TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Thursday, October 9, 2008

Marginal Tax Rates Under Obama (50%), McCain (40%)

The Tax Foundation has published How Do the Presidential Candidates’ Tax Plans Affect Taxpayers’ Marginal Tax Rates?, by Robert Carroll:

The Presidential candidates have proposed comprehensive tax plans that reshape tax policy in important ways. The two candidates have put forward two very different visions, with Senator Obama's tax plan emphasizing redistribution and Senator McCain's tax plan focusing more on economic growth. A perhaps neglected aspect of their tax plans is how they alter effective marginal tax rates, the amount of tax that people pay out of their last dollar of income. ...

Both Senator Obama's and Senator McCain's tax plans affect marginal tax rates, but for different reasons. Senator Obama's tax plan includes a number of proposals for new or expanded tax benefits that are generally targeted to low- and moderate-income taxpayers. Many of these additions to the "skyline" change taxpayers' effective marginal tax rates in important ways, lowering or raising them, sometimes significantly. ...

Senator McCain's tax plan also affects marginal rates, but for very different reasons. His tax plan includes only two individual tax proposals and only his health tax credit has a material effect on effective marginal tax rates. The McCain health tax credit—$5,000 for family coverage and $2,500 for individual coverage—replaces the current income tax exclusion for employer-based health insurance. The repeal of this exclusion has the effect of increasing taxpayers' taxable incomes, which then pushes some taxpayers into higher income tax brackets. ...

Marginal tax rates will rise to over 50% on some middle-income families if Sen. Obama's tax plan becomes law, and over 40% under Senator McCain's plan.

See charts below the fold:

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Update:

https://taxprof.typepad.com/taxprof_blog/2008/10/marginal-tax-ra.html

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Comments

This does not include changes to FICA or Medicare taxes. THOSE are the real kicker.

Posted by: Austin | Oct 10, 2008 5:24:44 AM

Only fools care about marginal rates. (Look at who cares and you have a good list of fools.) Effective rates are where the rubber meets the road.

And the EITC has always been jacked-up on marginal rates. Dog bites man.

Posted by: Marginal Rates Don't Mattter | Oct 10, 2008 5:36:42 AM

Precisely on the highest marginal rates. It is b.s. You could have a marginal rate at 99% and it may mean there is lower taxes than a maximum 20% marginal rate. It is al about WHERE the highest bite kicks in. This is one more example where folks on the right misuse a fact to mislead on the important part: revenue generation/actual tax rate and the impact on deficits. Funny I see no mention of that, ESPECIALLY since McCain just proposed another huge government program to bail out mortgages. Funny that . . . .

Posted by: B-Rob | Oct 10, 2008 5:49:52 AM

Could we see the graphs continued to the right? At least to $250K/yr or thereabouts?

Posted by: ...Max... | Oct 10, 2008 6:09:15 AM

Economists look at marginal rates because those are what determines behavior. In other words, the classic microeconomics question is, "do I work one more hour or do X". That extra hour of work (which is really a proxy for working for a promotion, emphasizing salary in your job hunt, or participating activities such as adult education that increase salary) is reduced by the marginal tax rate, not the average (effective) rate. Raise marginal rates and you'll see less income growth and more X. X could be many things (leisure, free time with family, etc), but things that increase income (productivity stuff, for the most part) aren't on the list.

This is basic, introductory microeconomics. Pick up any textbook at your local university or library and there's almost always a chapter that explains the difference between marginal and average values and why that's important.

Posted by: wells | Oct 10, 2008 6:29:17 AM

Could we get that chart re-done to change the interval on the X-Axis to show the relative number of people within each income level? Also, what in heck as a capitalistic country are we doing with a negative income tax at lower income levels?

Posted by: Georg Felis | Oct 10, 2008 6:46:31 AM

No person should be compelled to work more for all of us than for themselves. When the marginal rate exceeds 50%, regardless of when that threshold is crossed, that's exactly what happens.

You can wrap it in any sort of qualifier you want, but it is collectivism. And that is a distinction that shouldn't be ignored.

Posted by: Margina Rates Do Matter | Oct 10, 2008 6:56:11 AM

No person should be compelled to work more for all of us than for themselves. When the marginal rate exceeds 50%, regardless of when that threshold is crossed, that's exactly what happens.

You can wrap it in any sort of qualifier you want, but it is collectivism. And that is a distinction that shouldn't be ignored.

Posted by: Margina Rates Do Matter | Oct 10, 2008 7:03:51 AM

It would be more illuminating if Obama's proposals were accompanied by a chart that showed the additional impact of uncapping Social Security contributions.

Posted by: slinkybender | Oct 10, 2008 7:30:10 AM

Is it BS? Are you familiar with the concept of diminishing returns? If I am earning X, and every dollar after X will be taxed at a much higher rate, it may not be worth my time to work harder to make that extra money. Just about everyone resents having to pay taxes, and marginal tax rates will influence their behavior.

