## Tuesday, March 3, 2009

### And that's why they call them "marginal" tax rates

Media Matters highlights a baffling bit of nonsense in an ABC News report on Obama's plan to raise taxes on individuals making over $250,000: "According to ABC, one attorney "plans to cut back on her business to get her annual income under the quarter million mark should the Obama tax plan be passed by Congress and become law." According to the attorney: "We are going to try to figure out how to make our income$249,999.00." ABC also quotes a dentist who is trying to figure out how to reduce her income.

This is stunningly wrong.

The ABC article is based on the premise that an individual's entire income is taxed at the same rate. If that were the case, it would be possible for a family earning $249,999 to have a higher after-tax income than a family earning$255,000, because the family earning $249,999 would pay a lower tax rate. But that isn't actually how income tax works. In reality, a family earning$255,000 will pay the higher tax rate only on its last $5,001 in income; the first$249,999 will continue to be taxed at the old rate. So intentionally lowering your income from $255,000 to$249,999 is counter-productive; it will result in a lower after-tax income.

The people ABC quoted don't seem to understand that. Worse, ABC doesn't seem to understand it, either."

According to standard economic theory (in fact, it's principle #3), people make decisions at the margins. So if the marginal income tax rate goes up for income above $250,000, I might decide that it's not worth it for me to work an extra hour if my wage for that hour is taxed beyond a certain point. But if all the other marginal rates stay the same, why would I try to bring my income down below the threshold? I think the real question is how people this dumb can make$250,000 per year?

(HT: Paul Krugman)