In an era of rising taxes, how do tax marginal rates affect tax payers? What’s more, how do high-income tax payers avoid taxation? After all, they have more money to hire tax attorneys and accountants, so they might not be affected by a change in marginal rates. The top 1 percent of income earners reportedly get most of their income from capital gains, so any increase in the marginal rates on wages would need to be accompanied by special rates on other sources of income.
One way to look at the effect of changing marginal tax rates is to compare them to the rate of inflation. The higher-income groups are most responsive to tax changes, so a system with declining marginal tax rates is more desirable. In addition, higher-income taxpayers generally have higher sensitivity to tax changes, which makes a rise in marginal tax rates necessary to justify the higher rates. Nonetheless, this does not make the tax system more progressive.
The Organization for Economic Cooperation and Development provides data on the top marginal tax rates. According to the OECD, the U.S. top marginal rate was 46 percent in 2020, including state income tax and social insurance taxes. In comparison, Alaska’s combined top marginal rate was 22nd highest among OECD countries. If you think that the federal rate is high enough, it’s probably a mistake.
Comparing marginal tax rates over time is difficult. The value of tax expenditures has significantly changed over time, and thus it’s difficult to compare the rates in the same period. For example, a taxable income of $150,000 in 1991 is much different from the same taxable income of $150,000 in 2021. Moreover, there are differences in the tax rates according to family composition. This is because in the same period, income levels are similar, but taxable rates are not.
The same data are not available for the small businesses, which may be more exposed to taxes. However, their experiences could be useful in revenue projections. For instance, large taxpayers are more likely to be diverse than small taxpayers, and so size-specific elasticity estimates are more relevant. For that reason, they can be obtained from the experience of large businesses. Even if these estimates aren’t as useful as those for small businesses, the method would still be an improvement over the aggregate estimates.
Basically, tax marginal rates are the percentage of taxable income that each taxpayer pays in taxes. These tax rates affect millions of individual taxpayers. In the United States, the federal marginal tax rate increases for every additional dollar that an individual earns. Thus, the higher an individual’s income, the higher their marginal tax rate. If this rate is lower than their effective tax rate, it is less.
Although these data are not definitive, they do suggest that a modest tax rate encourages the development of the private sector and formalization of businesses, especially small and medium-sized enterprises. SMEs are responsible for between 25 and 35% of the nation’s tax revenue, and high tax rates discourage them from operating. In addition, these businesses are more likely to move into the informal sector or cease operations.
