Nobody From Nowhere (@i8dc)

Occasional Common Sense

Why Republicans Shouldn’t Want to Talk About Combined Federal Marginal Tax Rates

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In recent arguments against tax increases on the wealthy, conservative legislators like Congressman Paul Ryan and pundits like the Wall Street Journal’s Stephen Moore have been including payroll taxes to derive comprehensive marginal tax rates.  They argue that marginal rates that are too high damage incentives for top earners so much that they may elect to work and invest less, with an aggregate effect on the economy of less growth.

This is a genie Republicans should not want freed. The optics are awful for them if the argument is extended to the middle class.

When calculating what the total marginal federal tax would be under the Democrats’ budget proposal, Paul Ryan estimated the impact of Medicare taxes to be 2.3%.  This figure is the 1.45% paid by the employee plus a fraction of the 1.45% assessed on employers.  While the fraction is up for discussion, the approach is sound — absent the tax, some of that money would be paid to the employee in the free market.

Ryan combined the payroll tax with income taxes to argue that the Democrats’ plan would result in a top federal marginal tax rate of 44.8%. Here’s a comparison of current law and Ryan’s assessment of the Democrats’ preferred tax scheme:

Tax

Current

Prospective

Income Tax

35.0%

39.6%

PEP and Pease re-establishment

0.0%

2.0%

Affordable Care Act Medicare Tax

0.0%

0.9%

Current Employee’s Medicare Tax

1.45%

1.45%

Current Employer’s Medicare Tax that would otherwise be paid to employee

0.85%

0.85%

Total

37.3%

44.8%

Fair enough (except that the PEP and Pease deductions are phased out as incomes reach the top rate, so Ryan’s 44.8% should instead be 42.8%).   Ryan wants to depict Obama as advocating a hefty increase on the wealthy, which he argues (without evidence) would be sufficient to cause lower economic growth because of reduced incentives for the wealthy to be productive.

It’s a useful argument, but here’s why the Republicans shouldn’t want combined marginal rates to become a regular subject of discussion: today, most of the middle class faces higher rates than the wealthy.

The reason is Social Security, and here’s the math.  The government collects Social Security taxes on the first $106,000 of wages.   Just as Ryan reasonably argues that part of the Medicare tax paid by employers would otherwise go to the employee, so too with Social Security; assigning the same percentage Ryan used for Medicare, we can put the net or effective Social Security tax rate at 9.8%.  Add in Ryan’s 2.3% for Medicare and the total effective rate attributable to payroll taxes is 12.13% for all wages under $106K.

Here’s how it hits different taxpayers (unmarried):

Tax                     Salary:

$1M

$300K

$200K

$100K

$60K

Income Tax

35.0%

33.0%

28.0%

28.0%

25.0%

PEP and Pease re-establishment

0.0%

0.0%

0.0%

0.0%

0.0%

Affordable Care Act Medicare Tax

0.0%*

0.0%*

0.0%*

0.0%

0.0%

Current Employee’s Medicare Tax

1.45%

1.45%

1.45%

1.45%

1.45%

Current Employer’s Medicare Tax that would otherwise be paid to employee

0.85%

0.85%

0.85%

0.85%

0.85%

Current Employee’s Social Security Tax

0.0%

0.0%

0.0%

6.2%

6.2%

Current Employer’s Social Security tax that would be paid to employee

0.0%

0.0%

0.0%

3.63%

3.63%

Combined Federal Marginal Tax Rate:

37.3%

35.3%

30.3%

40.13%

37.13%

* The Affordable Care Act will add 0.9% Medicare to tax on incomes in excess of $200,000 starting in 2013.

When all payroll taxes are included for all taxpayers, the highest marginal rates are faced by a segment of the middle class; those making between around $75K-$106K.  These poor souls likely are in the 28% income tax bracket, and are still paying Social Security (9.83%)  in addition to the Medicare tax (2.3%).   Even if they make somewhat less, as little as $45,000, their total marginal federal tax would be 37.13%, which is higher than that faced by those earning $300,000, and virtually identical to that faced by million-dollar earners.

Bottom line: most taxpayers in the middle class face higher combined federal marginal tax rates than most of the top 1% of taxpayers.

And that doesn’t even address capital gains, which have a top marginal federal tax rate of 15.0%; 80% of all capital gains are captured by the 2-3% of taxpayers with incomes higher than $250,000 per year.  This is why the top 400 taxpayers, each of whom made more than $138,800,000 in 2007, paid an average of just 16.62% of their income in federal income taxes.

Just from an apparent fairness point of view, Republicans should not want to bring combined marginal rates into tax policy discussions.

Useful links:

http://www.taxfoundation.org/news/show/250.html

http://www.irs.gov/pub/irs-soi/10winbulindincretpre.pdf

http://www.irs.gov/pub/irs-soi/07intop400.pdf

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Written by David Clayton

June 10, 2011 at 11:20 pm

Posted in Punditry

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