There Isn’t a “Stealth Tax Bracket” in the House Tax Reform Bill

By Ryan Ellis

Forbes

November 4, 2017

 

Over the last couple of days, there has been an unhinged response to the high income bracket phaseout contained in the House tax reform plan. It works like you see below:

You’ll notice there is a “bubble rate” in there which appears to create a bracket higher than the top bracket of 39.6 percent. The only purpose of that rate (which is really a calibrated 6 percent phaseout wedge on incomes exceeding $1.2 million for married couples and $1 million for everyone else) is to deny high income taxpayers the benefits of the 12 percent bracket. It really shouldn’t be considered a tax rate per se, but more like the clawing back of a prior tax rate, the 12 percent bracket.

The “bubble rate” is just deep enough to deny the benefits of the 12 percent bracket to those well into the 39.6 percent bracket. For those who have traversed all the way through the bubble rate, their bracket structure looks more like this:

See what happened there? The 12 percent bracket instead becomes 39.6 percent for those filers making more than $1.2 million ($1 million if unmarried).

Win One for the Gipper?

The Wall Street Journal editorial page, which routinely calls for working poor people to be put back on the tax rolls and for child tax credits to be repealed for middle class parents, isn’t happy about denying millionaires the benefits of a 12 percent rate on their first $90,000 of income. They even invoked President Ronald Reagan in opposition:

With its new bubble bracket, the GOP is repudiating Reagan’s reform and bringing the top income-tax rate back to 50%. Voters might as well have elected Hillary Clinton.

There’s just one problem here: Reagan’s tax reform featured a bubble rate, too.

The 1986 Tax Reform Act had a similar structure to what you see in the House tax reform bill. The Tax Reform Act had a personal income tax rate structure that looked like this:

What’s that in there? That 33 percent bracket? That would be a bubble rate. It denied the benefits of the 15 bracket to those well within the new 28 percent bracket, and then stopped. The result for very high income earners was a 28 percent flat tax from dollar one of taxable income.

That’s much more draconian than what is in the House tax bill, whose bubble rate still lets high earners retain the middle brackets’ progressivity. The House bill’s bubble rate only denies the first, 12 percent bracket, and then stops.

To this day, the 1986 Tax Reform Act’s creation of a bubble rate persists in the corporate income tax. In fact, there are two bubbles in there:

Class Warfare Republicans?

Is all of this class warfare, and are Republicans succumbing to liberal mush-minded thinking on “taxing the rich?” Not according to the distribution table put out by the Joint Tax Committee yesterday:

I’ve even circled the key figures.

Under the plan, and including the much-maligned bubble rate, the share of federal taxes paid by millionaires actually declines slightly from 19.3 percent to 19.2 percent of all taxes paid. The average tax rate (taxes/income) of millionaires declines from 32.5 percent to 29.9 percent.

Lest people think I’m cherry picking a year, that effect is seen in every year chosen by JCT: the share of federal taxes paid AND the average tax rate paid by millionaires DECLINES in each year relative to current law.

Flip to the end of the report and you’ll see that millionaires get a 2019 tax cut of $41.6 billion in that year alone–almost half from personal income tax cuts.

AND THIS IS WITH THE BUBBLE RATE. It appears to me that the bubble rate could go even further, denying the benefits of the 25 and 35 percent brackets to these top taxpayers, and we might still see a decline in their share of federal taxes paid and their average tax rate (or at least no change relative to current law).

If this is class warfare, I’d hate to see tax cuts for the rich.

What about complexity?

Some have made the argument that everything above is just too complex for the average taxpayer.

Well, they are right.

That’s why the bubble rate doesn’t affect the average taxpayer, or anything close to the average taxpayer.

In fact, the bubble rate only affects those taxpayers in the top one-tenth of one percent (0.1 percent) of all taxpayers, according to the IRS. That’s fewer than 140,000 taxpayers at the very tippety-top of the income distribution. Guess what? All these people already have tax preparers and will have tax preparers in any form of tax reform. What looks complex to mere mortals is child’s play compared to the complexity these taxpayers deal with on an annual basis. This won’t even cause them to break a sweat.

So don’t worry–they’ve got this. I should know–I prepare taxes for these people and am an Enrolled Agent.

Simplification is not a goal for the uber-wealthy or for multi-national corporations. Simplification is a goal for the 90 percent of normal families who just want to make sure they have a clean and transparent April 15th every year without having to hire an accountant, go to a storefront, or pay for software to figure it all out.

So Why a Bubble Rate?

There are several reasons friends of tax reform should tolerate, if not embrace, a bubble rate concept:

1. It happens in the context of tax cuts for everybody, including those making more than $1 million per year. No class warfare. Everyone is getting tax relief under this plan.
2. It has the pedigree of Ronald Reagan’s 1986 Tax Reform Act, and didn’t come crawling out of some left wing think tank.
3. It raises $50 billion-$100 billion in the ten year budget window (according to various reports), and that matters when the budget only lets us cut taxes by $1.5 trillion in that window. That’s money available to reduce the corporate rate, enact full expensing, or kill the death tax
4. Think about this for a minute: will someone making $2 million per year really care, on the margin, what their tax rate was on their first $90,000 of income? All economic decisions happen on the margin, and the top personal marginal tax rate in tax reform remains 39.6 percent. They certainly won’t care about the complexity, and neither will their tax accountant.