Fiscal Fact No. 39
Anyone who has faced a job transfer or promotion has had to come to grips with the fact that a dollar of income earned in one region of America does not always buy the same standard of living as a dollar earned in another region. Yet many in the rising class of dual-income working couples live in high-cost urban areas and have incomes to match where they live. However, the 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. code doesn’t account for this. As a result, these couples pay the price in higher taxes even though their standard of living may be no better than a similar couple earning thousands less in a lower cost community.
To demonstrate how cost of living can affect a family’s tax liability, Tax Foundation economists adjusted the income of a median, dual-income childless married couple to various cities using the ACCRA cost of living index, one of the nation’s leading providers of cost-of-living data.
In 2004, the typical dual-income childless couple in America earned $74,443—an income large enough to put them into the top 20 percent of taxpayers, with a tax liability of roughly $8,081 and an effective federal income tax rate of 10.4 percent. As it happens, the city with the closest average income to the national average is Milwaukee, Wisconsin. (See Table 1).
Table 1. Cost of Living Has a Dramatic Impact on Tax Liability and Effective Tax Rates
| Metro Area | The Income You Need to Buy Median Standard of Living* | Puts You in This Group of Taxpayers | With This Tax Liability in 2004 | With This Effective Tax Rate |
|
Houston |
$67,315 |
Top 25% |
$6,999 |
10.40% |
|
National Average (Milwaukee) |
$74,443 |
Top 20% |
$8,081 |
10.90% |
|
Orange County, CA |
$100,079 |
Top 10% |
$14,506 |
14.50% |
|
San Francisco, CA |
$135,003 |
Top 5% |
$23,250 |
17.20% |
|
New York City (Manhattan) |
$162,974 |
Top 3% |
$31,139 |
19.10% |
*Married Dual-Income Couple in 2004, No Children
Source: ACCRA, Tax Foundation.
Let’s assume this Milwaukee couple is transferred to Orange County, California. In order to purchase the same standard of living they enjoyed in Milwaukee, this couple would need to earn more than $100,000 per year. However, that cost-of-living-adjusted pay raise is enough to put them among the top 10 percent of taxpayers. At this new income level, their tax bill grows to $14,506 and their effective tax rate jumps to 14.5 percent, yet their standard of living hasn’t changed.
For a more extreme example, take that same couple and transplant them to New York City. To maintain the same standard of living they had in Milwaukee and Orange County, they would need a joint income of nearly $163,000. This income thrusts them into the top 3 percent of taxpayers and boosts their tax liability to more than $31,000 per year and their effective rate to 19.1 percent.
In terms of economic purchasing power, this illustrative couple has the same standard of living in each of these cities. But because our progressive taxA progressive tax is one where the average tax burden increases with income. High-income families pay a disproportionate share of the tax burden, while low- and middle-income taxpayers shoulder a relatively small tax burden. rate structure is not adjusted to the varied cost of living throughout the United States, they face dramatically higher effective tax rates and tax payments simply by moving to a higher cost metropolitan area.
Nationally, it is difficult to calculate the total amount of “phantom” income that is being taxed at the highest 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. s because of the large concentration of dual-income couples living in high-cost urban areas, but it is likely in the tens of billions of dollars.
While the tax code was indexed for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. in 1985 to protect Americans from “bracket creepBracket creep occurs when inflation pushes taxpayers into higher income tax brackets or reduces the value of credits, deductions, and exemptions. Bracket creep results in an increase in income taxes without an increase in real income. Many tax provisions—both at the federal and state level—are adjusted for inflation. ,” nothing has been done to protect them from “cost of living creep.” For some couples, the home mortgage interest deductionThe mortgage interest deduction is an itemized deduction for interest paid on home mortgages. It reduces households’ taxable incomes and, consequently, their total taxes paid. The Tax Cuts and Jobs Act (TCJA) reduced the amount of principal and limited the types of loans that qualify for the deduction. may provide some protection from rising housing costs, but the Alternative Minimum Tax can equally lessen some of that protection for families in high-cost, high-tax areas.
(This “Fiscal Fact” is based on the forthcoming Tax Foundation book Putting a Face on America’s Tax Returns. For more information, contact the press office at 202-464-6200.).
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