CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

Effective Marginal Tax Rates on Labor Income

NOVEMBER 2005

0

-10

0

10

20

30

40

50

60

Marginal Federal Income

and Payroll Tax Rate

Marginal Federal

Income Tax Rate

-20

-30

-40

10 20 30 40 50 60 70 80 90 100

Cumulative Percentage of Tax Returns with Earnings

Percent

The Congress of the United States O Congressional Budget Office

CBO

Effective Marginal Tax Rates

on Labor Income

November 2005

A

PAPER
Note

Numbers in the text and tables of this paper may not add up to totals because of rounding.
Preface

The system of marginal tax rates (the share of an additional dollar of income that will 

have to be paid in taxes) created by the tax code determines how taxes affect people’s economic 

behavior. This Congressional Budget Office (CBO) paper—prepared at the request of the 

Chairman of the Senate Finance Committee—examines the marginal tax rates on labor 

income that currently exist and how those rates will change if tax legislation enacted in 2001, 

2003, and 2004 expires as scheduled. In keeping with CBO’s mandate to provide objective 

analysis, this paper makes no recommendations.

Edward Harris of CBO’s Tax Analysis Division wrote the paper under the direction of David 

Weiner, Roberton Williams, and G. Thomas Woodward. David Brauer and Kevin Perese of 

CBO provided useful comments.

Christian Spoor edited the paper, and Leah Mazade proofread it. Denise Jordan-Williams prepared early drafts of the text, tables, and figures. Maureen Costantino produced the cover, and 

Christian Spoor prepared the report for publication. Lenny Skutnik produced the printed 

copies, and Simone Thomas prepared the electronic version for CBO’s Web site 

(www.cbo.gov).

Douglas Holtz-Eakin

Director

November 2005

Introduction and Summary 1

Types of Tax Rates 1

Factors That Affect Marginal Tax Rates 3

Taxpayers’ Characteristics 3

Individual Income Taxes 3

Payroll Taxes 10

State Income Taxes 10

Benefit Programs 10

Stylized Examples of Marginal Tax Rates 10

Single Filer 11

Head of Household with One Child 11

Married Couple with Two Children 14

Payroll and State Income Tax Rates 16

Distribution of Effective Marginal Tax Rates 19

Methodology 20

Distribution of Statutory Federal Income Tax Rates 21

Distribution of Effective Marginal Federal Income Tax Rates 21

Distribution of Combined Federal and State Tax Rates 22

Effective Marginal Tax Rates by Income Group 24

The Change in Marginal Tax Rates If Current Laws Expire 25

Appendix: Distribution of Marginal Income Tax Rates 

for Different Populations 31

CONTENTS
vi EFFECTIVE MARGINAL TAX RATES

Tables

1. Selected Provisions of the Federal Individual Income Tax 

That Affect Effective Marginal Tax Rates in 2005 4

2. Distribution of Individual Income Tax Returns and Earnings, 

by Statutory Marginal Tax Bracket, in 2005 21

Figures

1. Statutory Federal Income Tax Rates, by Filing Status, in 2005 2

2. Effective Marginal Federal Income Tax Rates for a Single 

Filer in 2005 12

3. Effective Marginal Federal Income Tax Rates for a Head of 

Household with One Child in 2005 13

4. Effective Marginal Federal Income Tax Rates for a Married 

Couple with Two Children in 2005 15

5. EEffect of Payroll Taxes and State Income Taxes on Effective 

Marginal Tax Rates in 2005 18

6. Distribution of Effective Marginal Tax Rates in 2005 23

7. Effective Marginal Tax Rates, by Earnings Level 25

8. Effective Marginal Federal Income Tax Rates for a Married 

Couple with Two Children Before and After the 

Expiration of EGTRRA 28

9. Distribution of Effective Marginal Federal Income Tax Rates 

Before and After the Expiration of EGTRRA 29

A-1. Distribution of Effective Marginal Federal Income Tax Rates 

for Different Populations 32

Boxes

1. Including the Employer’s Share of Payroll Taxes in 

Calculations of Marginal Tax Rates 16

2. Recent Tax Laws That Alter Marginal Rates on Labor Income 26
Effective Marginal Tax Rates

on Labor Income

Introduction and Summary

Taxes influence many of the economic decisions that people make: whether to work, in what occupation, and to 

what extent; what fringe benefits employers offer and 

how much value workers place on those benefits relative 

to wages; how much to consume or save; what type of 

investments to make; whether to buy a home; and how 

much to donate to charity. By altering the returns from 

working and investing and by changing the relative prices 

of goods and services, taxes favor some activities over others, which can lead to economic inefficiencies—too much 

activity in areas favored by the tax system and too little 

activity in areas treated less favorably. Those inefficiencies 

impose costs on taxpayers (beyond the money actually 

paid in taxes) and result in lower levels of national wellbeing. 

In general, the type of tax rate that most directly affects 

decisions about whether to engage in more of an activity 

is the effective marginal tax rate—the percentage of an 

additional dollar of income that will have to be paid in 

taxes. Higher marginal rates tend to cause more behavioral changes than lower rates do, leading to larger inefficiencies. Taxes on activities about which people are very 

flexible in how much of them to pursue will tend to create greater distortions than taxes on activities about 

which people have less discretion. And taxes that affect 

broad aspects of the economy—such as how much work 

is done—can have the greatest distortionary impact.

This paper examines the effective marginal tax rates that 

people face on income from labor—federal and state 

individual income taxes as well as payroll taxes for Social 

Security and Medicare—under current law. The analysis 

points to several conclusions:

B Provisions of tax law, such as the different tax rate 

brackets and the phasing in and out of various credits 

and deductions, interact with taxpayers’ individual 

characteristics to create a wide range of effective marginal tax rates on labor income. Moreover, marginal 

rates can vary substantially for taxpayers with comparable incomes, because many factors other than 

income level, such as filing status or eligibility for a 

credit, affect the marginal tax rate on earnings.

B In terms of federal individual income taxes, most taxpayers face effective marginal rates of 15 percent or 

less. Less than one-fifth face rates of more than 25 

percent, and about 7 percent of taxpayers face rates in 

excess of 30 percent. Taxpayers who are subject to 

higher rates tend to be disproportionately high earners: the one-15th of taxpayers with marginal rates 

above 30 percent account for one-fifth of total earnings, whereas the two-thirds with marginal rates of 15 

percent or less account for just one-third of earnings.

B Payroll taxes and state income taxes significantly raise 

effective marginal rates. For example, the median marginal federal income tax rate is 15 percent, but the 

median rate including payroll and state income taxes is 

more than twice as high: 31.6 percent. (Payroll taxes 

account for most of the difference.)

B If tax provisions enacted in 2001, 2003, and 2004 

expire as scheduled over the next five years, marginal 

rates will increase across most of the income distribution. Compared with a fully phased-in version of existing law, expiration would raise effective marginal tax 

rates by an average of almost 3 percentage points. 

Roughly half of taxpayers would face higher marginal 

rates; most other taxpayers would see no change in 

their marginal rates.

Types of Tax Rates

Various ways exist to describe the tax rates that people 

pay on their income. Three common measures are statutory rates (those written into the tax system); effective
2 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

Figure 1.

Statutory Federal Income Tax Rates, by Filing Status, in 2005

Source: Congressional Budget Office.

marginal rates (the percentage of an additional dollar of 

income that is paid in taxes, taking into account all 

aspects of tax law); and average rates (the amount of tax 

paid as a percentage of a taxpayer’s total income). This 

analysis focuses on the second measure, effective marginal 

rates.

Statutory rates are the schedule of six tax rate brackets—

currently 10, 15, 25, 28, 33, and 35 percent—found in 

the individual income tax system (see Figure 1). For any 

taxpayer, the portion of taxable income that falls within a 

given bracket faces the tax rate for that bracket, regardless 

of the taxpayer’s total income level. For example, in 2005, 

the first $14,600 of a married couple’s taxable income is 

subject to a rate of 10 percent. That rate rises to 15 percent on the next $44,800 of taxable income, to 25 percent on the next $60,550, to 28 percent on the next 

$62,850, and to 33 percent on the next $143,650. All 

income in excess of $326,450 is taxed at a rate of 35 percent. The statutory marginal rate is the rate that applies 

to the last dollar of a taxpayer’s taxable income. 

