October 22, 2020
Director of Federal Tax Policy
October 22, 2020
The Trump campaign has failed to convince the public that large numbers of Americans would face tax hikes under Democratic presidential nominee Joe Biden’s tax plan. The claim has been widely discredited. For example, ITEP found that the federal taxes that people pay directly would rise for just 1.9 percent of taxpayers in the U.S., and that number does not vary much by state. So, Fox News and other conservative voices are trying out a new argument: Biden’s tax plan would be too burdensome for that 1.9 percent.
The new criticism of Biden’s plan is that those few households rich enough to pay higher taxes would face tax rates that are unreasonably high. They cite a report from the Tax Foundation describing the top marginal tax rate (the rate of tax paid on the last dollar of income a household earns), which is easily confused with the effective tax rate (the fraction of total income a household pays in taxes). The Tax Foundation report points out that the personal income tax and payroll taxes together under Biden’s plan could result in a top marginal tax rate for the rich approaching 50 percent.
The report goes on to explain that combined with state income taxes, the top marginal tax rate would be even higher in some parts of the country. The highest of all would be in California, which has a top income tax rate of 13.3 percent for taxable income exceeding $1.1 million, resulting in a combined federal and state tax rate for millionaires of around 62 percent.
Even if you put aside California’s top income tax rate on millionaires (which a U.S. president has no control over in any event), should anyone be concerned about a top federal tax rate of roughly 50 percent?
The truth is that, of the 1.9 percent who would pay higher taxes under Biden’s plan, a smaller fraction would pay at the top marginal rate. Even then, they would pay the top marginal tax rate on just a fraction of their income.
Biden’s plan is not radical. The top personal income tax rate would apply only to taxable income exceeding about half a million dollars. The payroll tax change under Biden’s plan would apply only to an individual’s earnings above $400,000.
As explained below, a taxpayer’s effective tax rate, meaning the share of income they pay in taxes, is always lower than their marginal tax rate.
How Biden’s Plan Would Raise Tax Rates
Under Biden’s proposal, personal income tax rates would stay the same except that taxable income above $400,000 would be subject to the higher rates that applied before the Trump tax law went into effect. ITEP interprets this to literally mean that for taxable income exceeding $400,000, the tax rates and the tax brackets would look as if the Trump tax law was never enacted (assuming normal inflation adjustments).
This means that taxable income above $400,000 could be subject to rates of 33 percent, 35 percent and 39.6 percent. The top rate of 39.6 percent would apply only to taxable income exceeding $450,200 for singles and $506,500 for married couples in 2022, the first year the plan would likely go into effect. If a married couple has taxable income of $507,000 that year, they would pay 39.6 percent on just $500 of their income.
And remember that this is taxable income. Total income is typically significantly higher because taxable income is reduced by deductions and other tax breaks.
Other personal income tax increases in Biden’s plan would limit deductions and other special breaks for those with taxable income exceeding $400,000, as explained in ITEP’s report.
Biden’s change to the Social Security payroll tax would apply only to individuals with earnings exceeding $400,000. Under current law, all of us who work already pay the 12.4 percent Social Security tax on earnings up to an annually adjusted cap, which is $137,700 this year. Of this, 6.2 percent is paid directly by employees while the other 6.2 percent is paid by employers. Under Biden’s plan, earned income exceeding $400,000 would also be subject to this tax.
Example of Taxpayer Subject to Top Rates
The effects of Biden’s plan can be illustrated with an example. Assume a childless married couple has $600,000 of total income and all of it is earned income. High-income people usually have some income from investments, which are not subject to the Social Security payroll tax under current law or under Biden’s plan and would therefore pay less than the couple in this example.
Assume also that this couple claims no deductions other than the standard deduction. High-income people usually claim tens of thousands of dollars in itemized deductions and would therefore pay less than the couple in this example.
Assume that in 2022, one spouse earns $450,000 and the other spouse earns $150,000 for a total of $600,000 of income.
