\-\-\-\--Original Message\-\-\-\--

From: Forman, Jonathan B.
\[[[mailto:jforman@ou.edu]{.underline}](mailto:jforman@ou.edu)\]

Sent: Monday, March 14, 2005 3:03 PM

To: comments

Subject: INDIVIDUAL COMMENTS: Solving the Problem of High Effective Tax
Rates on Low and Moderate-income Working Families

Earlier today, I submitted my individual comments via e-mail. Following
your guidelines, I now resubmit them to you as a MS Word attachment. I
apologize for any confusion that my earlier submission may have caused.

Jonathan Barry Forman (\"Jon\")

Professor of Law

University of Oklahoma

College of Law

300 Timberdell Road

Norman, OK 73019

\(405\) 325-4779

\(405\) 325-0389 (fax)

jforman@ou.edu
\<[[mailto:jforman@ou.edu]{.underline}](mailto:jforman@ou.edu)\>

[[http://www.law.ou.edu/profs/forman.shtml]{.underline}](http://www.law.ou.edu/profs/forman.shtml)

\<[[http://www.law.ou.edu/profs/forman.shtml]{.underline}](http://www.law.ou.edu/profs/forman.shtml)\>

\<\<TaxReformPanel2005.doc\>\>

![](media/image1.wmf){width="1.0631944444444446in"
height="1.0722222222222222in"}

*The University of Oklahoma*

COLLEGE OF LAW

300 Timberdell Road

Norman, Oklahoma 73019-5081

PHONE: (405) 325-4699 FAX: (405) 325-6282

> March 14, 2005

[VIA E-MAIL ATTACHMENT]{.underline}

The Honorable Connie Mack, III (Chairman)

The Honorable John Breaux (Vice-Chairman)

The President's Advisory Panel on Federal Tax Reform

1440 New York Avenue, N.W.

Suite 2100\
Washington, DC 20220

> Re: [INDIVIDUAL COMMENTS: Solving the Problem of High Effective Tax
> Rates on Low and Moderate-income Working Families]{.underline}

Dear Senators Mack and Breaux:

In response to your February 16, 2005, Request for Comments \# 1, I am
writing to express my concern about the high effective marginal tax
rates that are imposed on low and moderate-income working families. I am
writing in my individual capacity as a Professor of Law at the
University of Oklahoma College of Law where I teach and write about tax
and Social Security law. Prior to entering academia, it was my privilege
to serve in all three branches of the federal government. The purpose of
these comments is to suggest how we could combine the income and Social
Security taxes into a comprehensive tax system with low effective
marginal tax rates on earned income.

Sincerely,

> **Jon Forman**
>
> Jonathan Barry Forman

Professor of Law

SOLVING THE PROBLEM OF HIGH EFFECTIVE TAX RATES ON LOW AND
MODERATE-INCOME WORKING FAMILIES

Individual Comments

of

**Jonathan Barry Forman**

**Professor of Law**

**University of Oklahoma**

**College of Law**

**Norman, Oklahoma**

**March 14, 2005**

The purpose of these comments is to suggest how we could combine the
income and Social Security taxes into a comprehensive tax system with
low effective marginal tax rates on earned income.

# The Current Federal Tax System Imposes High Tax Rates on Earned Income

Taxes tend to influence individual choices between labor and leisure,
and high effective marginal tax rates on earned income tend to
discourage work. The implication is clear. If the government wants to
minimize work disincentives, it should keep the effective marginal tax
rates on earned income as low as possible. It is especially important to
try to have low tax rates on low and moderate-income workers, as they
are likely to have the largest behavioral responses to high tax rates.
Unfortunately, the current federal tax system imposes its highest
effective marginal tax rates on low and moderate-income workers.

## Effective Marginal Tax Rate Charts

The federal income tax system has a progressive tax-rate structure;
however, because of the many phase-outs and other special rules,
effective marginal tax rates can bounce all over the place. And the
highest effective marginal tax rates are imposed on moderate-income
working families in the phase-out range of the earned income tax
credit.[^1]

On the other hand, the Social Security payroll tax is regressive.
Workers effectively pay 15.3 percent of their first \$90,000 of earned
income but just 2.9 percent on earnings in excess of \$90,000.[^2]

When both income and payroll taxes are considered, the effective
marginal tax rates on earned income can be extraordinarily high,
especially on low and moderate-income workers with children.[^3] For
example, Figure 1 shows the effective marginal tax rates imposed on
married couples with two children and earned income only in 2005.[^4]
Figure 1 shows that the highest effective marginal tax rate -- 46
percent -- is imposed on couples earning around \$30,000 a year. Figure
1 also includes a linear trendline, so that the reader can imagine what
a more rational, progressive tax rate structure might look like.

![](media/image2.wmf){width="6.4944444444444445in"
height="3.2916666666666665in"}

Figure 2 shows similar results for heads of household with two children
and earned income only. Figure 2 also shows that the highest effective
marginal tax rate -- 51 percent -- is imposed on heads of household
earning around \$30,000 a year.

![](media/image3.wmf){width="6.4944444444444445in"
height="3.2916666666666665in"}

# Integrate the Income and Payroll Taxes

Many of the problems of the current tax system would disappear if we
combined the income and payroll taxes into a single, comprehensive
income tax system. For example, consider an integrated income/payroll
tax system with \$1,000 per person refundable tax credits and just two
tax rates: 20 percent of the first \$50,000 of income and 30 percent on
income in excess of \$50,000. To encourage work, the system could also
have a \$2,000 per worker refundable earned income tax credit (computed
as 20 percent of the first \$10,000 of earned income). There would be no
need to phase out either the refundable personal tax credits or the
worker credits. Figure 3 shows how this system would work.

![](media/image4.wmf){width="6.492361111111111in"
height="4.433333333333334in"}

All in all, such an integrated tax system would have a logical tax rate
structure, as opposed to the roller-coaster rate structure of the
current tax system. An integrated system would be simpler to administer
than the current system, it would promote greater economic justice than
the current system, and it would minimize work disincentives,. Low and
moderate-income families would have every incentive to get out there and
work, and even high-income families would face smaller work
disincentives than under the current system. In short, this approach
would help make our tax system work.

Respectfully submitted,

> **Jon Forman**
>
> Jonathan Barry Forman

Professor of Law

University of Oklahoma

College of Law

Norman, Oklahoma

[^1]: The kind of income that a taxpayer receives can also affect her
    effective marginal tax rate. For example, while earned income is
    taxed at stated income tax rates as high as 35 percent under the
    federal income tax, investment income is often taxed at much lower
    rates. For example, dividends and net capital gains are generally
    taxed at no more than 15 percent, and the interest earned on state
    and local bonds is tax-exempt.

[^2]: As is common in this type of analysis, I ignore the value of any
    future Social Security and Medicare benefits that might result from
    these payroll taxes. See, for example, Congressional Budget Office,
    *Effective Tax Rates, 1997 to 2000* (2003), 5. Of note, because the
    half of the payroll tax that is paid by the employer is excluded
    from the individual's taxable income, the effective marginal tax
    rates are actually slightly less than 15.3 and 2.9 percent.

[^3]: Worse still, these high effective marginal tax rates in the
    federal tax system often combine with similarly high
    benefit-reduction rates in the welfare system to result in virtually
    confiscatory effective marginal tax rates on the earned income of
    many low-income families trying to work their way out of the welfare
    system.

[^4]: The figure assumes that all family income consists of wages earned
    by a single worker, that all family members are under age 65 and not
    blind, that all families are eligible for the earned income tax
    credit, and that all children qualify for the child tax credit.