The effective marginal tax rate depends on features of tax 

law besides statutory rates. Most taxpayers’ effective marginal rate is the same as their statutory marginal rate. But 

in some cases, the two rates differ because of the phasing 

in or out of particular tax provisions. For example, the 

earned income tax credit phases out at a rate of 21.06 

cents for each dollar of earnings between $14,370 and 

$35,263 for a taxpayer with two children. In other words, 

if that taxpayer earned an additional dollar of income, his 

or her credit would shrink by 21.06 cents, increasing the 

taxpayer’s effective marginal rate by 21.06 percentage 

points. A married couple with two children in that income range might face a statutory tax rate of 10 percent 

but an effective marginal rate of 31.06 percent because of 

the phaseout of the credit. 

A person’s effective marginal tax rate influences many different decisions about working: whether to take on an 

overtime shift, bargain for wages or fringe benefits, get a 

second job, or enter the labor force at all. In principle, 

calculations of marginal rates would be customized to 

Married Filing

Separately

Single

Head of

Household

Married Filing

Jointly

0 50,000 100,000 150,000 200,000 250,000 300,000 350,000

$14,600 $59,400 $119,950 $182,800 $326,450

10% 15% 25% 28% 33% 35%

10

10

10

15%

15%

15% 25%

25%

25% 28%

28%

28%

33%

33%

33%

$10,450 $39,800 $102,800

35%

35%

35%

$166,450 $326,450

$7,300 $326,450

$7,300

$29,700

$29,700

$71,950 $150,150

$59,975 $91,400 $163,225

Taxable Income
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 3

measure the relevant labor force decision. The effective 

marginal rate associated with small changes in income 

from overtime work may differ from the rate associated 

with larger changes, such as deciding whether to work in 

the first place. In this analysis, the Congressional Budget 

Office (CBO) measures the marginal rate as the change in 

taxes associated with small increments of income. That 

rate might misstate the rate relevant to taxpayers who are 

making more-basic labor force decisions, such as whether 

to enter the workforce.

If taxpayers do not clearly perceive their effective marginal tax rate, the relationship between that rate and various labor force decisions may be weaker. Indeed, the 

income tax system does not make effective marginal rates 

very apparent, even when people use tax-preparation software.

The third measure, the average tax rate, equals the 

amount of tax that an individual pays divided by income. 

A taxpayer who pays $2,500 in federal income taxes on 

total income of $20,000 has an average tax rate of 12.5 

percent. Average tax rates are only loosely related to statutory rates, in part because total income differs from taxable income by the exemptions and deductions that taxpayers claim and because income can fall into multiple 

statutory brackets, as described above. Average rates are 

often used as an indicator of the fairness of the distribution of tax burdens, but they are less important for determining the effect of the tax system on people’s behavior.1

Factors That Affect Marginal Tax Rates

Many factors interact to determine how much of an additional dollar of earnings a taxpayer gets to keep. Provisions of income tax law obviously play an important role. 

But a taxpayer’s personal circumstances play an equally 

large part. Federal payroll taxes, state income taxes, and 

the rules of federal benefit programs can also affect a taxpayer’s effective marginal rate on earnings. 

Taxpayers’ Characteristics

To determine tax liability, a taxpayer adds together income from all sources; subtracts allowable adjustments, 

exemptions, and deductions to determine taxable income; applies a schedule of statutory tax rates to taxable 

income to calculate the amount owed; and reduces that 

tax liability by any credits for which the taxpayer is eligible. Anything that affects taxable income can alter the 

marginal tax rate: income (whether from the taxpayer’s 

earnings, a spouse’s earnings, or other sources), itemized 

deductions (such as interest payments on a mortgage or 

charitable contributions), number of children (which determines the number of personal exemptions and eligibility for several credits), and filing status (since, as shown in 

Figure 1, statutory tax rates apply at different income levels depending on whether a taxpayer files as single, head 

of household, or married).

Individual Income Taxes

Many provisions in the individual income tax system also 

affect a taxpayer’s marginal tax rate. In addition to the 

statutory rate brackets, many deductions and credits 

apply only over specific income ranges (see Table 1). As 

noted above, the phasing in and out of those items can 

cause taxpayers’ effective marginal rate to differ from 

their statutory rate.2 Since various deductions and credits 

phase out over similar income ranges, taxpayers in those 

ranges can face multiple phaseouts on top of their statutory rate.

In the case of many deductions or exclusions from income, the allowed amount gradually phases out over an 

income range, so as a taxpayer earns more, allowable 

deductions shrink and taxable income rises faster than 

earnings. The taxpayer pays taxes on the additional taxable income at the applicable statutory rate. Thus, he or 

she faces an effective marginal rate on additional earnings

1. For a discussion of average tax rates (sometimes called effective tax 

rates), see Congressional Budget Office, Effective Federal Tax Rates, 

1979-1997 (October 2001) and Effective Federal Tax Rates, 1997 

to 2000 (August 2003), as well as Web-only updates that extend 

the period of analysis to 2001 and 2002.

2. In 2001, the Joint Committee on Taxation identified 22 provisions of the income tax code that would cause a taxpayer’s effective 

marginal rate to differ from the statutory rates. Changes to the tax 

code since then have added some provisions affecting marginal 

rates, removed some, and changed the income range over which 

others apply. See Joint Committee on Taxation, Overview of 

Present Law and Economic Analysis Relating to Marginal Tax Rates 

and the President’s Individual Income Tax Rate Proposals, JCX-6-01 

(March 6, 2001). See also Joint Committee on Taxation, Present 

Law and Analysis Relating to Individual Effective Marginal Tax 

Rates, JCS-3-98 (February 3, 1998); and Thomas A. Barthold, 

Thomas Koerner, and John F. Navratil, “Effective Marginal Tax 

Rates Under the Federal Individual Income Tax: Death by One 

Thousand Pin Pricks?” National Tax Journal, vol. 51, no. 3 (September 1998), pp. 553-564.
4 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

Table 1.

Selected Provisions of the Federal Individual Income Tax That Affect 

Effective Marginal Tax Rates in 2005

Continued

Provision Description

Impact on Effective

Marginal Rateb 

Tax Rate Single Filer Joint Filers

10% $0 to $7,300 $0 to $14,600

15% $7,300 to $29,700 $14,600 to $59,400

25% $29,700 to $71,950 $59,400 to $119,950

28% $71,950 to $150,150 $119,950 to $182,800

33% $150,150 to $326,450 $182,800 to $326,450

35% $326,450 and up $326,450 and up

Alternative 

Minimum 

Tax (AMT)

An alternative method of computing 

taxes. Taxpayers must pay the higher of 

the AMT or the regular income tax. The 

AMT is calculated by applying AMT tax 

rates to alternative maximum taxable 

income (AMTI), which is equal to regular 

taxable income with certain deductions 

added back and an AMT exemption 

subtracted instead. The AMT exemption 

is $40,250 for single filers and $58,000 

for joint filers.

For taxpayers subject to the 

AMT, the marginal rate is the 

statutory AMT rate. For 

taxpayers in the AMT phaseout 

range, the marginal rate is 1.25 

times the AMT rate (32.5 

percent for taxpayers in the 26 

percent AMT bracket and 35 

percent for those in the 28 

percent bracket).

Taxation of 

Social 

Security 

Benefits

As their income rises, taxpayers must 

include increasing amounts of Social 

Security benefits in their taxable income. 

Benefits are included at one of two rates. 

In the first tier, the amount of benefits 

subject to tax is equal to 50 percent of 

income above a threshold, with no more 

than 50 percent of benefits included. In 

the second tier, the amount of benefits 

subject to tax is equal to 85 percent of 

income above a threshold, capped at 85 

percent of benefits. 

