Individual Taxes

The individual income tax on ordinary income is currently levied at seven different rates, ranging from 10 percent to 37 percent. A critical feature of tax brackets is that each rate only applies to the taxable income within each bracket, not to income below it.

For example, a single taxpayer with $40,000 in taxable income would face a 10 percent tax rate on their first $12,400 and a 12 percent tax rate on their taxable income that falls between $12,400 and $50,400—in this case, their next $27,600. Earning income above a certain bracket threshold only subjects the income above that bracket threshold to the higher rate, with income below the threshold still facing the lower rates.

Ordinary income includes most kinds of personal income that taxpayers earn. Because ordinary income is such a large part of the tax base, changes to the rates on ordinary income tend to have large effects on the amount of revenue collected.

Because the current system of brackets is steeply graduated, a taxpayer’s average rate is often much lower than his or her marginal rate. For example, a taxpayer may be in the 24 percent bracket for each additional dollar earned but still find that most of their income is taxed under the 12 or 22 percent brackets. Such a system can create high marginal tax rates, which disincentivize work, saving, and investment, while still levying low average tax rates, resulting in relatively less revenue.

This subchapter considers changes to the individual tax bracket rate structure. Some changes involve tweaking the rates within the seven existing brackets; others involve shrinking the number of brackets or even consolidating all brackets into a flat tax with only one rate.

Under the current US tax code, long-term capital gains and qualified dividends face a separate bracket and rate schedule from ordinary income. Long-term capital gains are profits from selling an asset held for more than one year. Qualified dividends are payments made by US corporations and some foreign corporations to shareholders who have owned stock for a certain length of time.

These two forms of income are taxed under a bracket schedule with three rates: 0, 15, and 20 percent. Additionally, for taxpayers above a certain income threshold, long-term capital gains and dividend income can face a 3.8 percent surtax called the net investment income tax that brings the top federal rate up to a combined 23.8 percent.

Capital gains and dividends face lower rates for two primary reasons. First, dividends and capital gains that taxpayers receive may have already been subject to the corporate income tax. The lower rate on capital gains and dividend income helps mitigate the double tax on US corporate income. Second, individuals typically pay ordinary income taxes on the principal of the investment before investing. As a result, investment returns are already implicitly subject to one layer of individual taxation.

Capital gains taxes can have a substantial impact on realization behavior. Capital gains are only taxed when realized, meaning taxpayers get to choose when they pay their capital gains taxes. This ability to defer tax makes capital gains income significantly more responsive to tax changes than other types of income.

Taxes on capital gains and dividends primarily matter for incentives to save. Because the US is an open economy, and businesses can receive financing from both foreign and domestic savers, taxes on domestic saving have a relatively limited impact on business investment. If taxes discourage domestic saving, businesses can turn to foreigners for financing. Domestic production can continue, but the returns to that production may instead flow to foreigners, meaning taxes on savers can reduce domestic income even if they have a relatively limited effect on domestic production.

This subchapter considers several changes to the tax treatment of various forms of capital income. Most options are incremental changes to the existing framework: tweaking the rates for capital gains and dividends as well as the net investment income tax. However, we also include complete redesigns of capital gains taxation.

Tax credits are provisions that subtract from a taxpayer’s tax liability directly. For example, if a taxpayer receives a credit of $1,000, the taxpayer’s total taxes owed would be reduced by $1,000.

Typically, tax credits cannot reduce a taxpayer’s tax bill below zero, but a few special credits, known as refundable tax credits, can give a taxpayer an income tax bill of less than zero. They are called refundable because they often result in the IRS sending out refund checks to taxpayers.

The earned income tax credit (EITC) and the child tax credit (CTC) are the two most claimed tax credits. In 2026, the CTC has a maximum value of $2,200, with up to $1,700 refundable, and both amounts are indexed to inflation. The EITC is fully refundable and varies by filing status and number of children. The premium tax credit, a subsidy for purchasing health insurance on Affordable Care Act marketplaces, is also refundable.

The major refundable tax credits act as part of the broader safety net for low- and middle-income taxpayers. Other smaller tax credits (such as the lifelong learning credit and the retirement savings credit) serve as subsidies for more narrowly targeted activities. Many tax credits in the individual income tax targeted at green energy, such as the clean vehicle tax credit, were repealed in the One Big Beautiful Bill Act of 2025.

