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Abstract

This article examines variations in tax liability and tax rates confronting typical families as income and the number of children change for tax year 2006. Although the examples represent very simple tax situations, they illustrate how hidden taxes and subsidies can make the marginal tax rate an amalgam of different effects. Often, the effective marginal tax rates and average tax rates can vary significantly from the statutory tax rates because of the phase-ins and phase-outs of deductions and credits, the individual alternative minimum tax, progressive tax schedules, and other aspects of our income tax system.

Introduction

This article examines how much income tax families pay in different situations, as well as the effective marginal tax rates they would pay on additional earnings, for tax year 2006. Although the examples represent very simple tax situations, they illustrate several key aspects of our personal income tax system. For example,

• Effective tax rates often differ substantially from statutory tax rates because of phaseins and phase-outs of deductions and credits and because of the individual alternative minimum tax.
• Average tax rates are always less than statutory tax rates because tax schedules are progressive and because deductions and credits reduce tax liability compared with a flat tax with no exemptions.
• The individual alternative minimum tax substantially changes effective marginal tax rates (and tax liability) for upper-income households and those with many children. However, millionaires with relatively simple tax situations are exempt from the tax.

The tables in this article illustrate the variations in tax liability and tax rates confronting typical families as income and the number of children change. Table 1 shows total taxes and average tax. Taxpayers subject to the individual alternative minimum tax (AMT) are indicated by dark shading. The AMT rate and AMT liability for taxpayers subject to the AMT are presented in table 2. The statutory income tax rate (the tax bracket) and the effective marginal tax rate for the same families are shown in table 3. Last, table 4 lists the effective marginal rates presented in table 3 and shows how interactions in the tax code combine to create them.

The families presented in this paper are assumed to file relatively simple returns. Filers are neither blind nor elderly; income is comprised solely of earnings, capital gains, and dividends; potential itemized deductions equal 21 percent of income, and the taxpayer claims the larger of their itemized deductions or standard deduction and no other deductions; all children are potentially eligible for dependency exemptions, the earned income tax credit (EITC) and the child credit (CTC); and the filer claims no other credits. Though many of the complexities in the individual tax return have been assumed away in this analysis, most households file relatively simple returns like those described here, and plenty of interactions remain to create large variations in tax liability and the effective tax rates on such returns.

Note: This report is available in its entirety in PDF Format.

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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