In the first tier, each $1.00 of 

additional income raises taxable 

income by $1.50, so the 

marginal rate is 1.5 times the 

statutory rate. In the second 

tier, each $1.00 of additional 

income increases taxable 

income by $1.85, so the 

marginal rate is 1.85 times the 

statutory rate.

Limit on 

Itemized 

Deductions 

Itemized deductions are reduced by 3 

percent of the amount of AGI above a 

threshold. Deductions cannot be reduced 

by more than 80 percent.

In the phaseout range, an 

additional $1.00 of income 

increases taxable income by 

$1.03, so the marginal rate is 

1.03 times the statutory rate.

Phaseout of 

Personal 

Exemptions 

The value of personal exemptions is 

reduced by 2 percent for each $2,500 of 

AGI above a threshold. 

The effect depends on the 

number of exemptions. For 

each exemption, an additional

Income Rangea

The range of taxable income for each statutory bracket is: For most taxpayers, their 

marginal rate equals their 

statutory rate. For taxpayers 

affected by other provisions of 

tax law, their marginal rate is 

still a function of their statutory 

rate.

AMTI up to $175,000 is taxed at 26 percent; AMTI above 

that is taxed at 28 percent. Additionally, the AMT 

exemption phases out at AMTI of between $112,500 and 

$273,500 for single filers and between $150,000 and 

$382,000 for joint filers.

The schedule of six brackets in the 

individual income tax. The portion of 

taxable income falling into a bracket 

faces the tax rate for that bracket.

Provisions Involving Exclusions, Deductions, and Exemptions from Income

Provisions Involving Tax Rates

For a single filer, the first tier begins at $25,000 of 

modified adjusted gross income (AGI), and the second tier 

begins at $34,000. For joint filers, the first tier begins at 

$32,000 of modified AGI, and the second tier begins at 

$44,000.

Statutory 

Tax Rates

Exemptions phase out between $145,950 and $268,450 of 

AGI for single filers and between $218,950 and $341,450 

for joint filers.

Itemized deductions begin to phase out for all taxpayers at 

$145,950 of AGI. The end of the phaseout depends on the 

amount of itemized deductions a taxpayer has. 
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 5

Table 1.

Continued

Continued

Provision Description

Impact on Effective

Marginal Rateb 

Phaseout of 

Personal 

Exemptions 

(Continued)

$1.00 of income increases 

taxable income by $1.0256. The 

marginal rate is 1.0256 times 

the statutory rate for a 

taxpayer with one exemption, 

1.0512 times the statutory rate 

for a taxpayer with two 

exemptions, and so forth.

Individual 

Retirement 

Account 

(IRA) 

Deduction

Taxpayers with income below certain 

levels can deduct up to $4,000 in 

contributions to an IRA. 

An additional $1.00 of income 

increases taxable income by 

$1.40, so the marginal rate is 

1.4 times the statutory rate.

Roth IRA Taxpayers with income below certain 

levels can make contributions to Roth 

accounts. Investment earnings in the 

accounts are not taxable.

Roth accounts reduce tax 

liability in future years. The 

impact on marginal rates 

depends on how long the 

account will be held, the rate of 

return, and the taxpayer's tax 

rate in future years.

Deduction 

of Interest 

on Student 

Loans 

Taxpayers with income below certain 

levels can deduct up to $2,500 of student 

loan interest from their AGI. Taxpayers 

do not have to itemize to claim the 

deduction.

The effect depends on the size 

of the deduction. For a single 

filer claiming the maximum 

deduction, each additional $1.00 

of income reduces the 

deduction by $0.167, so the 

marginal rate is 1.167 times the 

statutory rate.

Eligibility to deduct contributions phases out between 

$50,000 and $60,000 of AGI for single filers and between 

$70,000 and $80,000 for joint filers.

Provisions Involving Exclusions, Deductions, and Exemptions from Income (Continued)

Income Rangea

Floors on 

Itemized 

Deductions

Some itemized deductions are allowed All income ranges.

only to the extent that they exceed a 

floor, or minimum percentage of AGI: 

medical deductions in excess of 7.5 

percent of AGI are allowed, casualty 

losses in excess of 10 percent of AGI 

are allowed, and miscellaneous 

deductions in excess of 2 percent of AGI 

are allowed.

An additional $1.00 of income 

raises the floor, reducing the 

deduction (and thus increasing 

taxable income) by the relevant 

percentage of AGI. The floor on 

medical deductions causes the 

marginal rate to be 1.075 times 

the statutory rate; the floor on 

casualty losses causes the 

marginal rate to be 1.1 times 

the statutory rate; and the floor 

on miscellaneous deductions 

causes the marginal rate to be 

1.02 times the statutory rate.

Eligibility to make contributions phases out between 

$95,000 and $110,000 of AGI for singles filers and 

between $150,000 and $160,000 for joint filers.

The deduction phases out between $50,000 and $65,000 of 

AGI for single filers and between $105,000 and $135,000 

for joint filers.
6 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

Table 1.

Continued

Continued

Provision Description

Impact on Effective

Marginal Rateb 

Deduction 

of Tuition 

and Fees 

Taxpayers with income below certain 

levels can deduct up to $4,000 of higher 

education expenses from their AGI. 

Taxpayers do not have to itemize to claim 

the deduction.

Taxpayers who move past one 

of the income thresholds lose 

$2,000 of deductions. The effect 

on marginal rates depends on 

the income increment but can 

be quite high. If a taxpayer's 

income grew by $1,000 and 

that increase caused the 

person to lose a $2,000 

deduction, the effective 

marginal rate would be three 

times the statutory rate.

Deduction 

of Rental 

Losses 

Taxpayers with income below certain 

levels can deduct up to $25,000 in rental 

losses from their income. 

The effective marginal rate is 

1.5 times the statutory rate.

Earned 

Income Tax 

Credit

A refundable credit based on taxpayers' 

earnings and number of children. For 

taxpayers with no children, the credit 

phases in and out at a rate of 7.65 

percent. For taxpayers with one child, 

the phase-in rate is 34 percent and the 

phaseout rate is 15.98 percent. For 

taxpayers with two or more children, the 

phase-in rate is 40 percent and the 

phaseout rate is 21.06 percent.

The marginal rate equals the 

statutory rate minus the credit 

phase-in rate (for income in the 

phase-in range) or plus the 

phaseout rate (for income in the 

phaseout range). 

Child Credit A partially refundable credit of $1,000 for 

each child under age 17. The credit 

phases out above certain income levels. 

The refundable portion of the 

credit can reduce the marginal 

rate to 15 percentage points 

less than the statutory rate. In 

the phaseout range, the 

marginal rate equals the 

statutory rate plus the phaseout 

rate (5 percent).

Dependent 

Care Credit

A credit of up to 35 percent of child care 

expenses. Expenses are capped at 

$3,000 per child.

The effect of the credit on the 

marginal rate depends on the 

amount of child care expenses. 

At the full $3,000 of expenses, 

the marginal rate equals the 

statutory rate plus 1.5 

percentage points.

Provisions Involving Exclusions, Deductions, and Exemptions from Income (Continued)

The credit rate is reduced by 1 percentage point for each 

$2,000 of income above $15,000 until the minimum credit 

rate of 20 percent is reached (at income above $43,000).

The refundable portion can be as much as 15 percent of 

earnings over $11,000. The credit phases out at a rate of 

$50 per $1,000 of income for single filers with income 

above $75,000 or joint filers with income above $110,000. 

The end point of the phaseout depends on the number of 

children.

Provisions Involving Tax Credits

For a single filer with no children, the credit phases in 

from zero to $5,220 in earnings and phases out from 

$6,530 to $11,750. For a single filer with one child, the 

credit phases in from zero to $7,830 in earnings and 

phases out from $14,370 to $31,030. For a single filer with 

two or more children, the credit phases in from zero to 

$11,000 in earnings and phases out from $14,370 to 

$35,263. Joint filers face the same phase-in ranges, but 

both the beginning and end points of the phaseout ranges 

are $2,000 higher than for single filers.

Taxpayers with income below $60,000 for single filers or 

$130,000 for joint filers can take the full deduction of 

$4,000; taxpayers with income below $80,000 for single 

filers or $160,000 for joint filers can take a deduction of 

$2,000; and those with higher income levels cannot take 

any deduction.