Posted by: Captain Ramen | Oct 10, 2008 7:39:29 AM

Second for additional incomes to the right - $250k+.

Posted by: S37VEN | Oct 10, 2008 8:01:03 AM

I have been a tax practitioner for over 30 years. I remember pre-Reagan when earned income was capped at 50% but investment income was taxable at 70%. There was a ton of work because people HATED paying that much tax and were attracted to all kinds of tax shelters that made no economic sense.

Even the Beatles hated high taxes. Their song "Taxman" - "there's 1 for me 19 for you, taxman" - reflected the fact that UK taxes topped out at 95%. Portable high earners - artists, rock n rollas, doctors, engineers& scientists fled to lower tax jurisidictions. It was called the "brain drain."

But "Marginal Rates Don't Matter" & B-rob are right - it's just history that's wrong. To quote the great Daniel Patrick -"you're entitled to your own opinion but not your own facts."

Posted by: aircav | Oct 10, 2008 8:53:47 AM

Decisions are made based on the marginal tax rate. Averages are meaningless in that case. It's not b.s.

Posted by: La Mano | Oct 10, 2008 9:47:08 AM

The marginal rate only matter on a theoretical level, ie in the textbook. In REAL life, where REAL people work, you dont think about working that "extra hour." For a salaried employee the marginal rate does not matter. Are there people out there who won't want to advance their career because they have to pay a hire rate on their next raise? Really?

As for business owners, the marginal rate is not a big enough factor because your "wages" are not a direct function of your time, which is one of the basic assumptions required.

Posted by: R. Lee | Oct 10, 2008 12:23:18 PM

Please add more chart to the right! So we can see the higher incomes.

Posted by: What about above 140K | Oct 10, 2008 1:51:32 PM

Decisions are made based on marginal tax rate? Averages are meaningless? Well, hell, I have no idea what my marginal tax rate is right now. Does anyone else out there know how much their next dollar is going to be taxed? I think we all know approximately the percentage tax that gets taken out of our check ON AVERAGE. But show me one person who knows that their 39,000th dollar is taxed at 35% and their 43,000th dollar is taxed at 15%. Then, if you can do that, show me someone who actually changed their behavior based on that.

I'll admit, marginal tax rates make a difference at large corporations with staffs of accountants for whom it pays to spend the time needed to determine where the revenue should be booked to optimize their tax burden. But that's not what these charts are about.

Posted by: Kroft | Oct 10, 2008 2:11:43 PM

If I understand the graphs correctly, Obama will raise marginal tax rates on income between roughly $30,000-50,000. Presumably this will be an incentive to earn more than $50,000, because the marginal rate goes down. Maybe that's a good thing.

The negative income tax at lower levels reflects the fact that although we're capitalists, we're compassionate capitalists. We will give the poor enough money to at least survive, through refundable tax credits, EITC, etc. Even as a capitalist, I can support this idea. Not sure I want to give them even more $, but it is difficult to live on only $20k/year.

R. Lee, where REAL people work, I bet there are more employees who are paid by the hour, not salaried, so the marginal rate does matter. Unfortunately, I don't know where to find evidence of this. Anyone?

Posted by: kick in pants | Oct 10, 2008 2:15:44 PM

Hourly employees are going to get time and 1/2 for the additional hour so their tax rate is less consequential due the much larger increase in the wages. As R. Lee, stated for salaried workers, the marginal rate is always a secondary issue to the salary since we have a graduated tax rate system.

Posted by: Shabadoo | Oct 10, 2008 3:01:44 PM

Your income even in the elevated sections of (both candidates) will be taxed at a higher rate, thus increased your ETR. Yes, marginal tax rates mean something. Obama and the government is telling you, that 140,001st dollar you earned is less valuable to you and more valuable to them to give away to someone who didn't earn it (or did so by sitting on their arse).

Posted by: You're-all-crazy | Oct 10, 2008 3:08:09 PM

Marginal rates don't matter? Ask your boss if they matter. And that is just the federal portion. Kick in the state portion see if it does not matter. You will enjoy your tax cut while on the unemployemnt line.
If the 'rich' have to pay more, should not their vote count for more? After all we all get one vote irespective of our incomes or lack of one, we get the same level of federal services but we don't all pay the same for services consumed.
It is time to have weighted voting based on how much one pays below the the line in net paid for services and above the line for those services. And tax the wealthy on all of their revenue no mater the source at the income tax rate. Lets see how liberal Warren Buffet is when he gets hammered at the top rate along with George Soros. And finally, its time to elimnate the non profit status of charities. Exxon is more valuable to society each and every day than Harvard. Let them pay taxes on their billions in endowments.

