5

The US administration seems to be suggesting that that the personal income tax code would be "better" with three tax brackets rather than the current seven. So what are the advantages?

0

2 Answers 2

4

I don't think the breakpoints for the new brackets have been released yet, but given that the standard deduction is being doubled and that the current highest bracket of 39.6% is being eliminated, the effect is probably a tax cut. This in line with the other policies listed like eliminating the estate tax or the 15% corporate rate proposed. But since your question seemed to be about tax brackets in the first place, and why 3 brackets would hypothetical be better, I'll talk about that instead.

This lists the current brackets and their rates. So for example, if someone earns $20,000 they would be taxed at 0.1($9,325)+0.15($10,675)=$2533.75 (ignoring any possible deductions). This means that the leading portions of income are taxed at a lower rate that the trailing portions of income. The theory behind tax brackets, in which different portions of income are taxed at different rates is based on the idea of money having marginal utility. That is to say, the more money that an individual accumulates, the less value an additional unit of money will have to that individual. This is intuitively obvious when looking at any number of examples; a billionaire gaining another million dollars would not experience an appreciable change in his or her life, while $1000 might make a huge difference to someone in poverty. If you accept the marginal utility of money as a premise, then tax brackets are obviously a good thing so long as the value of governmental goods and services exceed the value of the money being taxed. In that case, even having something like a logarithmic tax curve would be better since it could track marginal utility more closely.

Having 3 brackets instead of 7 would make any attempted tracking of marginal utility harder. More brackets that apply to all income (including capital gains), would be better than less. Given how the Trump plan has been presented so far, its probably just a tax cut under the guise of making things "simpler". The reduction of number of brackets wouldn't even do that though since the calculation of personal taxes is pretty much all about deductions, which aren't even complicated for the vast majority of people.

4
  • If someone earns $20,000 after deductions of $10,000, their employer (since employers actually withhold taxes) would actually pay $7123.75 in tax (assuming your calculations are correct), as the employer would pay $3720 in Social Security tax plus $870 in Medicare tax in addition to the income tax withholding.
    – Brythan
    Sep 30, 2017 at 8:37
  • It was an example meant to removed all extraneous variables so I can explain tax brackets since most people have no idea what they are at all (hence the assumption of only income taxes, no deductions and selecting a simple number only crossing two different rates). Taxes are complicated, I'm just saying that tax brackets aren't why they are complicated.
    – Teleka
    Sep 30, 2017 at 9:29
  • 3
    Agree that tax brackets aren't the reason tax preparation is complicated. What I fear is that the average citizen hears "reduction in number of tax brackets" , focuses on the word reduction and concludes that the number of tax brackets will lower his tax burden.
    – BobE
    Sep 30, 2017 at 16:45
  • 1
    @Brythan The subject question relates only to Federal Income Tax, SS tax and Medicare Tax are outside the scope of the original question on reducing the number of brackets.
    – BobE
    Oct 2, 2017 at 0:16
2
  1. It's easier to say what the tax rates are: 12, 25, 35. Can you tell me what they are now? I had to look (because I only remembered six):

    10, 15, 25, 28, 33, 35, 39.6

    Perhaps that's a trivial advantage, but it feeds into the next advantage.

  2. It makes it easier to predict what your marginal tax rate is before you'll make it. Because along with the fewer rates, there are fewer points where the rate switches. Remembering where they switch is even more difficult than remembering the rates, as it looks more random and changes annually.

    Of course, predicting your rate only matters in budgeting and planning, when you can't just fill out the forms and calculate your actual tax. You need to understand how the rates work to make the budget. For small decisions, this isn't a big deal. Your next $100 will likely have just one marginal rate. For bigger decisions, this matters more.

    For example, you might be choosing between working on Wall Street in a high stress, high pay job or working in the rural or suburban South at a much more moderate pay and lower stress. That decision could cross multiple tax brackets, say from 39.6% down to 15%. Of course, most people don't make such extreme changes, so it will be of limited use.

  3. In particular, it avoids the current idiocy of a tax rate that applies only to people in the range $416,700 to $418,400 (single filer; same source). So there are three different tax rates in an income range covering just $1700. Why bother?

    It's $78.20 less than starting the next bracket early or $34 more than keeping the previous bracket. Extending the 33% bracket by $1100 (-$22) and starting the 39.6% bracket $600 early (+$27.60) would roughly even out. An extra $5.60 from each of the people above that range. Everyone more than $120 below $418,280 and above $417,700 would pay less. The government would come out slightly ahead without making anyone more than $5.60 worse off.

  4. More brackets means more ways to make mistakes and more difficult to see the mistakes.

    In order to calculate tax, you either need to do a bunch of multiplications to get the tax for each bracket, or you use a bracket table where the multiplications were already done for you. If you use a bracket table, then it is not that hard to copy the number wrong with seven rates. Your rate will be somewhere in the middle. Do you grab the fifth number? Or the fourth? Or was it the sixth? Make a mistake, and the IRS can charge you interest and penalties when they get around to noticing it.

    With three brackets, that's much more difficult. If you're in the last bracket, that's easy to see. Or if you're in the first bracket. If you're in the second bracket, then you know you aren't first or last. It's harder to make a mistake, because the numbers will be more distinct, e.g. from something like $0 to $15,000 to $80,000. If you use the wrong number, it will look wrong immediately.

10
  • 4
    Tax payments for the vast majority of people being paid a wage as their primary or only income is already known by the IRS. Pretty sure your 1040 doesn't care whether there are 7 or 3 brackets, it doesn't make things simpler for most people because refunds are from deductions.
    – Teleka
    Sep 30, 2017 at 7:53
  • 1
    I'm saying that it makes it easier to know what your tax will be before you earn the money, not that it will be easier to fill out tax forms.
    – Brythan
    Sep 30, 2017 at 7:57
  • 2
    @Algid It removes terms from your simple tax calculation: Instead of (a * x) + (b * y) + (c * z) + (d * w) + (e * v) + (f * u) + (g * t) you will have (a * x) + (c * z) + (f * u). It is certainly a simplification. Whether it is enough of a simplification to be worth bothering with, or whether this is the best place to make a simplification is opinion.
    – user9389
    Sep 30, 2017 at 8:46
  • 2
    @BobE No. My point is that if the next $100 is taxed at 15%, then you're really only getting paid $85. If it's taxed at 35%, you're only getting paid $65. If it costs $75 in extra childcare costs to work, that makes the difference between making money or losing money. Even without the childcare, someone who would work for $85, might not for $65. I am explicitly not claiming that there is any transition that would cause someone to lose money in the modern tax code (there still are in welfare programs but that has nothing to do with income tax brackets).
    – Brythan
    Sep 30, 2017 at 19:59
  • 4
    @not store bought dirt - or you can look it up - no calculations needed until your line 43 exceeds $100,000 then you have to do 1 multiplication and one subtraction - easy peezy.
    – BobE
    Oct 1, 2017 at 4:20

Not the answer you're looking for? Browse other questions tagged .