Saturday, March 14, 2009

The myth of tax brackets

I'm basically just venting here out of frustration, but I am hoping someone, somewhere with a bigger platform than KP will eventually start to discuss the myth of tax brackets. Tax brackets exist, certainly, but the endless layers of different tax credits and phaseouts pretty much moot their value for any sort of relevant discussion. For example, this opinion piece defending Obamanomics, which I frankly do not recommend reading unless you are prepping for a nap, makes quite a fuss about tax brackets and their historical fairness. At first glance, it makes a strong argument that tax brackets have not changed that much over the last couple of decades.

The problem is (and here I turn to personal venting) tax credits and their phaseouts skew the tax burden immensely. For example, GammaGirl and I have been thinking about buying a home, and we got pretty excited about the $8000 tax credit available to first-time buyers. But then we read the fine print, and as with every other tax credit , we are phased out....

Are there any income limits for claiming the tax credit?
Yes. The income limit for single taxpayers is $75,000; the limit is $150,000 for married taxpayers filing a joint return. The tax credit amount is reduced for buyers with a modified adjusted gross income (MAGI) of more than $75,000 for single taxpayers and $150,000 for married taxpayers filing a joint return. The phaseout range for the tax credit program is equal to $20,000. That is, the tax credit amount is reduced to zero for taxpayers with MAGI of more than $95,000 (single) or $170,000 (married) and is reduced proportionally for taxpayers with MAGIs between these amounts.

The flip side is that someone with zero tax liability gets sent a check by the government...

I read that the tax credit is "refundable." What does that mean?
The fact that the credit is refundable means that the home buyer credit can be claimed even if the taxpayer has little or no federal income tax liability to offset. Typically this involves the government sending the taxpayer a check for a portion or even all of the amount of the refundable tax credit.

For example, if a qualified home buyer expected, notwithstanding the tax credit, federal income tax liability of $5,000 and had tax withholding of $4,000 for the year, then without the tax credit the taxpayer would owe the IRS $1,000 on April 15th. Suppose now that the taxpayer qualified for the $8,000 home buyer tax credit. As a result, the taxpayer would receive a check for $7,000 ($8,000 minus the $1,000 owed).
This is just one example. There are a multitude of tax credits out there. I would guess that with enough of them lumped together, someone with a minimum tax liability could probably "earn" themselves a check of close to $15-20K from the government. How is that not income redistribution?

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