True Marginal Tax Rates under Chairman Camp’s Proposal

March 4, 2014

Alan Cole

Alan Cole

One of the selling points of Chairman Camp’s tax reform proposal is the simplification of moving to two brackets with an additional ten per cent “surtax.” Sometimes this is styled as three brackets, but given that the surtax has a different base, this isn’t completely appropriate.

However, discussing brackets alone gives a very inaccurate picture of the marginal tax rates that people actually deal with. There are many tax credits and deductions to keep track of, and in total a taxpayer faces a battery of over a dozen marginal rates.

Chairman Camp’s proposal makes an effort to lessen the total number of individual tax expenditures, and to make sure those expenditures phase out in an orderly fashion. Nonetheless, the end result is still quite jarring. Here is a summary of the marginal tax rates faced by a self-employed single parent with one child at different levels of income.

Table: Marginal Tax Rates under Camp Proposal

Income Level Statutory Bracket Marginal Tax Rate Comments
$0-6,000 10% -25% Child Tax Credit refundable to 25% of income. Other taxes canceled out by deductions and EITC.
$6,001-15,686 10% 0% Standard deduction and EITC cancel out income and payroll taxes.
$15,687-16,500 10% 15.3% EITC fully phased in, payroll taxes (15.3%) no longer canceled out.
$16,501-20,000 10% 25.3% Standard deduction and “additional deduction” fully phased in, income tax now applies toward marginal rate.
$20,001-30,000 10% 44.3% Earned Income Tax Credit phases out at 19%.
$30,001-32,631 10% 54.3% “Additional Deduction” for single filers with at least one child phases out.
$32,632-35,500 10% 35.3% EITC fully phased out.
$35,501-35,600 10% 25.3% Additional Deduction fully phased out. Only income tax (10%) and payroll tax (15.3%) have effects at the margin.
$35,601-117,900 25% 40.3% Move into 25% bracket.
$117,901-200,000 25% 27.9% Social Security payroll tax no longer applies.
$200,001-250,000 25% 28.8% 0.90% added to Medicare payroll tax from PPACA.
$250,001-$400,000 25% 33.8% Tax savings from 10% bracket and Standard Deduction are phased out sequentially at 5%.
$400,001-$441,800 35% 43.8% 35% bracket. Tax savings from Standard Deduction and Child Tax Credit phased out sequentially at 5%.
$441,801+ 35% 38.8% Income taxes (35%) and Medicare payroll taxes (3.8%) apply.

Many of the complexities associated with Chairman Camp’s plan are in fact legacies of the current tax code. If anything, the Camp plan reduces complexity in several areas. Nonetheless, this exercise should be a reminder that brackets aren’t everything, and that the tax code has a lot of hidden marginal rates that only become apparent if one digs through the details. It would have been more praiseworthy for Chairman Camp to go further in his efforts to simplify the code.

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A 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.

A surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services.

Tax expenditures are a departure from the “normal” tax code that lower the tax burden of individuals or businesses, through an exemption, deduction, credit, or preferential rate. Expenditures can result in significant revenue losses to the government and include provisions such as the earned income tax credit, child tax credit, deduction for employer health-care contributions, and tax-advantaged savings plans.

The 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.

A tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.