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Monday Chart: Marginal Tax Rates on Wage Income for a Family of Five

2 min readBy: Nick Kasprak

Instead of a Monday Map this week, I’m going to post a chart that showcases a new tool we will be releasing very soon.

How many marginal 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. rates does a family with three children go through on its way from $0 to $200,000 in wage income? You might think the best way to find the answer is to look up the basic tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. structure for 2011 (column 2 from here is one place you might look.) Looking at this table, you’d see that a married return is taxed at 10% on the first $17,000 in income, 15% up to $69,000, 25% up to $139,350, and 28% up to $212,300, and so your answer would be “four marginal rates.”

If only the answer were that simple. The first thing to realize is that these rates apply to taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. , not total income. A family of five’s taxable income is significantly lower than its total income, because it gets a standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. of $11,600 as well as five personal exemptions worth a total of $18,500. It has no taxable income until its total income exceeds $30,100.

The story doesn’t end there. Our tax code is complex and full of various credits and deductions. Two of the biggest are the Child Tax CreditA 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. and the Earned Income Tax Credit. The primary beneficiaries of these tax credits are low to middle income families with children. They’re what’s known as a “refundable” credit (a confusing term, since it has nothing to do with a tax refundA tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. Overpaying taxes can be viewed as an interest-free loan to the government. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s. as most people understand the term, i.e. for over-withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. .) In this context, refundable means that if the value of the credit exceeds your tax liability, not only do you owe zero income tax, but the IRS actually writes you a check. In other words, your tax liability is negative.

The credit is similar in many ways to the negative income tax bracket concept developed by Milton Friedman. Formulating it as a tax credit, however, leads to some problems – as the family’s income rises above the targeted income level, the phase-out of the credit leads to some very high effective marginal tax rates, reducing its incentive to earn more money. Furthermore, there are three tax provisions that share the same basic goal of poverty reduction and tax relief for families with children – the Earned Income Tax Credit, the Child Tax Credit, and the personal exemption. The overlapping effects of these three separate provisions can create incredible tax complexity. Whether or not you agree that poverty reduction programs have a place in the income tax code, it’s easy to see that the current system is needlessly complex; the same thing could be more easily accomplished by a negative tax bracket for the first few thousand dollars of income.

The actual answer to the question posed earlier is 14 marginal rates. Here is a chart that shows how this works: