So much of what we hear about taxes focuses on whether the rich should pay more income tax than they do today. So little coverage reveals the harm done by the code's complexity and its interaction with myriad government programs. Perhaps that's starting to change. Within the last month or so, I read two articles that illustrate just how messed up our tax code is and how it's detrimental to – wait for it – the working poor.
The marginal tax rate is the amount of tax you pay on each additional dollar of income; this is the "headline rate" that politicians talk about. The effective tax rate is your bottom line: total tax paid divided by total income earned. Effective tax rate is your "wallet rate" and is affected by how much income is from wage or nonwage income (the latter getting preferential treatment), government benefit programs, and tax subsidies (i.e., deductions and credits).
In an article about low-income workers, the earned-income tax credit (EITC), and benefit programs for the poor, The Economist noted:
As a low-paid worker moves up the income scale, benefits are gradually withdrawn. The Congressional Budget Office (CBO), a non-partisan number-cruncher, looked at how this might affect a single mother with one child in a typical state (Pennsylvania) in 2012. When her income exceeded $4,900, she would have lost TANF. At around $23,000, she would have lost food stamps and federal housing assistance. The CBO calculates that her effective marginal tax rate would range from a modest 17% to a jaw-dropping 95%. If the prospect of keeping only five cents of each extra dollar earned does not discourage work, it is hard to imagine what might. And the CBO’s calculation does not include Medicaid and several other means-tested benefits. [emphasis added]
In a separate report on low- and moderate-income workers the CBO noted that when including federal and state individual income taxes, federal payroll taxes (FICA), and the phasing out of benefits from the Supplemental Nutrition Assistance Program (SNAP):
- 37% of low- and moderate-income taxpayers face marginal tax rates of 30-39%
- More than 20% of these taxpayers face marginal rates of 40% or more
- 56% face marginal rates of 10-19% from the federal individual income tax system alone – about the same rate claimed by former presidential candidate Mitt Romney during his campaign
Do you know your effective tax rate? Probably not. Every year when I use TurboTax, I don't know until I print the summary page. I know with certainty that Social Security taxes the first $113,700 of wages at 6.2% and that Medicare taxes 1.45% of all wages. (My employer gets taxed an equal amount on the sames wages.) But when I add in interest and dividends then subtract out any of nearly 200 tax breaks for which I might be eligible, it gets a little fuzzy. Perhaps only God and accountants know my effective tax rate for sure.
When I ran for Congress in 2012, a former IRS employee I met commented that every tax break has a Member of Congress to thank for its existence; that goes for benefit programs as well. That's a lot of political capital to rein in. But those taxes, tax breaks, and benefits create a messy tangle that may even challenge the Almighty to undo.
The rational human – homo economicus – takes action when the result of an action yields an expected result. When it comes to our tax code, you might as well flip a coin. Simplicity brings certainty. Could that be the next chapter of this story?