A clearer version of this graph is available as an Adobe Acrobat PDF. 

The “skyline” graph depicts the marginal tax rates for a family of four, earning from $0 to $400,000 in 2004 dollars. The graph shows the tax that would be paid on the next $1,000 of income as the family’s income increases. The marginal tax rates this family faces illustrate the complexity that can exist under the U.S. tax code, but they are not intended to be representative of the rates faced by an average family.

2004

It is assumed that the family is made up of a married couple and two children. One spouse earns 60 percent of the total family income while the other one earns the remaining 40 percent. They have one young child, and they have a child in college for whom they pay at least $2,000 in tuition. One of the adults is in school with tuition of at least $10,000, and the family has one school loan with interest of at least $2,500. Each spouse is covered by a retirement plan at work, and each spouse separately contributes 5% of his or her income to a traditional IRA up to a maximum of $1,500. Each spouse also contributes another 5% of his or her income to a Roth IRA up to a maximum of $1,500, and together the husband and wife contribute 10% of their total income, up to a maximum of $2,000, to a Coverdell Education Savings Account (ESA) for their younger child.  The family spends 10% of its income on child care up to a maximum of $3,000. The couple files a joint return, and the couple claims both the standard deduction and exemptions. 

Initially, due to deductions and exemptions, the couple’s income is exempt from tax, and the earned income credit (EIC) is the only factor affecting the marginal tax rate. The EIC phases in at a rate of 40% of earned income, giving the family a -40% marginal rate. Once the EIC reaches its maximum at $11,000, the additional child tax credit (CTC) begins phasing in at a rate of 15% of income, creating a -15% tax rate. The additional CTC continues phasing in when the EIC begins to phase out at $15,000, and the two credits combine to form a 6.1% marginal tax rate. Then the additional CTC reaches its maximum at $18,000, and the family faces a marginal rate equal to the EIC phaseout rate of 21.1%. Once the EIC reaches its ending eligibility point of $35,000, the family faces a 0% rate because the child and dependent care tax credit (CDCTC) and the education credits (Hope and Lifetime Learning credits) are offsetting all taxable income, so the family is receiving a constant refund equal to the maximum value of the additional CTC. At $65,000, the education credits reach their maximum, and the regular CTC begins to be applied to offset taxable income. This causes the additional CTC to phase out at a rate of 14.4%, since the 15% tax bracket interacts with the IRA deductions. The marginal rate rises to 23.7% at $70,000, when the traditional IRA deduction begins to phase out, and falls to 15% at $75,000 when eligibility for the traditional IRA deduction reaches its end. At $88,000, the marginal rate moves to 42.5% when the taxpayer moves into the 25% tax bracket and the education credit begins phasing out. It moves up to 46% as the student loan deduction begins phasing out at $100,000. At $107,000, the education credit fully phases out, so the marginal rate drops to 27.1%, moving up again to 32.5% at $112,000 as the family reaches the phaseout range of income for the regular CTC. At $130,000, the student loan deduction is entirely phased out, so the marginal rate drops to 25%, which is equal to the rate for the tax bracket. At $145,000, the family moves into the next tax bracket of 28%. From $150,000 to $160,000, the maximum contribution amount to the Roth IRA phases out, raising the tax rate to 36.4% during that income range, before it drops back to 28%. At $190,000, the maximum contribution to the Coverdell ESA starts to phase out, and the marginal rate rises to 29.9%. When the family moves into the next tax bracket of 33% at $202,000, the rate rises again to 35.2%. At $215,000, the rate rises to 38.7% as the value of personal and dependent exemptions phase out, and it drops to 36.3% at $220,000 when the Coverdell ESA deduction is completely phased out. At $330,000, the family moves into the next tax bracket of 35%, and the rate rises to 38.5%. Once exemptions fully phase out at $337,000, the marginal rate falls to the rate of the tax bracket, 35%, and remains there.

1988

In 1988, the assumptions for the family are the same except that the couple does not contribute to Roth IRAs or a Coverdell ESA because these savings vehicles did not yet exist. Instead, each spouse contributes 10% of his or her income to a traditional IRA, up to a maximum of $2,000 (1988 dollars). The income levels in the discussion below are all in 2004 dollars, as calculated using the NIPA personal consumption deflator.

Similarly to 2004, the standard deduction and exemptions create a non-taxable income range up to about $20,000. Up to $10,000, the family has a marginal tax rate of
-14%, which is the EIC phase-in rate. The marginal rate then increases to 0% when the EIC reaches its maximum credit and rises again to 10% when the EIC begins to phase out at $15,000. The CDCTC is first applied at $21,000, when the family moves out of the tax-exempt income range. At $26,000, the CDCTC, although still increasing, can no longer completely offset taxes owed, and the marginal rate moves to 20.9%, which is a combination of the CDCTC, the EIC phaseout rate, the IRA deduction, and the 15% tax bracket. At $28,000, the EIC reaches its ending eligibility point, and the marginal rate drops to 10.9%. At $30,000 and $33,000, the rate bumps up very slightly as the value of the CDCTC, which has brackets based on income, decreases. At $36,000, the CDCTC reaches the maximum for its bracket, and the 15% tax bracket and the IRA deduction interact to form a 13.5% marginal tax rate. The higher-earning spouse reaches his or her maximum IRA contribution at $49,000, and the marginal rate increases to 14.4%. At $59,000, the IRA deduction begins to phase out and the marginal rate climbs to 21%.

At $66,000, the family moves into the 28% tax bracket, and the marginal tax rate moves to 39.2% since the tax bracket is combined with the IRA deduction phaseout. Once the IRA deduction is fully phased out at $74,000, the marginal tax rate drops to 28%. It increases to 33% at $124,000, when the family moves into the next tax bracket.

Kevin A. Hassett is a resident scholar and the director of economic policy studies at AEI.