Obamacare Puts Infinite Marginal Tax Rates in Action

October 15, 2013

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 tax 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 rate 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 credit has a phaseout, so that you don’t lose all of the benefit at once. Our income tax brackets 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.

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