by Fergus Hodgson
Director of Fiscal Policy Studies
Discussions of tax proportionality along income lines are not complete without an address of the various credits and welfare payments that offset them. Since these handouts decline as one’s income rises, the rate of marginal taxation is the combination of the increased taxes and the forgone benefits.
Even if one takes into consideration only the Earned Income Tax Credit forgone, and not benefits such as Medicaid and food stamps, he finds that many low-income earners face a higher effective marginal tax rate than the highest income earners. For example, a couple who file jointly with a combined income of between $22,500 and $40,000 face an effective marginal tax rate of 36.2 percent—higher than the 35 percent of the highest income tax bracket (and that’s before state income taxes).
Such steep effective taxes on income have consequences, a stifling supply-side effect. In the context of the current GOP tax proposals, Sven had this to say:
Established economic theory says that steep marginal income taxes discourage increases in labor supply and labor effort. A move from the current six-tiered income tax system to a flat tax will undoubtedly encourage more effort from those who make or are within reach of high incomes. But our economy also needs more labor supply at the lower end of the scale. Low-income earners also need encouragement to work more and earn more.
It’s not that individuals currently on low incomes necessarily need encouragement to work more. Rather, current policies reward them for not working, so we can hardly be surprised when they respond in that fashion.