Recently, Congressman Dave Camp (R-MI), the chairman of the House Ways and Means CommitteeThe Committee on Ways and Means, more commonly referred to as the House Ways and Means Committee, is one of 29 U.S. House of Representative committees and is the chief tax-writing committee in the U.S. The House Ways and Means Committee has jurisdiction over all bills relating to taxes and other revenue generation, as well as spending programs like Social Security, Medicare, and unemployment insurance, among others. , released the details of his taxA 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. reform proposal.
One of the claims is that the proposal slightly lowers the top marginal tax rateThe 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. on dividend and capital gains income. From the discussion draft (page 3):
“The modified tax preference for long-term capital gains and dividends would result in such income being taxed at 60 percent of the taxpayer’s marginal rate. Thus, for example, taxpayers in the 35-percent bracket would pay an effective rate of 21 percent on adjusted net capital gain. Combining this with the additional 3.8 percent tax imposed on such income by Code section 1411 yields a top effective rate of 24.8 percent, slightly lower than the top effective rate under current law, which is 25 percent.”
This isn’t exactly right. If you take into account all the phase-outs of deductions and benefits in the Camp plan, marginal tax rates on capital gains and dividends are higher than current law at certain income levels. In addition, if you account for state tax rates with the elimination of the state and local tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. , rates are higher at all income levels over $250,000 under the proposal compared to current law in states with state and local income taxes. Taxpayers facing the top marginal tax rate in states without taxes on dividends or capital gains are the only taxpayers facing lower rates compared to current law.
Phase-outs Create Hidden Marginal Tax Rates and Bubbles
The big reason why rates go up for many taxpayers at certain levels of income is the sequential phase-out of three major tax provisions that occur at $250,000 of MAGI ($300,000 for married taxpayers). Modified adjusted gross incomeFor individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.” in Camp’s proposal is a separate, broader definition of income than Adjusted Gross Income. More on that here and here.
The income levels at which these phase-outs begin and end can vary, but each phase-out adds an additional 3 percentage points to the top marginal rate on capital gains and dividend income. This creates a “bubble” at which top marginal tax rates spike before declining at higher levels of income. The table shows that the top marginal capital gains and dividend tax rate for a married family with two children is 18.8 percent at $250,000 of MAGI. It climbs to 27.8 percent between $450,000 and $600,000 of MAGI. It then declines to 24.8 percent on investment income after $683,600.
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Comparison of Top Marginal Capital Gains and Dividend Tax Rates, Current Law and Camp Proposal |
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Marginal Tax Rate |
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Modified Adjusted Gross Income Levels (AGI for Current Law) |
Current Law |
Camp Proposal |
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$250,000 – $299,999 |
25.0% |
18.8% |
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$300,000 – $449,999 |
25.0% |
21.8% |
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$450,000 – $683,599 |
25.0% |
27.8% |
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>$683,600 |
25.0% |
24.8% |
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Note: a married taxpayer with two children. |
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With No State and Local Tax Deduction, Combined State and Federal Marginal Rates are Higher In Most States Under Camp's Plan
There is another complicating factor in Camp’s bill that makes tax rates on capital gains and dividend income higher. One deduction that was eliminated in Camp’s bill was the state and local income tax deduction. This deduction allows individuals to deduct the taxes they pay to state and local governments from their federal adjusted gross income. Whether one believes this deduction is good policy or not, the deduction lowers a taxpayer’s marginal tax rate when accounting for state and local taxes.
When you combine the new federal tax rate on capital gains and dividends with state and local taxes, taxpayers in some states would need to pay an effective marginal tax rate of over 38 percent on capital gains and dividends. The U.S. average top marginal capital gains taxA capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. These taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment. rate faced by taxpayers is 30.9 percent, 30.8 percent for dividends. Both of these rates are 2.2 percentage points higher than current law.
Some of the highest rates would be in states where the state and local tax burdens are high and the state and local deduction had the most effect. The highest rates are California (38.1 percent), New York (35.5 percent), Oregon (34.7 percent) and Minnesota (34.7 percent).
Taxpayers in the nine states with no tax on capital gains tax would actually see lower rates than under current law. (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming) all have a rate of 24.8 percent.
It is also worth noting that these top marginal rates would apply after all phase-outs in the federal tax code occur. Marginal rates could be higher for some taxpayers.
