Every politician favors marriage, family and improvements in the tax code. Many routinely criticize the income tax as biased against marriage and families. Some go much further and claim that we could eliminate these biases by throwing out the current system and starting over with a flat tax or a national retail sales tax.
While some of the charges against the income tax are valid, they are exaggerated. But fundamental tax reform will not eliminate the biases and could even make them worse.
The income tax creates penalties for 42% of married couples, because as income rises, tax rates rise and items like the earned income, child and education credits are phased out. But the tax also subsidizes 51% of couples, through tax brackets that differ based on marital status and other features. Marriage bonuses actually exceed penalties by $4 billion.
Under the flat tax proposed by Rep. Richard Armey (R-Texas) and Sen. Richard Shelby (R-Ala.), households would pay taxes on their wages and pension income above exemption levels of $11,600 for single people, $14,850 for heads of household and $23,200 for couples. Armey says that the flat tax eliminates the marriage penalty, but this is incorrect. Two people with children could obtain $26,450 in exemptions if they were not married—one filing singly, one as household head—but only $23,200 if they were married. At a flat tax rate of 20%, this would impose an annual marriage tax of $650 per year on couples with children in which each spouse earns at least $14,850.
The proposed national retail sales tax also contains marriage penalties. To partially offset the regressivity of the sales tax, households would receive “demogrants” or rebates equal to the tax rate times the poverty line. This year’s poverty line set by the federal government—the income families need to stay out of poverty—is $7,890 for one person, plus $2,720 for each additional person. At a sales tax rate of 30%, a conservative estimate, two single people would be entitled to rebates of $2,367 each for a total of $4,734. If they married, they would receive $3,183, so their marriage penalty would be $1,551.
Advocates like to assert that tax reform is “pro-family” and point to the demogrants in the sales tax and large exemptions for children in the flat tax. Children and families benefit disproportionately from numerous features of the current system, however, including dependent exemptions, child care credits, earned income credits and education credits. And the preferential treatment of housing, health insurance and state and local tax payments also helps families, since they consume relatively more housing, medical services and government-provided services such as education. All of these preferences would be eliminated under fundamental tax reform.
Moreover, compared with childless couples, families with kids generally have high consumption relative to income, so switching from an income tax to a consumption tax would further raise tax burdens during years when family needs were highest. A study based on 1996 data found that a broad-based, flat-rate consumption tax like a sales tax or flat tax would hurt families with incomes less than $200,000, because of the loss of tax preferences, but would help families with income above $200,000 due to the dramatic reduction in the top tax rate.
Advocates might claim that families would benefit from reduced hassles of tax filing and increased economic growth. While tax complexity is a real problem, many families actually have quite simple tax returns: 22% file simplified 1040A or 1040EZ forms, and 56% do not itemize their deductions. Economic growth effects also can be overstated. Reasonable estimates suggest that a well-designed consumption tax would raise income per person by at most 2% over the first 10 years, and a poorly designed reform could reduce growth.
Thus there are some cautionary lessons here. First, the existing system may have some redeeming features to go along with its obvious headaches. Second, special attention needs to be given to unintended effects of tax reform. Third, finding fair ways to tax married versus single taxpayers and those with children versus those without is not easily addressed by dogmatic approaches.
Fortunately, many reforms that are sensible and achievable—including closing loopholes, reducing rates and simplifying taxes—also would reduce tax penalties on marriage and help families. Politicians would do well to improve the existing system rather than radically change it.