After much hee-hawing about hurting small businesses and wealthy Americans, Congress raised the top marginal tax rate to 39.6% in January 2013. But they forgot about the working poor.
Low-income households face high marginal tax rates of 30%, nearly the same as upper income households, according to the Congressional Research Service.
Today in Tax Notes, Aspen Gorry and Sita Slavov show how low-income individuals face high implicit marginal tax rates because of the phase-out of government benefits. The result is that low-income individuals have a strong disincentive not to work.
The same logic applies to older workers and married women, both of whom are highly responsive to changes in take-home pay. Older workers face higher average tax rates because of the set-up of the entitlement system. Secondary earners – usually married women — face higher tax rates on their earnings because their entire income gets taxed at a rate that is at least equal to the primary earner’s marginal tax rate.
The tax code should incentivize work,not discourage people from earning a paycheck. Gorry and Slavov recommend transitioning to a proportional tax system to improve transparency and eliminate the variation in marginal and average tax rates within income groups. The system could be made progressive by adding a universal transfer payment or an income exemption.