As the Super Bowl weekend excitement fades and the Panthers have left California with a loss, at least one player takes a second hit. Since out-of-state athletes are levied with the ‘Jock Tax’, Cam Newton will pay $101,360 on his bonus of $51,000- effectively making his loss one championship ring and roughly $50,000. That’s a bad day.
The importance of understanding marginal tax rates and average tax rates plays into this seemingly odd mess for Cam Newton but also relates to the average taxpayer who travels for work and must comply with the heavy federal and state tax burdens. Let’s break it down.
Here’s an example from Dan Mitchell at the Cato Institute: Picture a taxpayer who earns $50,000 and pays $10,000 in tax. From this, we know the taxpayer’s average rate is 20%.
Consider these three simple scenarios with different marginal tax rates:
· Tax system A (Head tax)-$10,000 annual charge on all taxpayers. Under this system, our taxpayer gives the IRS $10,000 of his $50,000 income- making his average tax rate 20%. But what if he earns more than that? Any addition income over the first 10,000 will not be taxed. His marginal tax rate= 0%. In this scenario, the tax system does not discourage additional economic activity.
· Tax system B (Flat Tax)- flat rate of 20% on every dollar of income. Under this system, our taxpayer pays a 20% tax on every dollar of the $50,000 he made. Anything additional money made would still be taxed 20%. His marginal tax rate= 20%. In this scenario, the tax system imposes a modest penalty on additional money earned.
· Tax system C (Personal exemption)- $40,000 personal exemption + 100% tax rate on all income over that level. Under this system, our taxpayer pays $10,000 of tax on $50,000 of income- average tax rate= 20%. His marginal tax rate= 100%. In this scenario, the tax system would destroy incentives for any additional money earned.
Back to Newton:
The marginal tax rate matters when evaluating tax systems and its effects. In Newton’s case, the Golden State tax system taxes out-of-state athletes by how many days they spend there and their earnings in addition to their total yearly income. The state is taxing Cam’s entire annual income based on the number of days he has worked in the state (Duty Days).
Being a professional athlete, he must play by the ‘Jock Tax’ rules and is taxed based on his yearly income. To understand this tax, apply a duty day calculation.
Duty Days within the State X Player’s Salary
Total Duty Days of the Year
There are about 206 total duty days during 2016 for the Panthers, which includes preseason, regular season, playoffs, and organized team activities, (Newton must attend or is fined $500,000). Seven of those days will be in California for the Super Bowl- making those days liable for the burden of California’s out-of-state athlete tax in addition to taxation on his entire income.
So while Cam Newton may have an average tax of 13.3% on his earnings in California, after the Super Bowl loss, Newton ‘won’ $51,000 and his net gain was taxed $101,360 for a marginal tax rate of 198.8%!
While Newton is not your average employee, the real lesson to be learned here is that higher federal and state tax burdens can have a huge impact on employees in jobs that require travel. What about the athletic trainers that followed the Super Bowl to California? What about the referees that worked in the state for a number of days? It is important to understand the implications of an average tax versus a marginal tax as the latter determines the undue burden on the taxpayer.