Does It Pay to Save?

Studies | Taxes

No. 298
Friday, June 01, 2007
by Laurence J. Kotlikoff and David S. Rapson


Effective Marginal Taxes on Saving

ESPlanner TM software was used to analyze how the various programs discussed above, in combination with federal and state income tax schedules and the payroll (FICA) tax, determine overall incentives to save.  This analysis considers representative single-parent and same-age, married-couple households at various ages and income levels.  Both household types are assumed to have two children born when the parents were ages 27 and 29.  The effective marginal tax on saving was measured by uniformly allocating a reduction in spending in 2005 to all future periods, such that consumption income in all future years is increased by the same percentage.

“Middle-age, middle-income couples face higher tax penalties.”

 

 

Couples with Children.   For couples with children, effective marginal taxes on saving generally fall between 20 percent and 40 percent at most income levels.  For young and middle-aged households, the effective marginal tax on saving rises with income.  But for 60-year-old couples, the tax rate rises, falls and then rises again as income increases.  Specifically:

  • Effective marginal taxes on couples at age 30 range from 20.5 percent for households earning $20,000 a year to 51.5 percent for those earning $500,000.  [See Figure I.]
  • For 45-year-old couples, tax rates are also high, but progressive - ranging from 20.1 percent for couples earning $20,000 a year to 43.4 percent for couples earning $500,000.  [See Figure II.]
  • For 60-year-old couples, however, the highest marginal tax rate is 38.6 percent for a couple earning $20,000, while those earning $50,000 face only a 22 percent marginal tax.  [See Figure III.]

“Low-income couples face the highest marginal taxes among 60-year-old couples.”

 

 

“Single-parent households face much different tax rates than couples.”

Singles with Children.   The effective marginal tax rates on regular savings for single-parent households are very different from those for couples.  At higher incomes and at older ages, the rates range from around 20 percent to 40 percent.  However, for very low-earning, young and middle-aged single parents, the rates are astronomical, reflecting the impact of various asset tests on transfer benefits.  As Figure IV shows:

  • A 30-year-old single parent earning $10,000 a year faces an 82.7 percent effective marginal tax on an additional $1 of saving.
  • A 30-year-old single earning $15,000 a year faces an effective marginal tax of 260 percent!

In both of these cases, low-income single households become ineligible for transfer benefits because their savings have surpassed the asset limit.  Compare these low-income households to those with much higher incomes at the same age:

  • A 30-year-old single parent earning $100,000 faces only a 25.5 percent effective marginal tax on a dollar of saving, one-third the rate on the $10,000-a-year single household.
  • A 30-year-old single parent earning $250,000 faces a 30.6 percent effective marginal tax on a dollar of saving, less than one-sixth the tax rate on the single household earning only $15,000 a year!

This mishmash of regressive tax rates does not stop with the 30-year-old single.  Similar comparisons can be made with 45-year-old singles [see Figure V]:

  • For the lowest-income single parent, at $10,000 a year, the effective marginal tax on an additional dollar of saving is almost 110 percent; but for a single earning just $5,000 more (at $15,000) the rate falls to less than 20 percent!
  • For the single earning $250,000 a year, the effective marginal tax rate (39.2 percent) is higher than the $15,000-a-year earner, but still significantly lower than for the $10,000-a-year earner.

“Young, low-income single parents face extraordinarily high marginal taxes!”

Compare low- and high-income single-parent households at age 60.  Figure VI shows:

  • A 60-year-old earning $10,000 has the lowest effective marginal tax on saving (20.5 percent) of all the income levels at this age.
  • However, the highest rate among 60-year-olds is 41.4 percent, which applies to the single earning only $15,000 a year.
  • By contrast, the rate for a single earning $250,000 a year is 35.8 percent.

Again, these arbitrary rates are due to the fact that low-income singles begin losing transfer benefits as their savings surpass the asset-test limit.

“Additional savings by some low-income singles are effectively taxed away.”

 

 


“Low-income singles face the
highest marginal taxes among
60-year-olds.”

 

 

 

 


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