Tax Whiners Don't Understand How Marginal Tax Rates Work

A blog about business and economics.
Nov. 20 2012 8:56 AM

Tax Whiners Don't Understand How Marginal Tax Rates Work

Kristina Collins, a chiropractor in McLean, Va., said she and her husband planned to closely monitor the business income from their joint practice to avoid crossing the income threshold for higher taxes outlined by President Obama on earnings above $200,000 for individuals and $250,000 for couples.
Ms. Collins said she felt torn by being near the cutoff line and disappointed that federal tax policy was providing a disincentive to keep expanding a business she founded in 1998.
“If we’re really close and it’s near the end-year, maybe we’ll just close down for a while and go on vacation,” she said.
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Everyone from congressional Republicans to even some Democratic senators keeps making this mistake, but for the dozenth time this isn't how marginal income tax rates work. But who can blame people for being confused if the confusion of others just gets passed along like this in newspaper articles? The bulk of that article by Nathaniel Popper and Nelson Schwartz is dedicated to an informative discussion of genuine income timing strategies that rich people try to use to minimize the amount of taxes they pay on their investment income. Given the broader context, a typical person is going to read this stray remark from Kristina Collins and think that she must be onto something.

But she's not. The after-tax value of her $250,001st dollar of Adjusted Gross Income will be slightly lower if Obama gets his way than if he doesn't get his way. But under either scheme, earning a higher pre-tax income will leave you with a higher after tax income. If you want more money, you want to get more more customers and earn more revenue just as usual.

Indeed, if you look at the high tax Clinton years you'll see that hours worked per employed person was steadily rising. I would hardly say that's because tax rates were higher back then—it was because the labor market was booming, but it goes to show that the rate structure didn't do anything perverse to people's incentives. Extra hours were readily available at the time to those who wanted them, and despite the relatively high tax rates many people did want them.

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