Beware of Creating Tax Bubbles
Posted at 10:15 a.m. on Nov. 28, 2012
Nate Silver skillfully breaks down the math behind marginal tax rates and explains the dangers and complications involved with proposals to do away with marginal rates and tax a person’s entire income at a certain rate once they reach a high level of income.
“For every dollar that a taxpayer earns up to $8,700, she owes the federal government 10 cents in taxes — regardless of how much money she makes thereafter. The government then taxes 15 cents of every dollar once the taxpayer reaches $8,701 in income… There are several more steps in the scale until the taxpayer reaches the top marginal rate. Because tax rates are applied in this way, a taxpayer making $400,000 would owe about $117,000 in federal taxes, or about 29 percent of her earnings — rather than $140,000 if all her income had been taxed at the 35 percent rate.”
“Here’s the problem: the government would now want to collect 35 percent of the taxpayer’s overall income, when it had been billing her at a lower rate on almost all the income she had earned so far… It can only accomplish that by making the tax rate greater than 35 percent on at least some of the income that she has received.”
“There is…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 percent rate instead… This is what’s known as a ‘tax bubble’.”
