions themselves aren't as great as they seem, since many of them are phased out for incomes over $100,000 or so. That means as a rough ballpark, deductions mean the most for people in that sweet spot, tax wise, of 50k to 100k.

After 100k, due to the phase out of deductions and higher tax rates, the amount of taxes climbs fast; actual tax rates are a combination of higher taxes and lost deductions.

All this being said, I agree with the OP and many in this thread that deductions are counter productive. Many exist to encourage specific behavior, but that comes at a cost of taxing others more who don't engage in that behavior. Case in point, the mortgage deduction. Renters are often people who can't afford a mortgage, why should they pay more taxes than people who can afford to buy? That's the cost of a deduction designed to help out homeowners.

There was a little discussion on business related deductions. Those are a no brainer. If you sell widgets for 100 dollars each, you have to deduct the cost of each widget. If for example widgets cost 80 dollars each, you should only be taxed on the net profit of 20 bucks each. And from that net profit, you have to deduct overhead. If your store of Widgets-R-US costs 50k a year in rent, that's a cost of business and you shouldn't be taxed on it. Likewise, if you pay an employee 50k a year, that is also a cost of doing business (which costs the business maybe 60k or more due to employer related taxes and costs) so that too is a business deduction.

The real gray area of business deductions are those that are a mix of business and personal. If Mr. Big, who owns the Widget company takes a pleasure cruise for the purpose of wining and dining business prospects and lands a 10 million dollar widget contract with Ms. GoGetter, owner of Wonka Widgets, should Mr. Big and Ms. GoGetter be allowed to deduct the cost of the cruise from their respective businesses.

On one hand, there's a good reason to argue yes, since now there's that much more work for Widget workers and possibly more jobs. The result of this business meeting is more work.

On the other hand, there's a good reason to argue no, since both Mr. Big and Ms. GoGetter are smart. They both know that if they plan their family cruise as a business trip, they can make their family vacation a business expense and save on taxes.


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