Reduce Marginal Tax Rates
February 14, 2001
Under our income tax system, marginal rates are higher than average tax rates -- not just for high income earners, but for middle income taxpayers.
- For a married couple in the 15 percent tax bracket deciding whether to take a second job, work overtime or make an investment, the relevant question is whether it is worth keeping only 85 cents for each dollar gained.
- If their taxable income were to rise to $45,200 -- not very much for a two earner couple -- they are now in the 28 percent bracket, and will get to keep only 72 cents from each additional dollar earned.
- At the top of the income tax schedule, people in the 39.6 percent bracket get to keep only 60 cents for working or saving more, or making risky investments such as starting new businesses.
Clearly, there are investments people will make for a 10 percent return that they won't make for a 6 percent return. Thus someone in the 15 percent or 28 percent bracket would make that investment, but someone in the top bracket will not.
High marginal tax rates discourage work, saving and investment. Because the highest tax rates apply to those who least need to work, save or invest to maintain their lifestyles -- i.e., the rich -- they are especially sensitive to even small changes in tax rates and the after-tax rate of return.
Only permanent changes in marginal tax rates affect the rate of return on work, saving and investment. Temporary tax changes have no impact and those that affect only average tax rates also have no impact. That is why the idea of a tax rebate is so wrong-headed.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, February 14, 2001.
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