I use this occasional feature to expose spoken or written “wisdom” that is technically correct, but is also misleading and potentially harmful to investors’ financial well-being. This issue’s likely is not harmful, but it illustrates the danger in looking at percentages without understanding a broader context.

As a simple example showing that the way a percentage is presented can give a misleading impression consider a case where 10% of something is “bad” in a given year, so 90% is “good.” The following year the percentages are 11% and 89%. Looking at the bad, there was a 10% increase (in the percentage or in the underlying number of instances). Looking at the good, there was 1.1% decrease. The change in the overall population was 1% in either direction. Is the change important? We can’t tell from this simplified example. Someone who wants to criticize or gain attention might well promote the 10% increase in bad. Someone else might point out that the change was not all that large.

In its September 10 issue, the Wall Street Journal published a letter illustrating how quirks in the federal income tax laws can result in some startling percentages increases in taxes owed. If a senior citizen was receiving $10,000 in Social Security benefits along with $20,000 of taxable other income, the Social Security portion would not be taxable, and the income tax on the adjusted gross income of $20,000 would be $936. Given the various provisions in the tax law, I can’t tell what assumptions are behind that amount or if they are correct. However, let’s accept the $936 as being correct.

The “unfair” (to the writer) part comes if the person takes a required minimum distribution (RMD) in the year of $14,000. If the recipient has just turned 70-1/2, that means the IRA, assumed to be fully tax deferred had a value of $383,600 at the end of the prior year. If the person was older, then RMDs had been taken for some number of years, and the remaining value would be less. If the IRA was not fully tax deferred, it would be larger, likely by a considerable amount.

The letter writer points out that the RMD increases income from $30,000 to $44,000. Because 85% of the Social Security becomes taxable at that level, the income tax due increases to $4,311, an increase of 361%. The letter writer uses terms such as “whopping” referring to the 85% and “punitive” about the tax code.

Now let’s take a look at the larger context. The increase in income is 37%. More importantly, the increase in taxes of $3,375 is a little over 24% of the RMD. That is not a terribly high marginal rate, the one the newspaper’s editorials think is the key to all things good economically, although some presidential candidates would feel oppressed by that rate. Note that the total tax is not quite 10% of the higher income. Hardly “punitive.”

Looking further at the example, the retiree has managed to have a substantial IRA without paying any income taxes on the savings. Is it so bad to have pay 24% of the withdrawals in federal income taxes?

I wrote a letter with the above points, but it was not published. There are some comments on the paper’s web site in response to the letter that make some similar points to mine and point out some other problems with the letter writer’s thinking. Those also have not appeared in the print edition. I am not surprised because its editorial policy thinks just about everything about our current tax system is bad except the provisions that would enable Romney to pay only at a 10% rate on millions of income had he not decided for political purposes to “donate” about half a million to the government.

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