Two economists have a plan to help fix a distortion in the tax code that incentivizes secondary earners to forego work.
Here’s the problem:
When two people are married, they no longer file taxes as individuals. Instead, their incomes are combined. This causes them to face a higher tax schedule and a phase-out of benefit programs. For low- and middle-income households, this means that the secondary earner lose a large portion of their take home pay to higher taxes and reduced benefits.
The authors of the proposal, Melissa Kearney and Lesley Turner, calculate that for household in which both spouses earn $US25,000 per year, the secondary earner only takes home 29% of their pay. This high marginal tax rate incentivizes this secondary earner to forego work and stay at home.
Kearney and Turner propose a new tax deduction for dual-income families that would allow them to deduct 20% of the first $US60,000 in secondary earnings. The plan would phaseout at $US110,000 and would be partially offset by a reduction in the spousal personal exemption.
This new deduction would raise the take home pay to 34-35% of the secondary earners income, increasing the household’s disposable income by more than $US1,000. Nevertheless, the marginal tax rate on secondary earners would remain high.
“It doesn’t fix the problem,” Kearney, the new Director of the Hamilton Project, said. “But it mitigates it a little bit.”
Peter Orszag, the former director of the Office of Management and Budget for the Obama Administration, and Kevin Hassett, a senior fellow at the American Enterprise Institute, both expressed their support for the proposal at a panel today.
Orszag emphasised the fact that this problem is an unavoidable result of means-testing welfare programs.
“Targeting programs towards those who are most in need automatically means there’s a phase-out,” he said. “There is no way around that. You cannot create a new benefit program where the subsidies are concentrated to the lower-moderate income distribution without creating a phase-out.”
This is true for low-income individuals who can face high marginal tax rates as they move up the income ladder and simultaneously face higher taxes and lose their benefits, but this distortion is exacerbated for married couples, because they must file jointly and are not taxed as individuals. Switching to a system where spouses are taxed individually would fix this marriage penalty.
Yet, Orszag notes that transitioning to such a system would have its own issues with spouses shuffling income from one to the other to minimize their tax bills.
“There’s no perfect solution here,” he said.
“The solution is not to have a progressive tax code,” Hassett replied.
Kearney and Turner also include a revenue-neutral option that offsets the increased costs of the new deduction by reducing the spousal exemption by 75%. This would have its own distributional effects.
“Who will be the losers here?” Turner rhetorically asked. “Married couples with one working spouse. The redistribution will come from married couple households with a single earner.”
This proposal has similarities with Senator Mike Lee’s plan to reduce the parent tax penalty by giving all parents a yearly $US2,500 tax credit for each child up until they turn 18. Both see a problem in the tax code that distorts the life decisions of families and attempts to correct it.
With backing from both Orszag and Hassett, Kearney and Turner’s proposal already has bipartisan support. Now they must make the case for it on Capitol Hill. Mike Lee wouldn’t be a bad place to start.
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