## November 28, 2012

### Nate Silver: Congressional Proposal Would Create 'Bubble' in Tax Code

New York Times:  Congressional Proposal Could Create ‘Bubble’ in Tax Code, by Nate Silver:

The coming Congressional debate over fiscal policy is sure to feature a wide array of proposals, some of which would hit certain taxpayers harder than others. But one idea being floated by Congressional negotiators, as described in an article by The New York Times’s Jonathan Weisman on Thursday, is hard to defend from the standpoint of rational public policy making. Its arithmetic could require that the 300,000th dollar of income was taxed at a rate of about 50% -- even while the three millionth dollar of income, or the three billionth, was taxed at a lower 35% rate instead.

The math behind these calculations is not all that complicated. It’s just a matter of understanding how marginal tax rates work.

Take an American who earns \$400,000 a year in taxable income. (This is roughly the threshold at which a taxpayer reaches the top 1% of households.) The top marginal federal income tax rate is now 35%, and kicks in at earnings above \$388,350. Someone making \$400,000 is above the \$388,350 threshold. Does this mean that she’d be taxed at a 35% rate on all \$400,000 of income, meaning that she’d owe the government \$140,000?

Not under current law. Instead, only a small fraction of the taxpayer’s income – the \$11,650 she earns after she’s already reached \$388,350 – is taxed at the top 35% rate. This is because the tax rates are applied on a marginal basis. ...

[U]nder [the] proposal, the taxpayer making \$400,000 would in fact pay 35 percent in overall income taxes and would owe \$140,000 — about \$23,000 more than she does currently. ...

There is still a perversity introduced by this proposal. Specifically, after the taxpayer had hit her 400,000th dollar of income, her marginal tax rate would then decline. Rather than owing 50 cents for each dollar earned, she’d be back to a 35% rate instead. ... This is what’s known as a “tax bubble”: when someone earning less income might be taxed at a higher marginal rate than someone making more.

It’s also a question of whether the tax increase would make the tax code more efficient or less so. One might favor a flatter schedule of marginal tax rates or a steeper one. All taxes have the potential to discourage work. But smoother increases in marginal tax rates, as under current law, create less economic friction, and fewer deadweight losses, then those with a number of peaks and valleys. It is hard to see the economic rationale for creating a bubble in the middle of the tax code.

(Hat Tip: Ed Kleinbard.)

November 28, 2012 in Tax | Permalink

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I'm looking at the left hand side of the chart - and it says that the effective marginal tax rate on \$0 *income* is ten percent.

And about 28% on \$50,000 (news to the 47% - and even bigger news to the 53%...).

Perhaps Silver is talking about *taxable* (not gross) income (although only the *non-Silver* article suggests that - but the chart is from the Silver article).

And even if that (generous) assumption is made - do people under \$50,000 in *taxable income* pay the chart-indicated amounts in *effective* (post deduction/credit) tax rates?

I don't think so - that is precisely how 47% end up paying zero federal income taxes - because their exemptions/deductions/credits zero out their *effective* tax liability on their taxable income (all very, very carefully calculated by a DC congenitally committed to gaming the democratic system).

So what the hell is Silver's chart talking about?

Considering that the Left has assumed to itself a monopoly on "fact-based reasoning" (cough, cough, barf) - can some Silver-bug explain how the Master's chart makes sense?

Or is it simply mis-labelled, with the intent to mislead?

Posted by: cas127 | Nov 28, 2012 3:54:05 PM

The idea that marginal rates can increase before they decrease is not new. In fact it is current law. Silver should stick to predicting elections.

Posted by: Mike Petrik | Nov 28, 2012 5:48:56 PM

I think that the simple answer to your question is that this is a chart showing marginal, not average, tax rates, and that includes in federal taxes both payroll and income taxes. It also seems to look at labor income rates -- it self-evidently is not a chart of marginal capital gains rates, for example. So this means, starting with zero, you have to ask, how much federal income tax will be imposed on my next \$100 of income (that is, on going from zero to \$100 of labor income)?

The answer is that someone who goes from zero income to \$100 of wage income incurs payroll taxes amounting actually to 15.3 percent of that first \$100, without exemptions or deductions of any kind, once the current temporary payroll tax holiday expires. That comprises both the employee and the employer's share, because all economists, left, right, purple or Martian agree that the "employer's share" in fact economically falls on the employee.

Since the payroll taxes are capped they drop out of the marginal tax rate once the cap (roughly \$110,000) is reached.

Posted by: Edward Kleinbard | Nov 28, 2012 6:10:24 PM