Income Rangea

The maximum deduction is phased out for taxpayers with 

AGI of between $100,000 and $150,000.
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 7

Table 1.

Continued

Source: Congressional Budget Office adapted from Joint Committee on Taxation, Overview of Present Law and Economic Analysis Relating 

to Marginal Tax Rates and the President's Individual Income Tax Rate Proposals, JCX-6-01 (March 6, 2001).

Note: The descriptions in this table focus on two types of taxpayers: individuals who file singly and married couples who file a joint return. 

The parameters of the provisions described here may differ for taxpayers with other filing statuses.

a. In general, income range is defined in terms of adjusted gross income (AGI), but for several provisions, modified definitions of AGI are 

used.

b. Assumes that the taxpayer currently faces a statutory rate. Taxpayers can be affected by multiple provisions, causing the effect on marginal rates to cumulate.

Provision Description

Impact on Effective

Marginal Rateb 

Hope and 

Lifetime 

Learning 

Credits

The Hope credit equals 100 percent of 

the first $1,000 of education expenses 

and 50 percent of the next $1,000. The 

Lifetime Learning credit equals 20 

percent of the first $5,000 of expenses.

For single filers, the effective 

marginal rate is the statutory 

rate plus 10 percentage points. 

For joint filers, the effective 

marginal rate is the statutory 

rate plus 5 percentage points.

Savers 

Credit

A credit equal to either 50, 20, or 10 

percent of the first $2,000 of a taxpayer's 

contributions to a retirement plan.

The effect depends on the 

amount of retirement 

contributions, the income 

threshold crossed, and the 

dollar increment of additional 

earnings that causes the 

taxpayer to cross the 

threshold. A taxpayer with 

$2,000 in contributions who 

earned an additional $1,000 and 

crossed from the 20 percent to 

10 percent credit rates would 

face an effective marginal rate 

equal to the statutory rate plus 

20 percentage points.

Tax Credit 

for the 

Elderly and 

Disabled

A credit for elderly or disabled taxpayers 

with income below certain levels. The 

maximum credit is $750 for single filers 

and $1,125 for joint filers.

The effective marginal rate is 

the statutory rate plus 7.5 

percentage points.

Adoption 

Credit

A credit equal to 100 percent of adoption 

expenses, up to $10,650 per child.

The effect depends on the size 

of the credit. With a $10,000 

credit, the effective marginal 

rate equals the statutory rate 

plus 25 percentage points.

The credit phases out between $7,500 and $17,500 of 

income for single filers and between $10,000 and $25,000 

for joint filers.

Income Rangea

The credit phases out between $159,450 and $199,450 of 

AGI.

The credits phase out between $40,000 and $50,000 of 

income for single filers and between $80,000 and $100,000 

for joint filers.

Single filers with income below $15,000 are eligible for the 

50 percent credit; those with income below $16,250 are 

eligible for the 20 percent credit; and those with income 

below $25,000 are eligible for the 10 percent credit. For 

joint filers, the income range is double that for single filers.

Provisions Involving Tax Credits (Continued)
8 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

equivalent to the statutory rate plus the statutory rate 

multiplied by the rate at which the deduction phases out. 

Similarly, with tax credits, taxpayers often gradually lose 

the ability to claim a credit as their income nears the 

upper limit of the specified range for the credit. In that 

case, an additional dollar of earnings still faces the statutory rate, but in addition, the credit that can be subtracted from tax liability is reduced at the rate of the 

credit phaseout. Those taxpayers face an effective marginal rate equal to the sum of their statutory rate and the 

credit phaseout rate.

A few tax benefits disappear immediately once a taxpayer 

reaches a certain income level rather than gradually phasing out over a range of income. Those “cliffs” can create 

very high effective marginal rates. For example, single taxpayers with income between $60,000 and $80,000 can 

deduct up to $2,000 of tuition from their income, but 

those with income above $80,000 cannot claim the deduction at all. Someone who earned an additional $1,000 

that pushed income over that threshold would lose 

$2,000 in deductions, causing taxable income to rise by 

$3,000. The taxpayer would face an effective marginal 

rate three times his or her statutory rate: for instance, a 

taxpayer in the 25 percent bracket would face an effective 

marginal rate of 75 percent.

Although many provisions of the individual income tax 

have an effect on marginal rates, some—such as the 

student loan interest deduction or the dependent care 

credit—apply to relatively narrow groups of taxpayers. 

Others are wider in scope. The broadest provision is statutory tax rates, which apply to everyone with taxable income. Other provisions that affect the largest number of 

people or have the greatest impact on marginal rates are 

described below.

Earned Income Tax Credit. The earned income tax credit 

(EITC) reduces tax liability on the basis of the taxpayer’s 

earnings and number of children. The credit is refundable; in other words, if it exceeds a person’s tax liability, 

the excess is paid to the taxpayer. Below a threshold level 

of income, the EITC phases in as earnings increase, until 

the maximum credit amount is reached. Taxpayers receive 

that maximum credit until their earnings exceed a second 

threshold, at which point the credit begins to phase out 

gradually as earnings rise, until it reaches zero. The main 

features of the EITC—the rate at which it phases in and 

out, the maximum amount of the credit, and the two 

income thresholds—depend on whether the taxpayer has 

no children, one child, or more than one child.3

The EITC can dramatically alter marginal tax rates for 

taxpayers who claim it, especially taxpayers with children. 

For people with income in the credit’s phase-in range, the 

EITC reduces marginal rates below statutory rates, usually to negative levels. For example, for taxpayers with 

two children, each additional dollar of earnings increases 

their credit by 40 cents (34 cents for taxpayers with one 

child and 7.65 cents for taxpayers without children). 

Throughout the plateau—the income range between the 

two thresholds, where taxpayers receive the maximum 

credit—the EITC has no effect on taxpayers’ marginal 

rate. In the phaseout range, their marginal rate exceeds 

their statutory rate by the phaseout rate: 21.06 percentage points in the case of a taxpayer with two children, 

15.98 percentage points in the case of a taxpayer with one 

child, and 0.765 percent for a childless taxpayer.

CBO expects that 23 million taxpayers will claim the 

EITC in 2005. Of those, roughly 6 million will be in the 

phase-in range, which means their marginal tax rate will 

be below their statutory rate. About 13 million taxpayers 

will have income in the phaseout range and thus face a 

marginal rate above their statutory rate. (More taxpayers 

are in the phaseout range partly because it covers a wider 

swath of income and partly because more taxpayers have 

income at those levels.) The other 4 million taxpayers will 

receive the maximum credit, so the EITC will have no 

impact on their marginal rate.

Child Tax Credit. Taxpayers can claim a credit of up to 

$1,000 for each child under 17 years old. The credit is 

partially refundable—people who owe no taxes can receive a credit equal to 15 percent of their earnings above 

$11,000. In that income range, an additional dollar of 

earnings increases the credit by 15 cents, lowering the 

marginal tax rate by 15 percentage points. The refundable portion of the child credit begins after taxpayers have 

reached the income range for the maximum EITC; thus, 

it mitigates the large increases in marginal rates that occur 

as taxpayers enter the EITC plateau and phaseout ranges.

3. Those features are generally the same for taxpayers filing singly, 

jointly, or as a head of household, with one notable exception: 

under the Economic Growth and Tax Relief Reconciliation Act of 

2001, the income level at which the EITC begins to phase out is 

higher for married couples filing jointly than for other taxpayers.
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 9

In some instances, the child credit can lower a taxpayer’s 

marginal rate to zero. Some taxpayers are unable to claim 

the full amount of the credit because it more than offsets 

the taxes they would otherwise owe. If such taxpayers 

earned more income, their tax liability (before the credit) 

would increase, but that additional liability could be offset by the portion of credit they cannot claim now. Thus, 

the taxpayers would see no change in their taxes, regardless of their statutory marginal rate.

