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Obamacare Puts Infinite Marginal Tax Rates in Action

By: Alan Cole

This piece by Kathleen Pender of the San Francisco Chronicle has drawn a lot of attention for its clear demonstration of the perverse incentives Obamacare brings to the table. Pender’s offhand advice, that “you can also consider reducing your 2014 income by working just a bit less,” speaks to the fears some have about Obamacare. Unfortunately, those fears are completely justified.

Everyone is familiar with the concept, if not the terminology, of a 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. rate. Earn a new dollar, and some of that dollar is lost to taxes. The concept applies equally to means-tested assistance from the government. As you earn more income, you lose some cash in the form of government benefits. What’s unique about Obamacare – and not in a good way – is that you can actually earn a dollar more, and lose ten thousand dollars in benefits. The moment your modified AGI reaches 400% of the poverty line, you instantly lose a subsidy that could easily be worth $15,000. This is a discontinuity in public policy with respect to income. It is a place where an infinitesimal change can result in disastrous consequence for a taxpayer. At 400% of the poverty line, the 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. is infinite.

The result? We have reporters advising people to work less or to shift their capital gains from year to year in an effort to get their income under the magic threshold.

People have designed policy around this problem for a long time. The earned income 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. has a phaseout, so that you don’t lose all of the benefit at once. Our income 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. s have been designed to avoid the problem since the income tax was adopted in 1913. Students of good public policy know how to avoid infinite marginal tax rate cliffs.

Sadly, Obamacare is not good public policy. Public policy under Obamacare encourages people to devote their time and industry towards pretending to be poorer, not towards genuinely enriching themselves and others through economic activity.