What the New Tax Code Looks Like

The federal tax code is said to be 17,000 pages and 5.5 million words long. Marginal tax rates have been changed on average every 3.3 years for the last eight decades. If you brought together a group of physicists and tasked them with creating a system more complex than the modern tax code, they'd fail time and time again.

After the fiscal-cliff showdown earlier this month, the tax code is undergoing one of the biggest changes of the last decade. In short, those earning more than $400,000 per year ($450,000 for couples) will see marginal tax rates return to Clinton-era levels, creating a new 39.6% top tax bracket, up from the 35% top rate that had been in place since 2001.

What will these changes look like? The Tax Policy Center released some data last week to help put it into context. Here's how the nation's 155 million tax filers will sort out after the recent changes: 

Source: Tax Policy Center.

And another view:

Keep in mind, these charts show the statutory marginal tax rates people will fall under, which applies to the last dollar of income they earn -- not the effective tax rate they'll pay on their entire income after deductions and credits. We won't know what those numbers will look like until a year or two from now, when actual tax returns can be analyzed (again, it's complex), but the IRS publishes data on effective tax rates for previous years. Here's the breakdown for 2007: 

For a different view, check out this table by the Tax Policy Center. It shows the number of tax returns ranked by effective tax rates for the year 2008 and makes an important point: Because of lower marginal thresholds on the first few hundred thousand dollars of income, plus deductions and credits, roughly 1% of all tax filers that year earned enough to have income subject to the top tax bracket of 35%, but just 0.007% paid an effective tax rate of at least 35%. Something similar will occur with the new tax code: The number of people who will actually pay 39.6% of their total income in federal taxes will round to zero.

The other side of that point is that the small number of tax filers who will be hit with the new 39.6% tax bracket earn a disproportionate share of the nation's income. As economist Stephen Bronars writes (emphasis mine):

I estimate that the new top marginal income tax rate of 39.6% on annual income in excess of $400,000 per year will have a direct impact on about 7/10 of one percent of taxpayers. However, the income earned by these taxpayers in excess of the $400,000 threshold accounts for about 9.5% of aggregate personal income. 

In other words, the new tax bracket affects a small share of tax filers but a much larger share of the economy.

"The hardest thing to understand in the world is the income tax," said Albert Einstein. Timeless wisdom.

What do you think? 

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