70 to 80% Effective Marginal Tax Rates are Possible, and Not For the Rich

October 8, 2009

Mark Robyn

Mark Robyn

James Capretta, contributing editor at The New Atlantis, commented this week on what he sees as a lack of understanding on the real effects of the health care proposals. He calculates the effective marginal tax rate (EMTR) under the Baucus plan for workers making between 100 and 200 percent of the federal poverty level.

An EMTR calculation takes account not only for the statutory tax rates but also the implicit tax rates that are a result of the many tax benefits and social welfare benefits that phase out with rising income. Essentially, the EMTR is the tax rate that earners pay on their last dollar of income earned. Effective marginal tax rates are important because they affect an earner’s incentive to earn more.

By Capretta’s calculation, accounting for the personal income tax, payroll taxes, the phase-out of the earned income tax credit, and the phase-out of the health insurance entitlement provided in the Baucus plan, “the effective, implicit tax rate for workers between 100 and 200 percent of the federal poverty line would quickly approach 70 percent – not even counting food stamps and housing vouchers.”

Greg Mankiw comments that the situation may be even worse than that:

Indeed, Jim seems to understate matters, as he includes only the employee half of the payroll tax. Including both the employee and employer halves, as economic theory says is appropriate, appears to give a marginal tax rate closer to 80 percent. And, of course, many states impose income and sales taxes as well, and these would further raise the overall marginal tax rate.

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A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.

A sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding.

A payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue.

The marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax.

A tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.