Wednesday, October 21, 2009

Iowa CPA spots another bed buffalo

Every time Congress enacts a new provision of tax law, it's mating season for the bed buffaloes in our tax code, and they produce a whole herd of new baby buffaloes wandering around in unexpected places.

Eagle-eyed CPA Joe Kristan out in Iowa has just spotted yet another bed buffalo in our tax code. And you don't have be living on the Great Plains to run into this bed buffalo--what Joe describes below affects Americans across the country.


In boning up for the Farm Tax Schools I will be participating in starting next week (you can still enroll!), I noticed how the phase-out of the $8,000 first-time homebuyer credit over a $20,000 range of income adds 40% to the marginal tax rates of qualifying taxpayers in the phaseout range. That means a 60% effective rate on each dollar earned in that range, which starts at $75,000 for single filers, before even counting state taxes.That's just crazy.

According to the Brookings Institution's Tax Vox post, Will the real marginal tax rate please stand up?, about half of American taxpayers face an effective marginal tax rate that is different from their statutory tax bracket---often very different! It's true for the rich, it's true for the middle class, and it's true for the poor.

A low income family whose statutory marginal tax rate is 10% could easily face a true effective marginal tax rate of over 30%. And that's just talking about the federal income tax--before we even consider payroll and state and local income taxes.

The differences can go in both directions, for any taxpayer, rich, poor, or in the middle. The effective marginal rate depends on a whole host of complex and difficult to predict interacting features of the tax code--income, number of children, marital status, source of income (wages vs. self-employment vs. unemployment benefits vs. pension income). A herd of bed buffaloes can all influence the effective marginal tax rates, often in surprising, counterintuitive, and unpredictable ways. As Joe says above, "That's just crazy!"

Why? There is a massive herd of bed buffaloes roaming around in our patchwork quilt tax code: phase-ins, phase-outs, clawbacks, the Alternative Minimum Tax, ceilings, floors, ...

And each time Congress enacts a new tax provision, it introduces new bed buffaloes that interact and "mate" with all the preexisting bed buffaloes from prior tax law in unpredictable ways, creating new baby buffaloes. The herd grows and grows.

As I've pointed out before, the tax code is especially opaque for the poor, who often lack access to professional tax planning advice from pros like Joe Kristan and may not be able to foresee the tax consequences of the decisions they make.

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