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Top Marginal Tax Rate on Capital Gains, by U.S. States, Under Current Law and the Camp Proposal |
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State |
State Rate |
Current Law |
Camp Proposal |
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Combined Capital Gains Rate |
Combined Dividends Rate |
Combined Capital Gains Rate |
Combined Dividends Tax Rates |
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Alabama* |
5.0% |
27.4% |
27.4% |
28.6% |
28.6% |
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|
Alaska |
0.0% |
25.0% |
25.0% |
24.8% |
24.8% |
|
|
Arizona |
4.5% |
27.7% |
27.7% |
29.3% |
29.3% |
|
|
Arkansas* |
7.0% |
27.9% |
29.2% |
29.7% |
31.8% |
|
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California |
13.3% |
33.0% |
33.0% |
38.1% |
38.1% |
|
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Colorado |
4.6% |
27.8% |
27.8% |
29.4% |
29.4% |
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Connecticut |
6.7% |
29.0% |
29.0% |
31.5% |
31.5% |
|
|
Delaware |
6.6% |
29.0% |
29.0% |
31.4% |
31.4% |
|
|
Florida |
0.0% |
25.0% |
25.0% |
24.8% |
24.8% |
|
|
Georgia |
6.0% |
28.6% |
28.6% |
30.8% |
30.8% |
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Hawaii* |
7.3% |
29.4% |
31.6% |
32.1% |
35.8% |
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Idaho |
7.4% |
29.4% |
29.4% |
32.2% |
32.2% |
|
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Illinois |
5.0% |
28.0% |
28.0% |
29.8% |
29.8% |
|
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Indiana* |
3.4% |
27.8% |
27.8% |
29.5% |
29.5% |
|
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Iowa* |
9.0% |
29.6% |
29.6% |
31.8% |
31.8% |
|
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Kansas |
4.8% |
27.9% |
27.9% |
29.6% |
29.6% |
|
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Kentucky |
6.0% |
28.6% |
28.6% |
30.8% |
30.8% |
|
|
Louisiana* |
6.0% |
27.9% |
27.9% |
29.3% |
29.3% |
|
|
Maine |
8.0% |
29.8% |
29.8% |
32.8% |
32.8% |
|
|
Maryland* |
5.8% |
30.3% |
30.3% |
33.6% |
33.6% |
|
|
Massachusetts |
5.2% |
28.1% |
28.1% |
30.0% |
30.0% |
|
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Michigan* |
4.4% |
27.8% |
27.8% |
29.5% |
29.5% |
|
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Minnesota |
9.9% |
30.9% |
30.9% |
34.7% |
34.7% |
|
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Mississippi |
5.0% |
28.0% |
28.0% |
29.8% |
29.8% |
|
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Missouri |
6.0% |
28.6% |
28.6% |
30.8% |
30.8% |
|
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Montana* |
6.9% |
27.9% |
29.1% |
29.7% |
31.7% |
|
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Nebraska |
6.8% |
29.1% |
29.1% |
31.6% |
31.6% |
|
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Nevada |
0.0% |
25.0% |
25.0% |
24.8% |
24.8% |
|
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New Hampshire |
0.0% |
25.0% |
28.0% |
24.8% |
22.6% |
|
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New Jersey |
9.0% |
30.4% |
30.4% |
33.8% |
33.8% |
|
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New Mexico* |
4.9% |
26.5% |
27.9% |
27.3% |
29.7% |
|
|
New York* |
8.8% |
31.5% |
31.5% |
35.5% |
35.5% |
|
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North Carolina |
5.8% |
28.5% |
28.5% |
30.6% |
30.6% |
|
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North Dakota* |
3.2% |
26.3% |
26.3% |
27.1% |
27.1% |
|
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Ohio* |
5.4% |
28.3% |
28.3% |
30.3% |
30.3% |
|
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Oklahoma |
5.3% |
28.2% |
28.2% |
30.1% |
30.1% |
|
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Oregon |
9.9% |
31.0% |
31.0% |
34.7% |
34.7% |
|
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Pennsylvania |
3.1% |
26.8% |
26.8% |
27.9% |
27.9% |
|
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Rhode Island |
6.0% |
28.6% |
28.6% |
30.8% |
30.8% |
|
|
South Carolina* |
7.0% |
27.3% |
29.2% |
28.7% |
31.8% |
|
|
South Dakota |
0.0% |
25.0% |
25.0% |
24.8% |
24.8% |
|
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Tennessee |
0.0% |
25.0% |
28.6% |
24.8% |
30.8% |
|
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Texas |
0.0% |
25.0% |
25.0% |
24.8% |
24.8% |
|
|
Utah |
5.0% |
28.0% |
28.0% |
29.8% |
29.8% |
|
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Vermont |
9.0% |
30.4% |
30.4% |
33.8% |
33.8% |
|
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Virginia |
5.8% |
28.5% |
28.5% |
30.6% |
30.6% |
|
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Washington |
0.0% |
25.0% |
25.0% |
24.8% |
24.8% |
|
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West Virginia |
6.5% |
28.9% |
28.9% |
31.3% |
31.3% |
|
|
Wisconsin* |
7.7% |
28.2% |
29.6% |
30.2% |
32.5% |
|
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Wyoming |
0.0% |
25.0% |
25.0% |
24.8% |
24.8% |
|
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D.C. |
9.0% |
30.4% |
30.4% |
33.8% |
33.8% |
|
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U.S. Average |
N/A |
28.7% |
28.6% |
30.9% |
30.8% |
|
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Source: Tax Foundation, Commerce Clearing House, Tax Reform Act of 2014, and Author's Calculations |
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* States either allow a taxpayer to deduct their federal taxes from your state taxable income, have local income taxes, or have special tax treatment of capital gains income |
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