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Saturday, December 10, 2016

Marginal tax rates very high for the poor

Five years ago I posted about the extremely high marginal federal tax rates paid by the poor.

http://www.truncatedthoughts.com/2011/07/marginal-tax-rates-are-surprising.html

This situation has not improved. Updated tables are here:
http://www.taxpolicycenter.org/sites/default/files/legacy/taxfacts/content/PDF/family_inc_hist.pdf

At first glance, we seem to have a progressive tax system.  If we look at the 2014 numbers at the average federal tax rate paid by those making half the median annual income for a family of 4, it's -.87% (reflecting things like EITC, which allow you to get money back you didn't pay in).  At the median income, the tax rate is 12.99%, and for twice the median income it's 18.53%.

But that's the average rate.  If we look at the marginal rate, things look much different. At half the median income, it's 38.71%, at the median income it's 22.65%, and at twice the median income it's 26.45%.

Yes, that's right.  The marginal tax rate for the poor is higher than the marginal rate for the average and above average income individuals.

1. Why? Benefits like EITC are phased out as your income grows. I note these figures don't include the effect of the decline in subsidies for the Affordable Care Act.  And you start paying taxes.

2. Economic logic? If the rich are correct that low marginal tax rates are necessary for the rich because they encourage investment and economic activity, we should apply this same logic to the poor, probably more so.  If 40% of that additional income is going to disappear, that should clearly lower the incentive to work at a low paid job.

3. Stability Risk? In addition, low paying jobs also tend to be unstable. So if you lose that job, you then may have a time delay before EITC kicks in, for example -- you have to wait until the next time you file for taxes. For other benefits, there may be a lengthy, somewhat uncertain application process.

This hasn't always be the case. The Tax Policy Center tables go back to 1955, when the marginal rates were 2% (half median income), 20% (median income) and 22% (twice median income).  It was in 1992 that the big change in the marginal rate came, due to a large increase in the marginal rate at the low end (from 22.65% in 1991 to 35.79% in 1992).

Although this issue has been out there for at least two decades now, it doesn't seem to fit into either party's narrative and so it gets ignored.