As illustrated in the calculations below, this couple would pay 30.6 percent of their income in federal taxes under Biden’s plan. This is another way of saying that their effective federal tax rate would be 30.6 percent under Biden’s plan. (This is just a small change from their effective tax rate of 29.6 percent under current law, as explained in the note at the end of this post.)
When Fox News reports that the rich would pay at a top federal tax rate of roughly 50 percent, they are talking about marginal tax rates. The couple in this example would pay a marginal tax rate of 48.2 percent, meaning a portion of their income would be taxed at 48.2 percent (including personal income taxes and payroll taxes). But as this example shows us, that does not tell us how much income a household must set aside for taxes.
Personal Income Tax
Under the personal income tax, the couple would claim a standard deduction of $25,400 (which is unaltered by Biden’s plan) leaving taxable income of $574,600.
ITEP interprets Biden’s tax plan to mean there will be eight income tax brackets for earned income, including brackets of 10, 12, 22, 24 and 32 percent, as under current law, and, for taxable income exceeding $400,000, brackets of 33, 35 and 39.6 percent.
As already mentioned, in 2022 the top rate of 39.6 percent would apply to taxable income exceeding $506,500, which for this couple means that $68,100 of their income would be subject to the top rate, which comes to $26,968 that they will pay at the top rate.
The personal income tax on their taxable income in all the lower brackets would come to $125,545.
The couple’s total personal income tax for 2022 would therefore be $152,513.
Under current law, employees pay a Social Security payroll tax of 6.2 percent of their earnings up to a cap, which will likely be $142,500 in 2022. Both spouses in our example earn more than that so they both pay 6.2 percent of $142,500 which comes to $8,835 each.
Under Biden’s plan, individuals would also pay the Social Security tax on earnings exceeding $400,000. In our example, one spouse has $50,000 of earnings exceeding $400,000. The 6.2 percent employee payroll tax on that would come to $3,100.
Both spouses would also pay Medicare taxes, which Biden’s proposal does not change.
The regular Medicare tax is 2.9 percent on all earnings, and half that amount, 1.45 percent, is paid by employees.
One spouse would pay 1.45 percent of $450,000 which comes to $6,525. The other spouse would pay 1.45 percent of $150,000, which comes to $2,175.
An additional Medicare tax of 0.9 percent applies to earnings exceeding $250,000 for a married worker. (This tax was enacted as part of the Affordable Care Act.) The higher-earning spouse in this example earns $450,000 and thus pays 0.9 percent of $200,000, which comes to $1,800.
As illustrated in the table below, the higher-earning spouse pays a total of $20,260 in payroll taxes and the other spouse pays a total of $11,010 in payroll taxes. The couple’s combined payroll taxes for the year come to $31,270.
Effective Federal Tax Rate
The couple’s personal income tax of $152,513 plus their combined payroll taxes of $31,270 would equal a total of $183,783 in total federal taxes that they pay directly for 2022, which is 30.6 percent of their total income of $600,000. This is another way of saying that their effective federal tax rate would be 30.6 percent in 2022 under Biden’s plan.
As already explained, other households with $600,000 of income would likely pay less than the couple in this example, whose income is entirely from work and who, unusually for someone of their income level, claim the standard deduction.
This example demonstrates that the effective rate paid by a high-income household is typically significantly lower than the marginal tax rates that critics of Biden’s plan talk about.
Note on Current Tax Law Calculation
The tables below illustrate how federal taxes would be calculated under current law (rather than under the Biden plan) in 2022 for the same couple in the example above.
Under current law, the top personal income tax rate is 37 percent, but that rate applies to taxable income exceeding $635,150 in 2022, which is more than the couple in this example has. The highest personal income tax rate under current law that applies to this couple would be 35 percent.
As under the Biden plan, both spouses would pay Social Security taxes and Medicare taxes, but there would be no additional Social Security taxes paid on earnings beyond the earnings cap that applies under current law.
The total federal taxes paid by the couple would equal 29.6 percent of their income.
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