Americans' 90% tax rate

Editor's note: Edward J. McCaffery is Robert C. Packard Trustee Chair in law and a professor of law, economics and political science at the University of Southern California. He is the author of "Fair Not Flat: How to Make the Tax System Better and Simpler."

(CNN) -- In a recent opinion column on Phil Mickelson's tax comments, I pointed out that some of the working poor face marginal tax rates "approaching 90% as they lose benefits attempting to better themselves."

Readers were incredulous, asking how it could be that in a nation with a top federal income tax rate of 39.6% on individuals making more than $400,000 a year, anyone could face a 90% rate.

It is true. Marginal tax rates, especially for those below the top rate brackets, are chaotic, confusing, and all over the map.

Edward J. McCaffery

As a result, some of the working poor face extremely high rates on their next dollar earned. Tax scholars and economists have long known this. Dan Shaviro of NYU published a study in 1999 showing marginal tax rates above 100% on the working poor; specifically, he illustrated that a single parent earning $10,000 would lose over $2,500, after taxes, by earning another $15,000, pushing her income to $25,000.

Last year, a study from the Congressional Budget Office shows how a single parent making $18,000 now faces a marginal tax rate of 88% in 2013, down from 95% in 2012. The CBO report is 45 pages long, with complex details. Adding in all the taxes along with a host of other things that have strange acronyms like SNAP and TANF, and the result is that it is possible to face marginal tax rates approaching 90%.

What does this mean? It means that, like Mickelson, these individuals will not gain all that much from working additional hours.

Take a hypothetical single mother of two, Jane, earning $18,000 a year. Earning an additional $1 will increase Jane's actual cash available to spend by just 12 cents.

How can this be? The effect comes about because governments at various levels give aid to the very poor, such that the extremely low earners face negative tax rates. In short, we pay some poor to work -- this is the "welfare to workfare" move of Bill Clinton's legacy. But then the law takes these benefits back from the near-poor via high marginal tax rates in a "phaseout" range. The most important of these provisions is the earned income tax credit (EITC) located in the federal income tax. This provision pays the working poor up to 40 cents on the dollar up to approximately $10,000 of earnings.

If Jane makes $10,000, the government mails her a check for $4,000. Over a certain range, Jane keeps that money. But as she starts earning more than approximately $18,000, Jane begins to lose the $4,000, at a roughly 20% rate. Add that to payroll taxes (7.65%), the regular income tax (15%, at that range), and Jane is in a rate bracket over 40%, and we are just getting started -- other federal, state and local programs and taxes pile on to the same effect.

You might be thinking that losing a benefit is not a tax. That is an understandable sentiment, but Jane will not be comforted by it. Looking just at the EITC, as Jane's earnings go over $18,000, she loses some of the dollars she is earning to "regular" taxes, and the $4,000 she was getting in assistance is disappearing. It's real, green, money that she is losing. This is the net effect that Shaviro was describing: Compare Jane earning $10,000 in the workplace to Jane earning $25,000, and the latter Jane simply has over $2500 fewer dollars to spend.

If this is all so complex, how can it affect anyone's real behavior? But what we don't know, or don't fully, can affect us.

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It is known that working more brings in little if any additional cash for many poor households, especially those with children. These taxpayers may not calculate their actual rate, yet they notice the stress and lack of funds. That's real life. It is also a fact that marriage is very costly for the poor largely because of taxes and phaseouts -- and so, again, there is less cash, more stress, and fewer examples of married households all around. More a quarter of American children are being raised in single-parent households, most of them poor. A staggering 72% of African-American children are being raised by just one parent.

Some may conclude that it is fair to take back the money given to the poor as soon as they are no longer really poor. But this creates the high marginal tax rates just noted. And this is a major public policy problem, for at least two reasons.

One, these high marginal tax rates create "poverty traps" that keep the poor poor, and make escape to the middle class difficult. Similarly, the middle class these days are having a hard time doing the savings that might elevate them from their class into the upper class. Our tax laws essentially create a caste system, with barriers between income class levels.

Two, the poverty trap is also a severe marriage penalty, making it virtually economically impossible for lower income classes to marry. If Jane, making $18,000 a year, marries Dick, also making $18,000, suddenly Dick and Jane become a household, a single taxpayer (and benefits recipient) as far as the government is concerned. Their income has moved from $18,000 to $36,000 -- exactly a range of steep marginal tax rates.

Politicians on both the left and right criticize the poor for not having more stable marriages, but they conveniently ignore the simple but brutal fact that the poor cannot afford to marry.

This is not the "fault" of the poor any more than it is Mickelson's "fault" that he is considering leaving the country for tax reasons. The poor cannot go to Canada, France, or Russia to flee taxes. But they can flee the institution of marriage. And they do. It is time to fix this situation, beginning with paying attention to it.

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The opinions expressed in this commentary are solely those of Edward J. McCaffery.