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

April 11, 2011

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 tax 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 bracket 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 income, not total income. A family of five’s taxable income is significantly lower than its total income, because it gets a standard deduction 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 Credit 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 refund as most people understand the term, i.e. for over-withholding.) 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:


(Click to view full-size.)

This chart comes from a new, interactive tax tool that we will be releasing sometime in the next few days. It builds off of work done on our Bush tax cuts calculator, using the scenario that eventually became law (the Obama/Republicans compromise) and allowing the user to pick any input and graph it as a range. It then shows tax liability over that range, as well as marginal and average tax rates.

This tool is a great way to demonstrate the absurd complexity of our tax system. It’s silly that we have 14 marginal rates between $0 and $200,000, and there’s absolutely no reason to (briefly) impose a 42% marginal rate on a family of five making around $48,000. Such distortionary tax policies harm income mobility and impose a significant burden on middle class families.

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