Effective Marginal Tax Rates for Low- and Moderate-Income Workers

November 15, 2012

Effective marginal tax rates among low- and moderate-income workers are about 30 percent, on average, with about one-third of that rate stemming from the federal income tax, more than a third from federal payroll taxes, and the remainder from state income taxes and the phaseout of SNAP benefits.

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The effective marginal tax rate is the percentage of an additional dollar of earnings that is unavailable to a worker because it is paid in taxes or offset by reductions in benefits from government programs. In part, such rates are determined by income and payroll tax rates and other features of the tax system, such as tax credits and deductions that depend on earnings. However, effective marginal tax rates are also determined by programs providing cash and in-kind benefits, referred to as transfers, that target assistance to people of reduced means. Because increases in earnings for low- and moderate-income workers can cause relatively large reductions in such assistance, this analysis of effective marginal tax rates (hereafter referred to as marginal tax rates) focuses on those workers. Those rates affect people’s incentives to work: All else being equal, people tend to work fewer hours when marginal tax rates are high.

To examine the distribution of marginal tax rates across households, CBO simulated tax liabilities from income and payroll taxes and benefits from the Supplemental Nutrition Assistance Program (SNAP, formerly known as the Food Stamp program) using a sample of tax returns from 2006 supplemented with information from household surveys. Benefits from SNAP were included in the analysis because it is a widely used program with cash-like benefits that can be calculated using information from household surveys; including additional programs would generally increase estimates of marginal tax rates.

Working Taxpayers with Income Below 450 Percent of Federal Poverty Guidelines Face a Marginal Tax Rate of 30 Percent, On Average, Under 2012 Law

Some provisions of taxes and transfers, such as statutory income tax rates and federal payroll taxes, affect most workers. (Statutory income tax rates are specified in law and apply to the last dollar of earnings.) Other provisions, such as reductions in tax credits and SNAP benefits, affect fewer people but result in relatively high marginal tax rates for those affected.

  • Federal Individual Income Taxes. Under the federal income tax system, workers with income below 450 percent of federal poverty guidelines (commonly known as the federal poverty level, so abbreviated as FPL) face, on average, a marginal tax rate of 11 percent. (Poverty guidelines vary by household size; in 2012, the guideline for a household of four is $23,050.)
  • Federal Payroll and State Individual Income Taxes. For most low- and moderate-income workers, payroll taxes cause marginal rates to rise by about 12 percentage points. State income taxes contribute a modest amount to marginal rates, on average.
  • Reduction of SNAP Benefits. For recipients, the reduction in benefits that occur as income rises adds an average of 25 percentage points to their marginal tax rates. However, CBO estimates that under 2012 law, only about 18 percent of taxpayers in the group it studied receive SNAP benefits. As a result, SNAP increases marginal tax rates for the group as a whole by only 5 percentage points.

The combined effect of federal and state individual income taxes, federal payroll taxes, and the reduction of SNAP benefits results in an average marginal tax rate of 30 percent among working taxpayers with income below 450 percent of FPL.

Share of Returns Filled by Low- and Moderate-Income Workers, by Marginal Tax Rate, Under 2012 Law

Marginal Tax Rates Vary Across Taxpayers’ Earnings Levels and Among Taxpayers with Comparable Earnings

Marginal tax rates depend on taxpayers’ financial characteristics (such as income), their nonfinancial characteristics (such as the presence of children in the family), and whether they participate in means-tested programs. Survey data show that the majority of lower-income families do not receive means-tested transfers, either because they do not meet additional, nonfinancial eligibility requirements or because they are eligible but do not apply for benefits. Of those who receive transfers, the majority participate in only one program.

Marginal tax rates vary across earnings levels, with the differences driven largely by provisions in the federal income tax system, particularly the earned income tax credit. Marginal tax rates also vary substantially for taxpayers with comparable earnings because of many other factors, such as their marital status or the presence of children. For taxpayers with earnings below 50 percent of FPL in 2012, 43 percentage points separate the 10th percentile and 90th percentile of marginal tax rates (see figure below).

Range of Marginal Tax Rates Between the 10th and 90th Percentiles, by Earnings Group, Under 2012 Law

Various Provisions of Current Law Will Cause Marginal Tax Rates Among Low- to Moderate-Income Workers to Rise, On Average, to 32 Percent in 2013 and to 35 Percent in 2014

Under current law, the reductions in individual income taxes that were extended by the 2010 tax act will expire at the end of 2012. As a result, statutory income tax rates will increase in 2013 and certain refundable tax credits will shrink or be eliminated. In addition, the temporary reduction in payroll taxes in effect in 2012 will end. Consequently, for the taxpayers in the group CBO studied, the marginal tax rates arising from the combined effects of tax provisions and SNAP benefits will increase from 30 percent in 2012 to 32 percent in 2013, on average.

Under provisions of law that are scheduled to go into effect in 2014, some people will become eligible for refundable tax credits to help cover the cost of health insurance. The value of the credits will decline as income rises. CBO estimates that 11 percent of taxpayers in the group CBO studied will receive premium assistance credits in 2014, which will increase their marginal tax rates by an average of 12 percentage points. Along with new subsidies for cost sharing under health insurance policies, the marginal tax rate for taxpayers in the group CBO studied will rise from 32 percent in 2013 to 35 percent in 2014, on average.