Monday, October 20, 2008

Joe the Plumber -- the economics

A correspondent has asked me a question about the assumptions underlying the whole Joe the Plumber discussion in the last debate between Barack Obama and John McCain: how much must a company take in before the owner takes home $250,000?

Keep in mind that companies, unlike individuals, are taxed on profits, not on income (unless it's capital gains from investments). From everything a company receives as revenue for the goods or services it sells, one must first subtract the legitimate business expenses (materials, labor, overhead, etc.) that for the purposes of the tax code are deductions.

What's left is profit. Since Obama said he is exempting businesses with taxable income (profit) of $250,000, that means, assuming a low profit margin of 10%, that the company had to have revenue of $2.5 million. That profit can be plowed back into the company, after it is taxed, or distributed before taxes as a dividend to the owner(s), then taxed as the owner's income.

But wait! The owner can still have made $250,000 from the business with a smaller revenue.

Say Joe's business makes $1.25 million, or half of what we just said. If 10% was profit, that would be $125,000 the company could pay him as a dividend, assuming he's the sole owner. Joe could, in addition, have paid himself $125,000 in salary throughout the year.

This is not typical for a plumbing business of that size and I understand that the real Joe makes about $40,000 a year.

Moreover, at that level, the business would not pay additional taxes, according to what Sen. Obama said, because the profits were not $250,000. If Joe took $124,000, he would still be below the $250,000 at which his personal taxes will not be raised.

Last thing. The real median household income in the United States was $50,233 in 2007, the last year for which data are available. This means that half the households made more and half made less.

Want to know what percentage of households earned $250,000? About 5%.

The great myth that John McCain is selling is that Obama raises your taxes. If you are like 95% of all Americans, including me, that's just not true.

Sure, Obama will raise taxes on 7-home households like those of John McCain and his buddies. People at that level will not go hungry.
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