Posted by: cubanbob | Oct 10, 2008 3:16:35 PM

"Only fools care about marginal rates." Spoken by a guy who has never started a business, I guarantee.

This is EXACTLY 100% backwards wrong.

My marginal tax rate, as a non-worker married to a woman with a good income, determines ENTIRELY whether I will put out an iota of effort to make money.

With Obama elected, I will sit on my ass for 4 years. With McCain, I might start a business, hire people, and pay a boatload of taxes.

40% of something is better than 50% of nothing, Barack, you economic ignoramus. (Oh, sorry, am I a racist now?)

Posted by: Chester White | Oct 10, 2008 3:48:46 PM

People may not be aware that they are making decisions on the margin but that doesn't mean they aren't.

When you are driving your car on a crowded freeway, are you aware that you are using multivariable calculus to track all the cars around you? Obviously you are not visualizing that guy cutting you off on the right while jamming his brakes as an equation, but your brain is still doing it.

Posted by: Captain Ramen | Oct 10, 2008 5:26:25 PM

R. Lee, Ramen & B-Rob,

What's the matter boys, can't get you wealth envy on?

Posted by: will | Oct 11, 2008 12:00:54 AM

R. Lee, Ramen & B-Rob,

they cant get it that they are feeding at my trough

i paid 400,000 in income tax last year

and if obama comes and increases taxes and lifts the cap on ss
my taxes go up so high that it is not worth my while to keep working

i would rather play golf everyday

so what happens to the 25 odd people working for me


maybe they should ask obama

Posted by: gh | Oct 11, 2008 7:04:55 AM

Some points on these charts are pretty confusing -- I wonder how they came up with the sudden, temporary drop in marginal tax rates for ~$45-$50K, for example.

Posted by: Taxrascal | Oct 11, 2008 5:25:36 PM

Will - then quit working. Put your money where your mouth is and prove it. Quit working and fire them.

I got 100$ you won't do it.

Posted by: Me | Oct 12, 2008 2:42:35 PM

I would like to see the details of which tax credits were being for these calculations. Also, how about showing other familial situations, such as two-earner no children, single, etc. My guess is that most of the up and down variation in their effective marginal tax rates is due to exemptions for children, child and dependent care tax credits, and Hope and Lifetime Learning education credits. Not everybody uses those credits.

I also vote for extending the graph at least to where the highest statutory rate kicks in.

Posted by: xyz | Oct 12, 2008 3:18:47 PM

The claim that a higher marginal tax rate provides a greater disincentive than a lower marginal rate to work an additional hour wrongly assumes that tax rates have no impact on a worker's PRE-TAX income.

Marginal tax rates -- and tax rates in general -- have no impact on the value that a worker places on leisure time. For example, if John Smith values watching Monday Night Football at $100 (i.e., he would forego up to $100 in order to watch the game), that will stay the same regardless of if the marginal tax rate is 5% or 75% (because leisure time isn't taxed).

Assume that watching Monday Night Football will take four hours. Although this simplifies things just a touch, John Smith will choose to watch Monday Night Football unless his after-tax income is greater than $25 per hour for those four hours.

The marginal tax rate is only one factor in whether John Smith's take home pay will be more than $25 per hour for those four hours of Monday Night Football. The other factor is John Smith's PRE-TAX hourly earning power. Even if John Smith's marginal tax rate goes UP, this will not automatically reduce his incentive to forego Monday Night Football. If his PRE-TAX earning power also goes UP, then this will offset any effect the marginal tax rate might have.

The idea, of course, is that a tax structure that re-distributes income to the middle and lower classes -- as opposed to letting it "trickle down" through free market decisions by the wealthier classes -- will increase the PRE-TAX earning power of most (if not all) workers, therefore negating any disincentives to work that a higher marginal tax rate might otherwise have.

If one wants to argue empirically that a more progressive tax structure and a higher marginal rate will not have a positive increase on pre-tax earning power, go ahead and argue it. It's an interesting and important discussion. But to claim that marginal tax rates are THE DETERMINING FACTOR in whether one decides to work that additional hour or not is not logically sound, as I've demonstrated above.

Posted by: Aaron | Oct 12, 2008 6:54:30 PM

For all those asking for an example of someone changing behavior because of marginal rate, I have been directly impacted by this reality. I, along with a partner, own an evil corporation that makes more than $250K per year. When April 15 rolled around I got an irate call from my partner. It seemed that he owed more than 30K (never did tell me the number, I owed 25K). The accountant didn't adequately explain that we could draw more money but it did make it look like our taxes we're over 50%.

My partner asked me why he should try to make any more money. I couldn't argue with him. If the rates go to 50 or above, I know our growth will be impacted. Sad but true... We both have kids. At a point, I'll trade growth for time with my family and stupid tax shelters that I would never have used.

