When I quit my job to become a full-time freelance writer, little did I know the rude awakening that would befall me a year later. April 15, 2002 taught me that for every additional $100 I earn, I keep only about $53. And the more I earn, the less I keep. Talk about a disincentive to hard work.
TurboTax (or any other tax preparation software) is a nifty little tool. After it calculates your taxes, you can go back and plug in different income numbers to see what your tax would have been if you earned, say, $100 more. Even with my modest earnings, an extra $100 in self-employment income means $41 in additional federal income and Social Security/Medicare taxes. Tack on another $5.30 for state taxes. And that doesn't even include local taxes.
The tax albatross is enough to make me want to give up this self-employment stuff and get a regular job again. At least when you're on someone else's payroll, you ostensibly don't have to pay the full 15.3 percent Social Security and Medicare tax. (I say ostensibly because the employer pays half of that tax, although you end up paying it anyway through a lower overall salary than would otherwise be the case.)
Meanwhile, a TurboTax experiment showed that my marginal tax rate would be 34.3 percent were I single versus the 46.3 percent married rate. Now that's what I call a disincentive to getting or staying married. (Don't get me wrong. In my own case, love conquers all. But for other folks, it may not.)
To be sure, don't confuse marginal tax rates with overall tax rates. A couple's overall effective tax rate could be 15 percent, but their marginal effective tax rate could be 45 percent. For example, a combined income of $50,000 could mean an overall tax bill of $7,500. But, say the couple earns $51,000 the next year, bringing the overall bill to $7,950. That's an extra $450 in taxes for that additional $1,000 in self-employment income, for a marginal rate of 45 percent.
No one can argue with the fact that our tax code hurts the institution of marriage. But what about the institution of work? Some economists believe that high tax rates actually encourage work by prompting people to try to make up for all the money taken away in taxes. I grant that this is plausible. Observing my own behavior, I have to admit that one part of me wants to give it all up, while another part of me wants try to earn six figures after all, even if 50 percent of $150,000 is taxed away, $75,000 is still a respectable sum. (I jest. A freelance writer earning six figures? Get real.)
But high tax rates discourage work far, far more than they encourage it. To prove it, take a real-world phenomenon that has much the same effect as marginal tax rates. To motivate employees, some employers institute a sliding-scale pay system the more one sells, the higher the pay-per-unit. For example, a car salesman may get a 15 percent commission for each of the first 10 cars he sells, but for the 11th car and above, he gets a 20 percent commission. That's a big motivation to work harder or smarter.
Under our tax system, by contrast, the more one sells the less money one gets to keep. If anyone thinks this arrangement makes people work harder, I suggest talking to that car salesman.
High tax rates may not prompt me, at this point, to quit working. But it is a sure thing that millions of other Americans are prompted to either quit working, go out of business, not start a business at all, or not go back to school if higher pay only means higher tax rates.
This represents staggering amounts of goods and services that do not come into existence because of the tax code. And the amount of goods and services per person is the No. 1 factor that determines a society's quality of life. (Note to anyone who disagrees with that last point: If this were not the case, then millions more people would be leaving the developed world than trying to get into it.)
President Bush's tax cut is only a drop in the bucket. Yes, it's $1.3 trillion over 10 years, but that's $1.3 trillion out of total government revenue of nearly $30 trillion. While it's a start, we have a long way to go before marginal tax rates are brought down to non-punishing levels. Then people would work harder or smarter, marriage would be stronger, and our quality of life would be even better than it already is.