NCPA - National Center for Policy Analysis


September 2, 2008

Recently, Sen. Barack Obama declared that he wants to "reform our tax code so that it rewards work and not just wealth."  Unfortunately, his proposal would actually raise marginal tax rates for many middle-income taxpayers, a bad move for anyone seeking to promote economic growth, says the American Enterprise Institute (AEI).

Obama's tax breaks will undermine economic incentives in two ways.  First, whether or not you get those breaks will depend on your income.  In Washington, taking away tax breaks as families work harder to make more money is called a "phase-out."  Economists have a different name for it -- we call it a tax. Reducing a person\'s tax credit as his income goes up also reduces his incentive to earn more income.

Second, Obama would make some credits refundable for families with credits bigger than their tax liability, which would also have the nefarious effect of raising marginal tax rates:

  • For example, consider a worker in the 10 percent bracket with $1,000 of tax liability before credits who claims $1,200 in credits.
  • The tax impact of earning an extra $100 depends on whether the credit is refundable.
  • If it\'s not refundable, there\'s no tax penalty on earning the extra $100 because the worker\'s tax liability stays at zero.
  • But if the credit is refundable, earning the extra money pushes the tax up from negative $200 to negative $190 -- that\'s a 10 percent penalty on earning income.

To be sure, Obama's proposals will not tarnish an otherwise pristine tax code, but because phase-outs are so hard to decipher, many Americans may ignore them when making their work and saving decisions.  Creating a more confusing tax code certainly does not make for good government, says AEI.

Source: Alex Brill and Alan D. Viard, "The Folly of Obama's Tax Plan," The American, August 8, 2008.

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