The child credit phases out at a rate of 5 percent for single filers with income of more than $75,000 and joint filers with income over $110,000. For every $1,000 in additional income above those thresholds, taxpayers lose 

$50 of their child credit. Since the credit phases out at a 

constant rate until it is exhausted, the income range over 

which taxpayers are affected depends on the size of the 

credit, which in turn depends on the number of children. 

Taxpayers in the phaseout range face an increase of 5 percentage points in their marginal tax rate.

CBO expects that 32 million taxpayers will claim the 

child credit in 2005. The phaseout provisions will increase marginal rates for about 2 million of them, and the 

refundability of the credit will lower marginal rates for 

about 6 million others. (The rest will be in neither the 

phase-in nor the phaseout range and will see no change in 

their marginal rate.)

Limit on Itemized Deductions and Phaseout of the Personal Exemption. Taxpayers with adjusted gross income 

(AGI) above certain levels face limits on the amount of 

itemized deductions and the size of the personal exemption they can claim.4 The restriction on itemized deductions reduces deductions by 3 percent of the amount of 

AGI over $145,950 for all taxpayers in 2005, up to a 

maximum reduction of 80 percent. For taxpayers with 

income in the affected range, that provision increases the 

marginal tax rate by 3 percent. The reason is that an additional $1,000 of earnings reduces itemized deductions by 

$30 and increases taxable income by $1,030. A taxpayer 

in the 25 percent bracket would pay additional tax of 

$257.50, the equivalent of an effective marginal rate of 

25.75 percent (25 percent x 1.03). CBO expects the limit 

on itemized deductions to affect about 3 million taxpayers this year.

The personal-exemption phaseout reduces the value of 

exemptions by 2 percent for each $2,500 of AGI above 

$145,950 for single filers in 2005. Unlike the case with 

the limit on itemized deductions, however, a separate 

threshold ($218,950) exists for married couples filing a 

joint return. Personal exemptions are completely phased 

out for single filers with income of more than $268,450 

and joint filers with income over $341,450. 

The effect of that provision on marginal tax rates depends 

on how many exemptions a taxpayer claims. For taxpayers with only one exemption, the provision increases their 

marginal rate by a factor of 1.0256; for taxpayers with 

four exemptions, their marginal rate rises by a factor of 

1.1024. Thus, taxpayers in the 25 percent statutory 

bracket would face an effective marginal rate of 25.64 

percent if they had one exemption and 27.56 percent if 

they had four exemptions. CBO estimates that in 2005, 

the personal-exemption phaseout will affect 1 million 

taxpayers.

Alternative Minimum Tax. The individual alternative 

minimum tax (AMT), as its name implies, is an alternate 

method of computing federal income tax liability. To 

determine AMT liability, a taxpayer must recalculate taxable income by adding back several items that are not regularly included in it (such as the deduction for state and 

local taxes, personal exemptions, and the standard deduction) and subtracting an AMT exemption instead. The 

resulting measure, alternative minimum taxable income, 

is taxed at two rates: 26 percent on the first $175,000 and 

28 percent on the remainder. Taxpayers must pay the 

higher of their AMT liability or their liability under the 

regular individual income tax. Additionally, they may not 

take certain tax credits if those credits would make their 

individual income tax liability lower than their AMT 

liability. 

Taxpayers subject to the alternative minimum tax face 

one of the two statutory AMT rates, but they can face 

higher effective marginal rates if their income is in the 

phaseout range for the AMT exemption. That exemption 

($40,250 for single filers and $58,000 for joint filers in 

2005) phases out at a rate of 25 percent at higher levels of 

income. Taxpayers in the phaseout range—$112,500 to 

4. Under the Economic Growth and Tax Relief Reconciliation Act of 

2001 (EGTRRA), those provisions are scheduled to be repealed 

gradually between 2006 and 2010. In 2006 and 2007, the limitations will be reduced by one-third from the current level, and in 

2008 and 2009, by two-thirds. In 2010, they will be eliminated. 

However, the limitations would return in full in 2011 if EGTRRA 

expired that year as scheduled.
10 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

$273,500 for single filers and $150,000 to $382,000 for 

joint filers—can face effective marginal rates under the 

AMT of 32.5 percent and 35 percent.

CBO expects 3 million taxpayers to be subject to the 

AMT in 2005. Over the coming decade, the tax is likely 

to grow rapidly in importance as rising incomes push 

more and more taxpayers onto its rolls. In addition, 

under current law, a temporary increase in the AMT 

exemption is scheduled to expire at the end of 2005.

Payroll Taxes

Most income from wages and self-employment is subject 

to payroll taxes that help fund Social Security’s Old-Age, 

Survivors, and Disability Insurance (OASDI) programs 

and Medicare’s Hospital Insurance (HI) program. Employers and employees each pay an OASDI tax of 6.2 

percent on earnings up to a certain amount ($90,000 in 

2005) and a 1.45 percent HI tax on all earnings. Publicfinance theorists generally agree that the employer’s share 

of those taxes is passed on to workers in the form of lower 

wages. CBO follows that assumption and treats payroll 

taxes as if employees paid both shares. 

Because Social Security taxes are linked to benefits, 

including them in a calculation of marginal tax rates is 

problematic. On one hand, payroll taxes involuntarily 

reduce the return from working just as an income tax 

does, and as such they should affect people’s decisions 

about how much to work. On the other hand, earning 

more and thus paying more in Social Security taxes (up to 

the taxable maximum) will eventually entitle workers to 

higher Social Security benefits. The net effect—the true 

“tax”—is the portion of the OASDI tax not offset in the 

future by increased benefits. CBO has not attempted to 

divide the tax into its gross and net components; instead, 

for simplicity, this paper presents marginal tax rates with 

and without payroll taxes.

The proper treatment of the HI tax is less ambiguous. 

Under the Medicare program, once workers have earned 

credit for 40 quarters of contributions, they are eligible to 

start receiving benefits at age 65. In 2005, workers receive 

a credit for each $920 in earnings and can accumulate up 

to four credits per year. Because workers receive no benefit for earnings above $3,680 per year, any amount beyond that can be viewed as a pure tax. Once workers have 

accumulated 40 quarters, any additional HI tax paid over 

their lifetime does not affect benefits. Thus, the HI portion of payroll taxes is much closer to a pure tax than the 

OASDI portion is.

State Income Taxes

Most states (and some localities) levy income taxes.5 Several states conform, to varying degrees, to federal definitions of income and apply their own rate schedule. State 

income tax rates tend to be much lower and less varied 

than federal rates, with top statutory rates rarely exceeding 10 percent. In 2004, total collections of state income 

taxes were about one-fourth the size of federal income tax 

collections. However, state income taxes do affect the 

returns from working, and they interact with federal taxes 

in influencing people’s labor force decisions.

Benefit Programs

Federal programs outside the tax system that provide benefits to low-income people produce an effect similar to a 

tax as the benefits are phased out for people with higher 

income. That situation typically occurs with programs 

that are means-tested (that is, in which benefits are based 

on a household’s level of income or wealth). For example, 

eligible Food Stamp recipients at certain income levels 

lose 24 cents of their Food Stamp benefits for each additional dollar of wages, until their benefits decline to zero. 

Including the effects of benefit phaseouts on marginal tax 

rates is beyond the scope of this analysis. However, it is 

important to recognize the role that those phaseouts play 

in determining the returns from work for low-income 

people. Ignoring the effects of benefit phaseouts may substantially understate effective marginal tax rates.

Stylized Examples of Marginal 

Tax Rates

The provisions of the federal individual income tax that 

are described above and shown in Table 1 influence effective marginal tax rates over various income ranges. Moreover, taxpayers in certain ranges can be affected by multiple provisions. This analysis illustrates the interactions 

among those provisions by examining their impact on a 

hypothetical taxpayer as his or her earnings increase from 

zero to $500,000.

