View Research by Author - Mohammed Adeel Saleem

Citation URL: http://www.urban.org/MohammedAdeelSaleem

The federal tax system often imposes its highest effective marginal tax rates on low- and moderate-income individuals. This paper suggests several ways to reduce those high effective marginal rates but illuminates the large trade-offs involved. One approach would replace the current earned income credit (EIC) with a $2,000 EIC for working parents and a refundable $1,000 per child tax credit. A more comprehensive approach would integrate the individual income and Social Security tax systems into a single tax system with just two tax rates and a refundable $2,000 EIC for working parents and a $1,000 universal grant for every person.

The Urban-Brookings microsimulation tax model is a powerful tool for federal tax policy analysis. The model calculates tax liability for a representative sample of households, both under the rules that currently exist (current law) and under alternative scenarios. Based on these calculations, the model produces estimates of the revenue consequences of different tax policy choices, as well as their effects on the distribution of tax liabilities and marginal effective tax rates (which affect incentives to work, save, and shelter income from tax). The model is also a useful input to research on the effects of taxation on economic behavior. This paper describes the tax model's data sources and details its underlying statistical techniques. We also explain the capabilities of the tax model's individual income tax calculator and describe how the model estimates and distributes corporate, payroll, and estate taxes.

The individual alternative minimum tax (AMT) was intended to guarantee that high income people paid at least some tax, but it is poorly designed. Absent a change in law, close to 30 million taxpayers will become subject to the AMT by 2010. This data update presents new data for the tables in our July 2003 Tax Notes article and expands on the reform options presented in the Spring 2003 Journal of Economic Perspectives article. We also briefly explain the tables.

Before 1984, Social Security benefits were exempt from income tax. As part of the Greenspan Commission reforms intended to bolster Social Security's finances, up to 50 percent of Social Security benefits became subject to tax in that year, with proceeds from the income tax allocated to the Social Security Trust Fund. In 2004, we estimate that there are more then 28 million households receiving Social Security benefits.

The President's Budget, released on February 2, 2004, admits that there is a problem with the AMT, but proposes only a small and temporary fix—extending through 2005 an existing temporary fix that currently expires at the end of 2004. This not only fails to resolve the problem, it also substantially reduces the apparent budgetary cost of the President's main proposals to make the 2001 and 2003 tax cuts permanent (because taxpayers on the AMT will get less benefits from the rate reductions).

In the U.S. federal income tax system, the effective marginal tax rates and the average tax rates vary significantly from the statutory tax rates. These differences are important since they influence the incentives to work, save and to comply with the tax system. This article measures these differences for single individuals and families with different income levels and discusses why these differences exist. Often, hidden taxes and subsidies interact, making the effective marginal tax rate an amalgam of different effects.

How do the 2001 and 2003 tax cuts affect families and tax return filers? What are the tax consequences of having children or being middle-income? The following discussion addresses these questions for an array of families with varying income, number of children, and marital status, for tax year 2003. The table shows the combined amount of tax cut each hypothetical household received from the 2001 and 2003 tax cuts at different levels of adjusted gross income (AGI).

An individual's marginal tax rate--the additional tax that would be owed on an additional dollar of income--is an important indicator of how the tax system affects incentives to work, save, and comply with the tax system. It is natural to think of marginal tax rates as identical to the statutory tax rates--currently 10, 15, 25, 28, 33, and 35 percent--but this is not true for many people.

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