Marginal Tax Rates Can Be Overstated, But They Are Still Too High

January 5, 2015

One issue in policy that I believe needs more attention is the issue of implicit marginal tax rates on lower-income families. The problem, simply put, is that means-tested benefits “phase out,” so as you earn a dollar of income, you lose some of that money in benefits. These phaseouts add implicitly to marginal tax rates, which are problematic because they reduce the returns to productive work.

The Center on Budget and Policy priorities recently released a report on marginal tax rates on lower-income workers. Sharon Parrott and Robert Greenstein argue that they are often overstated, and that there are tough tradeoffs in lowering them. I would agree with both of these points. Furthermore, I think the factual points made in the article are excellent, and the marginal rate calculations and the budget math are fair.

But I think the facts themselves are more worrying than the CBPP report deems them. For example,

For example, the March 2014 report on the safety net from House Budget Committee Chairman Paul Ryan highlights a statement in a Congressional Budget Office (CBO) analysis that “some low-income households face implicit marginal tax rates of nearly 100 percent,” but fails to mention data from the same CBO report showing that most low-income households’ marginal tax rates are substantially lower.

Well. I would certainly hope that most people’s marginal tax rates are “substantially lower” than 100 percent. How much lower?

Some other low-income families, typically those with incomes modestly above the poverty line, can face marginal tax rates of around 65 percent over a relatively narrow income range, such as between about $18,000 and $25,000 for a family of three. (Their marginal rate can be higher if they receive benefits that go to only a modest minority of low-income households, such as housing assistance or child care assistance.)

Alright then. That is indeed substantially lower. That doesn’t mean it’s not a problem. I'm under the impression that a 65% marginal rate is actually a pretty big deal. There’s substantial agreement on the facts here, but I am surprised to see the CBPP so sanguine about them.

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