Posted by: Anony Mouse | Oct 16, 2008 12:39:13 PM

Why did you stop before the $250K threshhold that Obama talks about over and over? I'd like to see the chart go at least to $300K.

Posted by: coda | Oct 17, 2008 8:22:58 AM

One more thing not taken into account as far as I can see. When you talk about McCain's $5000 toward healthcare, it doesn't work. You can't get a decent health policy - and I'm not talking about a "cadillac policy" - for $5000 that doesn't have a huge deductible. And if you already can barely afford the portion you pay as part of the employer-based coverage, how are you going to afford the out of pocket expenses associated with the kind of plan $5000 buys? And that's without a prescription drug plan, too, of the kind most employer-based plans provide. So that tax on benefits hits you in multiple ways. It's obvious Mr. McCain has not had to purchase health insurance for his family out of pocket for 30 years and prior to that was part of a family and income that easily could afford care.

Posted by: coda | Oct 17, 2008 8:29:37 AM

All of these numbers over $100k are BS, for married folk anyway. Alternative Minimum Tax isn't even mentioned by anybody.

Posted by: jeff | Oct 19, 2008 11:34:29 PM

It is possible to get some pretty good health plans, with drug coverage, for about $6000 per year (age 55, two people, no kids) Insurance for young people is quite reasonable. A subsidy of $5000 would make it possible for many to afford basic insurance that otherwise could not. I agree with McCain that people have a responsibility to take care of their own health care. The government, according to the Constitution, is not required to provide it. I also think that all benefits should be taxed. To do otherwise amounts to a government subsidy.
For those lucky enough to have an employer paid plan, the McCain tax on benefits would be approximately offset by the $5000 subsidy, assuming you are in the 45% marginal bracket (including State tax) and your employer plan is worth about $13,000 a year.
Regarding marginal rates, it has been my experience that hourly workers are very aware of their marginal rate and will often turn down overtime, saying it is just not worth their time because of the additional taxes they will have to pay.

Posted by: Carl | Oct 21, 2008 1:37:41 PM

McCain's health care plan is very unlikely to pass. It is way too radical.

But while we're commenting on it, $5000 won't go very far with a family of 5--would make more sense if credit was on a per-person basis.

Recent changes in tax law make it possible for just about any small business to get health care in pre-tax dollars. And Health Reimbursement Arrangements or Health Savings Accounts are great when you pay for your own health/dental/eye exams.

At least in Illinois we have some really great high deductible options.


Posted by: Mama73 | Oct 23, 2008 6:06:29 AM

Oh yeah...let me add my vote for extending the chart to the right. Maybe to 250 - 300k or so?

...we can tell who's reading this blog.

Hello fellow "rich" people!

Posted by: Mama73 | Oct 23, 2008 6:09:19 AM

Obama's tax plan will destroy the Social Security system.

Obama says his income tax plan will lower taxes for 95% of Americans. There is just one problem with this, 40% of Americans already pay no income tax. Obama's response to this is that these people pay Social Security tax. Well, that's not income tax, but a contribution to their retirement plan. So if he wins and implements his tax plan, for the first time in the history of Social Security, 40% of the people who will get retirement benefits will have paid nothing for them. Social Security will then loose all pretext of being a retirement plan, and will become a national welfare program.

This will cause Social Security to lose public support in a massive way. Leave Social Security contributions out of income tax plans. If you take some peoples income taxes to pay others Social Security taxes, Social Security will be destroyed forever.

http://strategicthought-charles77.blogspot.com/2008/10/obamas-tax-plan-will-destroy-social.html

Posted by: charles | Oct 23, 2008 10:56:32 AM

Now that you've illustrate the "effective" marginal rates, illustrate the average tax rates in a similar fashion. It's the ATR that reflects the overall burden of a tax. In other words, I'd rather pay a mtr of 40% with an atr of 20% than pay a mtr of 25% with an atr of 21% because I end up with a little more take home pay.

Posted by: glh17 | Oct 28, 2008 5:45:11 PM

You don't know your marginal tax rate because you don't make enough money yet to care. They aren't that high at the lower levels that they influence your behavior. It's only at the upper brackets where they approach the magic 50% that the marginal rates really matter. When you have to start sending the government a lot more than you used to be able to earn that it starts to really piss you off. I'm going to get nailed with this increase after working 30 years to make the kind of money Obama thinks is rich. I have fallen drastically short of what I wanted to achieve and having to pay so much for the few years my husband and I have left that we will be able to earn this kind of money is immoral. It is as simple as that. Wait til you see how this affects our kids that begin to see that they goal post has been set too high and will just get moved when they actually achieve something.

Posted by: Jeanne Barber | Nov 9, 2008 1:27:29 PM