Asymmetrical Information - Megan McArdle

11.20.12

More On That Wrinkly Tax Code

Thanks to the tax code, sometimes work really doesn't pay

Reader Mark writes in to highlight some of those EITC problems I spoke of earlier:  

One short story about those tax wrinkles at the EITC range.   I’m a former MBA/Finance type who is now a congregational pastor.  So, the income goes from six figures to the $50,000 range.  Wife, 3 small kids, housing allowance tax exemptions (another wrinkle) and you easily end up in the EITC range.  What I usually depend upon is the tax credits from the kids and the EITC to offset the SE tax.  The last three years I am fully in that 47% who pay nothing – unless you count the 15.4% SE tax, the NY property tax, and the 8% sales tax which basically applies to everything I make.   A couple of years ago I forgot a $900 1099 when filing .  I actually didn’t forget, I just didn’t get a copy to remind me.  But about a year later the IRS did get one.  So they said first that I owed $5,000.  They got there by adding the $900 and canceling all the credits.  When I refilled adding the credits back the total owed was $914.  For the extra $900 of income on that 1099, the phase out of primarily the EITC put my marginal rate at about 102%.  I figure I have about a $4000 window where I am truly indifferent as to whether I receive a higher salary or not.  That effects all types of things.  Would my wife like to work for the local FEDEX hub this Christmas season to earn a little for more toys?  Yep.  Does it make sense?  No, because each dollar she earns for the next $4000 we just give to the federal government and that doesn’t include the increased state and local taxes.

Now, if the GOP would like to cement a generation of voters that would keep them in office and make them competitive in places like OH, NY and PA, end the injustice of the current tax code and make it easy to be a citizen instead of having that sinking feeling that you are both getting hosed and probably a felon at the same time.  And guess what, it’s the right thing to do.  Too bad the donor base is addicted to tax breaks and crony capitalism instead of the good of the nation.  

This is an enormously tough problem with the EITC.  I support the idea that our tax code should support low-wage work.  But the phase-outs create large income ranges where raising your salary doesn't make you noticeably better off--may even make you worse off.  It's sort of a miracle that anyone manages to break through those ranges into higher tax brackets.