Issues Surrounding ETRs

Last week, investment manager James Ross claimed he had a combined tax rate of 102%. However, the 102% was for Ross’ taxable income, which omits exclusions, deductions, and exemptions. In reality, Ross’ tax bill totaled just 20% of his adjusted gross income, which does not omit exclusions and deductions.

Ross also took advantage of many preferences which resulted in his taxable income only being a fifth of his adjusted gross income. In all, Ross likely paid less than 20% of his total income in taxes because even an adjusted gross income excludes tax-exempt interest on municipal bonds, retirement account contributions, and earnings on retirement accounts.

Much confusion surrounds effective tax rates (ETRs) because of the numerous ways to calculate ETRs. In other words, a taxpayer’s ETR will change depending on what taxes the taxpayer counts or the income measures the taxpayer uses. In an effort to help clarify the confusion surrounding ETRs, the Tax Policy Center recently released a table that demonstrates how an ETR is affected by the inclusion of more taxes or the use of alternative income measures.

For more information on ETRs, see Robert Williams, A 102% Tax Rate? Really?, Forbes, Feb. 8, 2012; Andrew Hodes, Issues With measuring Effective Tax Rates (ETRs), Wealth Strategies Journal 2.0 (Beta), Feb. 10, 2012.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.