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When the IRS gets 60 cents of your next dollar

October 21, 2009

Of all of the bad tax policies that have wormed their way into the tax law in the last 25 years, one of the worst is the proliferation of income-based "phase-outs" of deductions and credits. These can boost marginal tax rates -- the rates on each additional dollar earned -- to shocking levels. TaxVox has a great discussion of the problem, with this observation:

People lose confidence in a system that leaves them in a fog about the tax rates they face. And considering that we are going to have to rely on this revenue-raising structure more than ever in the coming years, that it not a good thing at all.

In boning up for the Farm Tax Schools I will be participating in starting next week (you can still enroll!), I noticed how the phase-out of the $8,000 first-time homebuyer credit over a $20,000 range of income adds 40% to the marginal tax rates of qualifying taxpayers in the phaseout range. That means a 60% effective rate on each dollar earned in that range, which starts at $75,000 for single filers, before even counting state taxes. That's just crazy.