5. For a description of income tax provisions in each state, see Faith 

Russell, Individual Income Tax Provisions in the States, Informational Paper 4 (Madison, Wis.: Wisconsin Legislative Fiscal 

Bureau, January 2005), available at www.legis.state.wi.us/lfb/

Informationalpapers/4.pdf.
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 11

The analysis uses three stylized examples: a single person 

with no dependents, a single parent with one child 

(someone who typically files as a head of household), and 

a married couple with two children. For simplicity, CBO 

assumes that all income comes from wages and that the 

taxpayers have itemized deductions equal to 18 percent of 

their earnings. Forty percent of those deductions are 

assumed to be state and local taxes (which are not deductible under the AMT), and the other 60 percent are charitable contributions and mortgage interest (which are deductible under the AMT). CBO chose to include only 

some of the most common features of the tax code in the 

examples; making assumptions about retirement savings 

or tuition payments for a student in college could lead to 

much more complex examples. 

Single Filer

At the lowest income levels, the income of a single taxpayer with no dependents is less than the combined standard deduction and personal exemption, so his or her 

taxable income—and tax liability before credits—is zero 

under the federal individual income tax (see the top panel 

of Figure 2). However, the taxpayer can claim the refundable earned income tax credit. The taxpayer’s initial effective marginal rate is a subsidy equivalent to the EITC 

phase-in rate: 7.65 percent for taxpayers without children. (That phase-in rate is intended to offset the employee’s share of payroll taxes in that income range.) As 

income increases, the taxpayer briefly moves onto the 

EITC plateau, where additional earnings do not affect 

the size of the credit. The taxpayer still has no taxable 

income, so his or her effective marginal rate rises to zero. 

At higher levels of income, the person enters the EITC 

phaseout range, where each additional dollar of earnings 

brings a 7.65 percent reduction in the credit.

At $8,200 of earnings, the taxpayer’s income exceeds the 

combined standard deduction and personal exemption 

and enters the first statutory tax bracket (10 percent). 

Because income is still in the EITC phaseout range, the 

taxpayer faces an effective marginal rate of 17.65 percent. 

At $11,750 of earnings, the EITC is completely phased 

out, and marginal tax rates begin to equal the statutory 

rates (10, 15, 25, and 28 percent).

Once income exceeds $145,950, two provisions—the 

limitation on itemized deductions and the phaseout of 

the personal exemption—alter the effective marginal tax 

rate of single filers (see the bottom panel of Figure 2). 

Together, those provisions add 1.56 percentage points to 

the 28 percent statutory rate, yielding an effective marginal rate of 29.56 percent. Both provisions remain in 

effect when the taxpayer enters the 33 percent bracket, at 

which point his or her effective marginal rate equals 

34.83 percent.

At higher levels of income, the alternative minimum tax 

begins to affect marginal rates. At income of just over 

$250,000, the taxpayer’s AMT liability exceeds regular 

income tax liability, so the AMT rate defines the effective 

marginal rate. At that income level, the statutory AMT 

rate is 28 percent and the AMT exemption phases out at 

a rate of 25 percent, producing an effective marginal tax 

rate of 35 percent. The AMT exemption is fully phased 

out for single filers with no children when income exceeds $300,000, at which point the marginal rate drops 

to the AMT rate of 28 percent. As income grows further, 

liability under the regular income tax starts to exceed 

AMT liability, so the taxpayer again faces the regular 

income tax. At that point, the 33 percent tax bracket and 

the itemized-deduction phaseout combine to create an 

effective marginal rate of 33.99 percent.6

 (The personal 

exemption has completely phased out.)

The marginal rate faced by a taxpayer who is subject to 

the AMT can be higher or lower than the marginal rate 

under the regular income tax. The two AMT rates, 26 

percent and 28 percent, are generally less than or equal to 

the statutory rates that apply to people in the same income range. However, the phaseout of the AMT exemption means that taxpayers in the exemption phaseout 

range face effective marginal tax rates under the AMT of 

32.5 percent and 35 percent, which often exceed the statutory rates applicable over comparable income ranges.

Head of Household with One Child

Families with children have considerably more variation 

in their effective marginal tax rates than single filers do, 

especially at lower income levels. With earnings below 

$7,830, a taxpayer filing as a head of household with one 

dependent faces the EITC phase-in rate: a subsidy of 34 

percent (see the top panel of Figure 3). When income 

exceeds that level, the taxpayer enters the EITC plateau, 

and his or her marginal rate jumps to zero. When income 

reaches $11,000, the taxpayer begins to claim the refund6. In these hypothetical examples, itemized deductions are assumed 

to increase proportionally with income, so the maximum reduction in itemized deductions is never achieved.
12 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

Figure 2.

Effective Marginal Federal Income Tax Rates for a Single Filer in 2005

(Percent)

Source: Congressional Budget Office.

Notes: This example assumes that the taxpayer has no dependents, that all income is from wages, and that the taxpayer has itemized deductions worth 18 percent of income and claims the greater of those deductions or the standard deduction. (Forty percent of the itemized 

deductions are assumed to be state and local taxes, and the rest are charitable contributions and mortgage interest.)

EITC = earned income tax credit; IDP = itemized-deduction phaseout; PEP = personal-exemption phaseout; AMT = alternative minimum tax.

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 100,000

-20

-10

0

10

20

30

40

Average Tax Rate

Statutory Tax Rate

Effective Marginal Tax Rate

Income up to $100,000

EITC

Phase-in

(-7.65%)

EITC Phaseout

and 10%

Bracket

(17.65%)

EITC

Phaseout

(7.65%)

EITC

Plateau (0)

10%

Bracket

15% Bracket

25% Bracket

28%

Bracket

100,000 150,000 200,000 250,000 300,000 350,000 400,000 450,000 500,000

0

10

20

30

40 Income of $100,000 to $500,000

28% Bracket,

IDP, PEP

(29.56%) 28%

Bracket

33% Bracket,

IDP, PEP (34.83%)

28% AMT Rate

and Exemption

Phaseout (35%)

28% AMT Rate

33% Bracket

and IDP

(33.99%)

35% Bracket and IDP (36.05%)
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 13

Figure 3.

Effective Marginal Federal Income Tax Rates for a Head of Household 

with One Child in 2005

(Percent)

Source: Congressional Budget Office.

Notes: This example assumes that the taxpayer has one dependent and files as a head of household, that all income is from wages, and that 

the taxpayer has itemized deductions worth 18 percent of income and claims the greater of those deductions or the standard deduction. (Forty percent of the itemized deductions are assumed to be state and local taxes, and the rest are charitable contributions and 

mortgage interest.)

EITC = earned income tax credit; CTC = child tax credit; AMT = alternative minimum tax; IDP = itemized-deduction phaseout.

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 100,000

-50

-40

-30

-20

-10

0

10

20

30

40

Average Tax Rate

Statutory Tax Rate

Effective Marginal Tax Rate

Income up to $100,000

EITC

Phase-in

(-34%)

EITC Phaseout and

10% Bracket (25.98%)

EITC Phaseout

and Refundable

CTC (0.98%)

EITC

Plateau (0)

15% Bracket

25% Bracket

25% Bracket and

CTC Phaseout (30%)

100,000 150,000 200,000 250,000 300,000 350,000 400,000 450,000 500,000

0

10

20

30

40

Income of $100,000 to $500,000

25%

Bracket 28% AMT Rate and

Exemption Phaseout (35%)

28% AMT Rate 35% Bracket

and IDP (36.05%)

EITC Phaseout and

15% Bracket (30.98%)

EITC Plateau

and Refundable

CTC (-15%)

28%

Bracket

26% AMT Rate and

Exemption Phaseout (32.5%)
14 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

able portion of the child tax credit in addition to the 

maximum EITC, dropping the effective rate to -15 

percent.

The taxpayer enters the 10 percent statutory bracket 

when income exceeds the $13,700 combined personal 

exemption and standard deduction. In the absence of any 

credits, the taxpayer would begin to owe taxes at that 

point. However, the taxpayer is not yet claiming the full 

child credit, so each additional dollar of taxes can be offset by a dollar of nonrefundable credit. 