While credits can greatly reduce a taxpayer’s liability, their economic effects are more ambiguous. Most credits (and importantly, the major ones) phase out at higher income levels, which creates a marginal tax penalty on additional work. Some, like the EITC, also phase in, which creates a marginal incentive for work for lower-income taxpayers.

This subchapter contains a series of potential changes—increases, decreases, and structural overhauls—of the major individual income tax credits.

Deductions reduce a taxpayer’s taxable income. The current tax code offers two primary ways for taxpayers to take deductions: the standard deduction or itemized deductions. Most taxpayers choose the standard deduction, a flat deduction that varies by filing status ($16,100 for single filers and $32,200 for married filers in 2026). Other taxpayers choose to itemize deductions, listing their deductible expenditures on Schedule A.

The largest itemized deductions are for state and local taxes paid, mortgage interest paid, and charitable contributions. Itemizing is popular among higher-income taxpayers because they often have significant deductible expenses in these categories. The Tax Cuts and Jobs Act (TCJA) of 2017 expanded the standard deduction and limited several itemized deductions, causing itemization to fall from 30 percent to 10 percent of taxpayers.

The One Big Beautiful Bill Act temporarily relaxed the TCJA’s limits to the deduction for state and local taxes, increasing itemization from 10 percent before 2025 to around 14 percent in 2026. It also expanded the standard deduction and imposed a new limitation on the overall value of itemized deductions for higher-income taxpayers.

In addition to the standard deduction or itemized deductions, the tax code provides other deductions to all taxpayers, or, occasionally, to standard deduction taxpayers only. New temporary provisions, like deductions for some tip and overtime income, are available to taxpayers regardless of itemization decision, but face income limits. And a new charitable deduction is available to non-itemizing taxpayers.

The individual income tax code also contains several exclusions. An exclusion refers to any income that taxpayers are not required to report or pay taxes on. The largest of these is the exclusion of employer-provided health insurance, which makes up a significant share of labor compensation but is not subject to tax.

Deductions and exclusions are worthy of scrutiny because they narrow the US tax base and often create distortions by favoring some forms of labor income over others, or some types of economic activity over others. They are more valuable to taxpayers facing higher marginal rates; a taxpayer in the top bracket saves 37 cents for every dollar of deduction taken, while a taxpayer in the 10 percent bracket saves only 10 cents for each dollar of deduction.

This subchapter includes several changes to deductions and exclusions, ranging from tinkering around the margins by raising or reducing existing deduction values to more dramatic reforms like eliminating the employer-sponsored health insurance exclusion entirely.

The number of potential changes to the individual income tax is practically infinite. This chapter considers four possible structural changes that do not fit properly in other subchapters.

The first is repealing the alternative minimum tax, or AMT. The AMT is effectively a second tax system running parallel to the ordinary individual income tax. It has lower rates and limited deductions. Some taxpayers must calculate their tax liabilities under both the individual income tax and the AMT and pay the higher of the two. By requiring many taxpayers to calculate liability twice, the AMT imposes significant compliance costs in the tax filing process.

The second is the creation of universal savings accounts. The US tax code features around a dozen tax-advantaged savings accounts for specific purposes, such as retirement (the most common), healthcare expenses, and education. These accounts provide neutral tax treatment to saving, eliminating the additional tax penalty on saving that would otherwise occur under an income tax. They accomplish this through different methods: some, like individual retirement accounts, offer either an immediate deduction for contributions and taxation upon withdrawal, or immediate taxation on contributions and exempt withdrawals. Health savings accounts, in contrast, allow deductions for contributions and exemptions for withdrawals, providing a double benefit. A universal savings account would be subject to only one layer of tax, and unlike the current complex savings vehicles, would permit withdrawals for any reason.

This chapter also includes the option to institute a wealth tax. While a wealth tax is a tax on wealth, and not income, it fits best here among the various chapters in this book. The key point to consider with a tax on wealth is that a low tax rate on wealth translates to a very high tax rate on income.

Finally, this chapter considers introducing an employee compensation tax as a replacement for the employer-side payroll tax. It would apply to all forms of employee compensation, not just wages. This base-broadening measure would include employer-sponsored health insurance and other fringe benefits in its tax base.