President Obama recently gave a lengthy speech on inequality, poverty, and what to do about it. He claimed inequality is increasing, which is debatable, and then offered a few populist ways to reduce it, such as raising...
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- Low and Moderate Income Taxpayers Face High Marginal Tax Rates Too
Low and Moderate Income Taxpayers Face High Marginal Tax Rates Too
Yesterday, the CBO released an interesting graphic showing the share of income earners below 450 percent of the federal poverty line. (Incomes up to $87,885 for a family of three).
From a sample of tax returns, they found that nearly 40 percent of those making 450 percent of the FPL and lower face a 30 to 39 percent marginal tax rate.
They also find that a good number of taxpayers face marginal tax rates that are even higher. More than 10 percent face a marginal tax rate between 40 and 49 percent. Some even face rates higher than 80 percent.
The marginal tax rate is the combined explicit and implicit percent reduction in the next dollar of income upon reaching a higher income tax bracket at both the state and federal level and losing benefits from SNAP (Food Stamps).
Suppose you make $99 and receive $1 dollar in food stamp benefits (total income of $100). You then earn an additional dollar. However, when you do so, you reach the first tax bracket (10 percent) and lose $.10 of Food Stamp benefits. The result is that instead of having $101 dollars, you have $100.80. Your marginal tax rate is then 20 percent ($0.20 off the original $1.00).
This is a great illustration of how our poorly designed progressive income tax code and federal benefit structure discourages work. When an individual works hard to earn more money and improve their lot in life, the penalty for their work increases. It makes work less valuable for them and makes them less likely to increase their hours or pay. Why take that raise if you are going to lose hundreds in benefits and be taxed at a higher rate?
While proponents of progressive taxation laud it as a way to make the rich pay their fair share, they often ignore the downside of such a tax code: low and moderate income people—the people we want to help the most—are actively discouraged from work.
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