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Wednesday, November 28, 2012

A Tax Bubble? Really?

As a general rule I try to stay away from using my blogging perch to fulminate about current events or policy issues beyond my legal expertise (but see, e.g.here).  But, to channel Emily Litella, what's all this I keep reading about a tax bubble?  Is the idea really to do away with some of the marginal nature of tax rates, and make some steps in the tax rates applicable to all the income the person crossing that step earns?  

I'm not certainly not an expert on this -- I didn't get past baby tax in law school (and even that was at Yale).  But even I could figure out that this seems to mean that, as soon as an income earner crosses an income threshold, that extra dollar of income actually means more than a dollar rise in her taxes.  

Are people seriously talking about this? If so, why?  Is it just a sad attempt by some Norquist dead-enders to be able to claim that they refused to raise actual tax rates?  Or am I missing something?  I'm really truly confused by this.  I have heard that there have been bubbles in the past, although I've also heard that at least some of them grew out of phased withdrawals of deductions (a concept whose effect in the bubble context already stretches my knowledge of tax law).  Is there any sane policy reason for this approach?  If not, what's the reason?

Posted by Bill Araiza on November 28, 2012 at 07:07 PM | Permalink


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From the details I've read, it isn't being designed to produce a tax cliff that would yield significantly less net income for any marginal income. Rather the idea is to play with combinations of phasing in and out different aspects of the code to produce a new marginal bracket while maintaining the ability to claim that they aren't raising that maximum marginal rate.

Of course there is always the possibility that the various provisions will interact in unforeseen ways.

Posted by: brad | Nov 29, 2012 12:01:23 PM

The bubble occurs under the Buffett rule because above a certain point of income you need to start taxing at a higher than "normal" rate to get rid of the benefit of the lower rates on the first 400K or so of income (or,if instead of the Buffett rule, you're taking away deductions, to get rid of the benefit of those deductions). Then, once you've gotten rid of all of the benefit of the lower rates (or deductions), you revert back to the normal rate on the rest of the income. The bubble is not really intentional, just a byproduct of getting rid of tax benefits on the nonmarginal income.

Some tax theorists actually suggest declining marginal rates on the theory that high earners' income is more elastic (i.e., they have greater flexibility to retire or work less or and ability to play games to avoid tax). I don't think this sort of thinking is directly driving the Buffett rule momentum, but concern about the behavioral effect of high marginal rates on top earners is what makes it hard to simply raise marginal tax rates at the top, which makes the Buffett rule a more attractive alternative to some.

Posted by: Gregg | Nov 29, 2012 11:22:10 AM

I don't know what number the cliff's edge is, but it's logically conceivable to design it to impact few workers and investors. If the distortions occur at a high enough income band, it is not about hourly employees or the rich. It is, as a prior commenter suggested, more of a problem for the upper middle class. Probably some small businesses at the edge would be affected. On the other hand, no rational person is going to choose $100k over $1m because they had to pay a surtax of, say, $40k.

We tolerate steep marginal rates on the poor, if you count benefit and credit phaseouts and marriage penalties. That doesn't mean it's wise, of course.

Posted by: anon | Nov 29, 2012 10:21:16 AM

Even if the marginal rate in the bubble is less than 100%, it'll be higher than the top marginal rate -- and no, there is no sound policy reason for this, save one: Protect the interests of the very, very wealthy, as against the interests of the merely wealthy.

This means you, successful lawyers -- yes, you, earning $300k or $500k or even $1M a year -- are in trouble. Some erstwhile defenders of your class are now trying to throw you under the bus in order to keep rates from going up on the really important people, those super-rich few with annual incomes in the eight or nine figures (tens or hundreds of millions).

Posted by: anon | Nov 29, 2012 2:27:19 AM

That is not how a "tax bubble" would be implemented. See here for explanation: http://fivethirtyeight.blogs.nytimes.com/2012/11/26/congressional-proposal-could-create-bubble-in-tax-code

Posted by: CKL | Nov 28, 2012 9:39:45 PM

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