A little late for tax season.
In response to an article at the NBER highlighting the difference between income inequality and consumption inequality in the states I decided to look into effective federal tax rates as a function of income.
If you look at the effects of the earned income tax credit the EITC which has been called the most effective (ahem) welfare program in the US (and recently written about byMankiw and Greenstein) then for poor people with children income after taxes and credit is over 50% greater than earned income financing quite a bit of the NBER’s consumption-income gap (other programs-like food stamps and housing assistance-and off the books income closing the rest).
Why not an even broader estimation of the effects of federal income taxation and benefits though?
Why not include unemployment taxes, and “employer contributions” to medicare and social security in addition to Gross income, exemptions, deductions, personal FICA, EITC, and refundable child tax credits?
I assume a very simple tax return:
- standard deductions only
- no capital gains
- no AMT
- no state taxation
Then compute the effective tax rate from zero to a million dollars. Realizing that employers employ others only if they produce more than the costs of employment salary and overhead included.
Money an employer allocates to salary must also cover the hidden taxes of unemployment and FICA, money the employee would otherwise receive. Therefore I sum total taxes paid “by the employee” and “on behalf of the employee” and refundable credits received by the employee and divide by gross wages plus taxes paid “on behalf of the employee” to come up with the effective tax rate. The y-axis of the chart is the effective federal tax rate as a function of the x-axis (compressed roughly logarithmically) which is nominal gross income.
Naively the blue line is how much you benefit/detriment as a result of tax and refundable credits. But, the blue line fails to account for unemployment and “employer” FICA. The Orange line is how much money one would be compensated in the absence of any government intervention. Where the blue line crosses the orange line (Which is the same as where the green line crosses 100%) is the break even point, households left of this don’t pay (income) taxes, people right of this do. The x-axis is properly log scaled now.
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