Marginal Tax Rates

Should five percent appear too small
Be thankful I don't take it all
--The Beatles

Prof John Cochrane at the Univ of Chicago offers some brief thoughts on marginal tax rates. Marginal tax rates are the penalties associated with bringing in streams of economic resources. Those resources may be brought in via production or via transfer payments from others' production.

The top marginal federal income tax rate is currently 35%. For unmarried individuals, this means that 35 cents out of each dollar earned in excess of $388,000 goes to the federal government.

Marginal tax rates are not just a concern for producers trying to determine how much of their production that they will be able to legally keep. Marginal tax rates are also a concern for people who are living fully or partially off the production of others. Because transfer payments phase out with rising income, personal production that exceeds these phase-out points serves as a tax--i.e., it reduces the incoming stream of economic resources.

Thus, people on welfare must worry about marginal tax rates as well. The marginal tax in their case is the loss in transfer payment income incurred when production income increases. If the marginal tax rate is high enough, then it serves as disincentive for getting off the dole.

Cochrane also observes that all taxes must be considered in marginal tax rate calculations - federal, payroll, state, local, sales, excise, and phaseouts. Cochrane suggests this CBO study as one that sheds some light on marginal tax rates facing lower income individuals.

The overarching point here is that in any social system where wealth is redistributed to some degree, both producers and non-producers face marginal tax rates that influence incremental economic calculation.