The marginal rate for such taxpayers next changes when 

income reaches the beginning of the EITC phaseout 

range. That phaseout adds 15.98 percentage points to the 

marginal rate, which, coupled with the -15 percent rate 

created by the refundable child credit, produces an effective marginal rate of 0.98 percent. At slightly higher income levels, the taxpayer receives the entire child credit, 

and thus the credit no longer offsets additional dollars of 

income taxes owed. At that point, the effective marginal 

rates jumps by the size of the statutory rate (10 percent) 

and the lost refundability of the child credit (15 percent) 

to 25.98 percent. Earning an additional dollar would increase taxes by the statutory rate and reduce the EITC by 

nearly 16 cents. The taxpayer is still in the EITC phaseout range when he or she reaches the 15 percent statutory 

bracket (with income of $24,200); at that point, the 

effective marginal rate is 30.98 percent—the highest rate 

the person will face until his or her income approaches 

$150,000.

Throughout the lowest portion of the income range, the 

taxpayer receives a net subsidy from the income tax system, mainly because of the EITC and the child credit. If 

income is on the EITC plateau, the subsidy can be as 

large as $2,662. At around $27,500 of income, the taxpayer’s net income tax bill turns positive. The head of 

household owes taxes of about $1,550 under the statutory tax rates, although that tax liability is offset by a 

$1,000 child credit and an EITC that has been phased 

down to around $550.

The EITC phases out completely when the taxpayer’s 

income reaches $31,030. From that point, the taxpayer’s 

marginal tax rate equals the statutory rate (15 percent or 

25 percent) until income reaches $75,000, when the 

phaseout of the child credit begins. That phaseout raises 

the effective marginal rate 5 percentage points above the 

statutory rate, to 30 percent. The phaseout ends when 

income reaches $95,000, and the taxpayer again faces the 

25 percent and then 28 percent statutory rates. 

When income exceeds $139,000, the taxpayer becomes 

subject to the AMT and an effective rate of 32.5 percent—the combination of the 26 percent AMT bracket 

and the phaseout of the AMT exemption (see the bottom 

panel of Figure 3). Higher income moves the taxpayer 

into the 28 percent AMT bracket and an effective marginal rate of 35 percent. Once the AMT exemption is 

completely phased out, the marginal rate declines to the 

AMT rate of 28 percent. At even higher levels of income—more than $429,000 in 2005—the taxpayer’s liability under the regular income tax exceeds that under the 

AMT, so he or she moves back to the ordinary income 

tax. At that income level, the taxpayer is in the highest 

statutory bracket and faces the limitation on itemized 

deductions, creating an effective marginal rate of 36.05 

percent.

Married Couple with Two Children

At the lowest income levels, a married couple with two 

children is affected by the same tax provisions as a single 

parent with one child filing as a head of household. However, those provisions become effective at different 

income levels and are more integrated, resulting in a 

smoother pattern of effective marginal tax rates (see the 

top panel of Figure 4). The couple reaches the EITC plateau at exactly the same income at which the refundable 

child credit becomes effective, so its marginal rate goes 

from -40 percent to -15 percent. Similarly, the EITC 

phaseout ends just before the 15 percent bracket begins, 

so the couple never faces those two provisions at the same 

time.

Once income exceeds the point at which the couple is no 

longer eligible for the EITC, its marginal rate equals the 

statutory 15 percent rate for a broad swath of the income 

range—from roughly $37,000 to $88,000. As income 

increases above that level, the family faces the 25 percent 

tax bracket. When income reaches $110,000, the child 

credit begins to phase out, raising the marginal rate by 5 

percentage points to 30 percent (see the bottom panel of 

Figure 4). The phaseout continues until the couple’s 

income reaches $150,000. That phaseout range is twice 

as long as the range for a family with one child because 

the child credit is twice as large. (The credit phases out at 

a constant rate of 5 percent, so a $2,000 credit phases out 

over a $40,000 income range, whereas a $1,000 credit 

phases out over a $20,000 range.)
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 15

Figure 4.

Effective Marginal Federal Income Tax Rates for a Married Couple 

with Two Children in 2005

(Percent)

Source: Congressional Budget Office.

Notes: This example assumes that the taxpayers are a married couple filing jointly with two dependents. All of the couple’s income is from 

wages earned by one spouse. The couple has itemized deductions worth 18 percent of income and claims the greater of those deductions or the standard deduction. (Forty percent of the itemized deductions are assumed to be state and local taxes, and the rest are 

charitable contributions and mortgage interest.)

EITC = earned income tax credit; CTC = child tax credit; IDP = itemized-deduction phaseout; AMT = alternative minimum tax.

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 100,000

-50

-40

-30

-20

-10

0

10

20

30

40

Average Tax Rate

Statutory Tax Rate

Effective Marginal Tax Rate

Income up to $100,000

EITC

Phase-in

(-40%)

EITC Phaseout and

10% Bracket (31.06%)

EITC Phaseout

and Refundable

CTC (6.06%) 15% Bracket

25% Bracket

100,000 150,000 200,000 250,000 300,000 350,000 400,000 450,000 500,000

0

10

20

30

40

Income of $100,000 to $500,000

25%

Bracket

28% AMT Rate and Exemption Phaseout (35%)

28% AMT Rate

EITC Plateau

and Refundable

CTC (-15%)

25% Bracket and

CTC Phaseout (30%)

26% AMT Rate

and Exemption

Phaseout (32.5%)

10% Bracket

25% Bracket,

CTC Phaseout,

and IDP (30.75%)

28% Bracket

and IDP (28.84%)

25% Bracket

and IDP (25.75%)
16 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

As income approaches $200,000, the family begins to 

face the AMT, with an effective rate of 32.5 percent (the 

combination of the 26 percent AMT bracket and the 

phaseout of the AMT exemption). Higher income moves 

the couple into the 28 percent AMT bracket and an 

effective marginal rate of 35 percent. Once the AMT 

exemption is completely phased out, their marginal rate 

falls to the AMT rate of 28 percent. The couple’s liability 

under the regular income tax does not again exceed that 

under the AMT until their income is greater than 

$500,000, so the taxpayers do not move back to the regular income tax in the income range shown in Figure 4.

Payroll and State Income Tax Rates

To provide a fuller picture of marginal tax rates on labor 

income, CBO also calculated rates including payroll taxes 

and state income taxes. The resulting combined effective 

marginal rate assumes that workers bear the full burden 

of both their and their employers’ shares of payroll taxes. 

To maintain consistency with that assumption, marginal 

tax rates that include payroll taxes are based on an additional dollar of compensation measured before the payment of employers’ payroll taxes, not an additional dollar 

of wages (see Box 1). State income taxes are simplified: a 

fixed 5 percent rate is applied to the federal measure of 

taxable income. That rate approximates the marginal rate 

in an average state.

Box 1.

Including the Employer’s Share of Payroll Taxes in Calculations 

of Marginal Tax Rates

The Congressional Budget Office (CBO) assumes 

that employees bear the burden of both their and 

their employers’ shares of Social Security and Medicare payroll taxes (because research suggests that employers pass on their share of those taxes to workers 

in the form of reduced wages). Consistency with that 

assumption requires calculating the marginal payroll 

tax rate on an additional dollar of compensation 

measured before the payment of the employer’s payroll taxes. The employee, of course, actually pays income and payroll taxes on income measured after the 

employer’s share of payroll taxes has been paid. 

Suppose an employer pays a worker $13,934 in cash 

wages. Both the employer and the employee must 

pay $1,066 in payroll taxes (7.65 percent of 

$13,934), and the employee, who is in the 10 percent statutory bracket, must pay $573 in federal income taxes (after various deductions). The employee’s share of payroll taxes is deducted from cash 

wages, but the employer’s share is in addition to 

those wages, making the pretax amount of compensation $15,000 (see the table at right). If the employer spent an additional $1,000 to compensate the 

worker, cash wages would rise by only $929 because 

the employer would have to set aside $71 to pay its 

share of payroll taxes. The employee would also pay 

an additional $71 in payroll taxes and $93 in federal 

income taxes. From that extra $1,000 of compensation, therefore, the federal government would receive 

$235 in taxes—thus, the worker’s marginal tax rate 

would be 23.5 percent. That rate is less than the sum 

of all of the applicable tax rates (7.65 + 7.65 + 10 = 

25.3 percent) because those rates are applied after the 

employer’s share of payroll taxes has been deducted. 

