Tax Update Blog: Permalink
« Previous · Tax Update Blog Home · Next »
WHAT'S WRONG WITH THIS PICTURE?
May 10, 2005
Zimran Ahmed, via his "Winterspeak" blog, provides pithy and scary-smart economics commentary from his perch at the University of Chicago. A recent post reproduced a New York Times illustration of marginal tax rates at different income levels:
The "marginal rate" is the amount of tax paid on the next dollar earned; if you earn $100 more and pay an additional $15 tax as a result, your marginal rate is $15.
The Times chart credits a forthcoming book from the American Enterprise Institute, Towards Fundamental Tax Reform.
Some parts of the chart made sense. The many peaks at odd income levels look reasonable because of the tax law's many deduction and credit phase outs at different income levels. The "zero" marginal rate that appears to run from $30,000 or so to maybe $65,000 is puzzling. That makes sense at some lower income levels, where the earned income credit functions, but it doesn't look right at what most people consider lower-middle class to middle class income levels.
We went to the AEI webpage, where we find the book available on pdf format, to try to find how this worked. The chart in the book only cites "Author's Calculations," so we didn't find our answer (Now we have; see update at bottom). But we did notice a subtle difference between the Times version of the chart and the original. Do you notice?
Look on the left. The original chart shows marginal rates well below zero for the lowest income levels - a negative income tax, in effect. The Times leaves this out.
It's easy to assume that the Times just didn't want to emphasize how progressive the system is at the lowest income levels. The chart would be consistent with that. Or maybe they just thought the chart didn't quite fit the space with the far left end, or they cut it off there for artistic reasons. Still, it seems that there is less information in the far right side, which they left in. While there may be an explanation other than political leanings for the way the chart was edited, bias does seem to fit the data.
UPDATE!
Via Marginal Revolution, we find an explanation for the zero bracket. They assume a family of four with kids in college:
Once the EIC reaches its ending eligibility point of $35,000, the family faces a 0% rate because the child and dependent care tax credit (CDCTC) and the education credits (Hope and Lifetime Learning credits) are offsetting all taxable income, so the family is receiving a constant refund equal to the maximum value of the additional CTC. At $65,000, the education credits reach their maximum, and the regular CTC begins to be applied to offset taxable income. This causes the additional CTC to phase out at a rate of 14.4%, since the 15% tax bracket interacts with the IRA deductions.
EIC = Earned Income Credit
CTC = Child Tax Credit
Bookmark: del.icio.us • Digg • reddit
Tax Updates
Subscribe to Tax Updates
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not neccesarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to
Search Tax Updates
Friends and Neighbors
Economics Nerds
Hard-Core Tax Nerds
Gigablogs
Insurance Folk
Goners
Legislation
Tax Update Data Feeds
Comments
Could the 0% marginal rate gap have something to do with the following: At around $35,000 in income people are more likely (almost compelled) to itemize. Once they itemize things like home mortgage interest and charitable contributions reduce the rate?
My guess is that the chart is not the function of some mysterious equation dreamed up by the author. Rather it is a rough reflection of the actual tax data at each income point. I.e. the tax data show that earners in the $35-65k income range, through whatever means, paid essentially zero income tax. Some more some less directly correlated to the skill of their accountant.
Posted by: Chad | May 10, 2005 8:55 AM
Chad-
I see what you are saying, but it's hard to see how itemizing gives you a zero marginal rate; increased deductions seem unlikely to offset increased taxes dollar for dollar. I will run some hypotheticals later and see what happens.
Posted by: Joe Kristan | May 10, 2005 10:02 AM
I don't think I stated it very clearly. Your restatement is better than mine that this income range the graph shows people don't pay zero tax they pay zero marginal tax. I agree that it seems unlikely that you get a dollar for dollar benefit from itemized deductions. (It certainly hasn't been my experience and I've been at nearly every data point in this range in the last 7 years). If you can figure out a way to drop me to zero marginal tax on my income between 35-60k I'll drop TurboTax like a bad habit.
Posted by: Chad | May 10, 2005 10:23 AM
Mystery solved. See update. Have some kids retroactively, put them in college, and you hit zero too.
Posted by: Joe Kristan | May 10, 2005 10:28 AM
Looks like my long term tax planning is paying off.
With three young kids, in inflation adjusted terms, I should enjoy a zero marginal tax rate in 18 years on income between $100,000 and $500,000. Oh drat. That damn AMT will still be around (and still apply to people making $120,000).
Posted by: Chad | May 10, 2005 10:38 AM