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In which John discusses popular tax deductions and who actually benefits from them. Sarah's Art Assignment video on Art and Taxes that inspired this one:

How to tax income is a huge part of our political discourse these days, but a lot of details get lost in ideological debates, so I thought I'd look at how deductions for mortgage interest and charitable contributions work, and whose mortgage interest and nonprofit donations are ACTUALLY deductible.

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Good morning Hank it's Tuesday, obligatory greeting from a hotel room. So last week Sarah made a brilliant art assignment video about how extremely wealthy people can sometimes use art collection as a strategy to avoid taxation. And it got me to thinking about how in general a lot of the US tax code seems to affect everyone, but in fact mostly matters only to rich people.

Okay so let's imagine four families with two parents and two kids. Family one makes $35,000 a year, family two makes the median US household income of $59,000 per year. Family three makes the average earned by the wealthiest 10% of US households $295,000. And family four makes the average earned by the wealthiest 1% of US households $1.2 million dollars.

So in the US we have these things called deductions, which allow you to deduct a certain amount from your taxable income. Like many business expenses are tax deductible, so if you make say a hundred dollars a year selling posters but they cost twenty dollars to print, your taxable income would be reduced to 80 dollars. But critically every taxpayer in the United States can take the so called standard deduction, which was created to simplify the tax code so that most people don't have to list their deductions, they can just take the standard one.

In 2018, the standard deduction for each of our hypothetical families will be $28,000 or $14,000 if you're single. So no matter what, each of our four families gets to take $28,000 off of their taxable income. Which also means that unless your other deductions exceed $28,000, you don't get a tax break from them. Example, most charitable contributions are deductible in the US, but if each of our families gave 8% of their income to charity, only the family in the 1%, who would donate $96,000, would see their taxable income go down as a result of charitable contributions alone. Because for the rest of them, their donations would be below $28,000.

Now, of course the rich family did give much more in dollar terms to charity. But they're also the only one of our four families to essentially receive a government subsidy in exchange for that donation. This deduction does incentivize charitable giving among rich people and without it charities would receive much less money, but I think it's worth remembering that every time you see someone's name in big letters at an art museum or a medical research facility, 35% of that money would have otherwise gone to the government. It would have gone to build roads and pay soldiers, and reduce the deficit? Probably not.

Side note, you might think these tax breaks would make rich people super generous, but no. Families making between $45,000 and $60,000 a year on average give between 3.5% and 4% of their income to charity. Those making between 1 and 5 million dollars a year give on average between 2.8% and 3.2%. 

Another popular tax deduction is for interest paid on your mortgage, which is supposed to incentivize people to buy homes. Although in practice it mostly incentivizes rich people to get mortgages.

To illustrate my point, lets imagine that each of our four hypothetical families, in addition to giving 8% of their income to charity, owns a home that costs 4 times their annual income. Assuming no other deductions our family making $35,000 a year gets no tax breaks for their mortgage or their charitable giving, because they're much better off with the standard deduction. As is our family making $59,000 a year. And our family in the top 10% also doesn't benefit much, their taxable income goes from $267,000 with the standard deduction, all the way down to $249,000 without it. That reduces their total federal tax bill by about $4,300, just over 1% of their income. Our family in the 1% meanwhile, would save over $40,000 on their tax bill, translating to over 3% of their total income. 

Now some families may have other deductions, especially around medical expenses, and I should note that home ownership and charitable giving are good things for governments to encourage. But I think it's worth remembering that these tax deductions mostly benefit wealthy people, and by far the greatest benefit, both in terms of absolute dollars and percentage of income, is reaped by the richest 1% of US households. 

If you want to learn more about taxes, specifically the shocking truth about art and taxes, I highly recommend Sarah's art assignment video on the topic. Hank, I will see you on Friday. *sneezes* oh, that's been coming. Yeah, I'll see you on Friday.