Computing marginal tax rates with respect to pretax 

compensation alters the marginal income tax rate as 

well as the marginal payroll tax rate. In the example 

above, although the employee is in the 10 percent tax 

bracket, his or her marginal income tax rate is 9.3 

percent. 

When this paper discusses a marginal rate that includes payroll taxes, the rate is computed with respect to pretax compensation. That approach is consistent with CBO’s assumption that the employee 

bears the full burden of payroll taxes. However, when 

the analysis considers individual income taxes in isolation, the marginal rate is computed with respect to 

wages received after payroll taxes have been paid. 

That formulation aligns effective marginal rates with 

the rates specified in income tax law. 
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 17

Payroll taxes raise the effective marginal rate by approximately the combined employee and employer statutory 

payroll tax rate (see Figure 5). Because the OASDI tax is 

capped, the effect of payroll taxes is larger for low- and 

middle-income earners than for high-income earners. 

Workers with earnings below the OASDI maximum—

$90,000 in 2005—face a total statutory payroll tax rate 

of 15.3 percent, consisting of a 12.4 percent OASDI tax 

and a 2.9 percent HI tax. Once earnings exceed the 

OASDI maximum, only the HI tax applies.

Payroll taxes have the same effect on marginal tax rates in 

each of the three stylized examples. For the married couple, CBO’s assumption that only one spouse has earnings 

drives that result. Payroll taxes are levied on individual 

workers, not married couples, so spouses can face different marginal payroll tax rates. At the extreme, if earnings 

are equally split between the spouses, the couple can face 

the combined 15.3 percent OASDI and HI tax rate until 

both workers reach the OASDI maximum (at combined 

earnings of $180,000).

Because CBO’s analysis assumes a single state tax rate of 

5 percent, state income taxes add basically a fixed amount 

to the marginal-rate calculation. At the lowest income 

levels, families have no state taxable income and hence 

owe no state taxes. Once taxable income becomes positive 

(which CBO assumes happens at the same thresholds as 

for federal income taxes), the effective marginal rate increases by about 5 percentage points (the assumed state 

marginal rate). State taxes interact with the federal marginal rate if the taxpayer itemizes deductions: when a taxpayer earns more, deductible state income taxes rise, so 

federal taxable income rises less than earnings, reducing 

Box 1.

Continued

Example of How Employers’ Payroll Taxes Affect Marginal-Rate Calculations

Source: Congressional Budget Office.

a. Assumes a single filer with no children.

b. Assumes that the employee ultimately bears both shares of payroll taxes because the employer will pass on its share in the form 

of lower wages than would otherwise be the case.

13,934 14,863 929

1,066 1,137 71 _____ _____ ____

Total Compensation 15,000 16,000 1,000

1,066 1,137 71

13,934 14,863 929

-5,000 -5,000 0

-3,200 -3,200 0 _____ _____ ___

Taxable Income 5,734 6,663 929

573 666 93

2,132 2,274 142 _____ _____ ___

Total Taxes Paid 2,705 2,940 235

With $1,000 Increase

Employee's Share of Payroll Taxes (7.65 percent of wages paid)

Employee's Taxable Income

Wages

At Base

Standard deduction

Employer's Costs

Employee's Tax Computationa

Employer's Share of Payroll Taxes (7.65 percent of wages paid)

Wages Paid to Employee

Compensation in Compensation Difference

Personal exemption

Federal Income Tax (10 percent bracket)

Employee's and Employer's Share of Payroll Taxesb
18 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

Figure 5.

EEffect of Payroll Taxes and State Income Taxes on Effective Marginal Tax Rates 

in 2005

(Tax rate in percent)

Continued

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 100,000

-50

-40

-30

-20

-10

0

10

20

30

40

50

Federal Income Tax

Plus Payroll Taxes

Plus Payroll and State Income Taxes

State Tax

Liability Begins

Taxpayer Begins

to Itemize

Social Security

Taxable Maximum

Single Filer with No Children

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 100,000

-50

-40

-30

-20

-10

0

10

20

30

40

50

Federal Income Tax

Plus Payroll Taxes

Plus Payroll and State Income Taxes

State Tax

Liability Begins

Taxpayer Begins

to Itemize

Social Security

Taxable Maximum

Head of Household with One Child

Income
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 19

Figure 5.

Continued

(Tax rate in percent)

Source: Congressional Budget Office.

Notes: These examples assume that the taxpayers are a single filer with no dependents, a single filer who has one dependent and files as a 

head of household, or a married couple filing jointly with two dependents. All income is from wages (in the case of the married couple, 

those wages are earned by one spouse). The taxpayers have itemized deductions worth 18 percent of their income and claim the 

greater of those deductions or the standard deduction. (Forty percent of the itemized deductions are assumed to be state and local 

taxes, and the rest are charitable contributions and mortgage interest.)

State taxes are assumed to be 5 percent of federal taxable income.

Marginal rates are computed as a percentage of compensation before the employer’s share of payroll taxes has been paid.

the federal marginal rate. Because of that interaction, the 

incremental effect of including state income taxes shrinks 

for taxpayers who itemize deductions. That effect disappears if taxpayers become subject to the AMT, because 

state and local income taxes cannot be deducted under 

the AMT. 

In reality, of course, the state marginal income tax rate 

depends on the laws in each state. Those laws vary in 

many ways, including the definition of income, the structure of tax rates, and the availability of deductions and 

credits. In general, however, state tax laws define income 

similarly to federal tax law, and state tax rates tend to be 

lower and less diverse than federal rates. The examples 

shown in Figure 5, although an oversimplification, give a 

rough indication of the effect of state income taxes on 

marginal tax rates.

Distribution of Effective Marginal 

Tax Rates

Stylized examples of taxpayers can illustrate interactions 

among provisions of the tax code at different levels of 

income, but they provide little information about the 

marginal tax rates that actual households face or how 

many households fall into each income range. Simulating 

the taxes paid by actual filers provides information about 

the distribution of effective marginal rates across the 

population.

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 100,000

-50

-40

-30

-20

-10

0

10

20

30

40

50

Federal Income Tax

Plus Payroll Taxes

Plus Payroll and State Income Taxes

State Tax

Liability Begins

Couple Begins

to Itemize

Social Security

Taxable Maximum

Married Couple with Two Children

Income
20 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

Methodology

CBO simulated tax liabilities using information from a 

sample of income tax returns filed in 2002 (the most 

recent data available at the time of the analysis). The sample was designed to be representative of the population 

that filed tax returns in that year. For each return in the 

sample, CBO simulated income tax liability under 2005 

tax law.7

 The analysis then calculated marginal rates by 

adding $1,000 to the earnings on each return and recomputing the amount of income tax owed. The difference 

between the two tax liabilities, divided by $1,000, equals 

the household’s marginal tax rate.8 The tax-simulation 

model that CBO used to perform those calculations 

accounts for most, but not all, of the provisions that affect people’s effective marginal federal income tax rate.

Since the analysis focuses on marginal tax rates on labor 

income, it considers only tax returns with earnings. Ideally, the analysis would also include potential workers 

(those who might join the labor force), but such people 

cannot be readily identified. One possibility would be to 

include all households in the analysis in order to capture 

potential workers. However, that approach would also 

include many people who have permanently left the work 

force, such as those who have retired or become disabled. 

The appendix to this paper shows how expanding the 

population under consideration affects the distribution of 

marginal tax rates.

CBO included payroll taxes in parts of the distribution 

analysis (again using the assumption that the employer’s 

share of those taxes is passed on to employees). Most 

workers are in jobs covered by Social Security and Medicare and thus face the OASDI and HI taxes, but around 

5 percent of employees are exempt from those taxes. 

CBO’s model contains information from W-2 forms 

about which workers were exempt from payroll taxes.9

Because payroll taxes are levied on the worker, not the 

tax-filing unit, each earner in a married couple filing 

jointly can face a different payroll tax rate—if, for example, one spouse is above the OASDI taxable maximum 

and the other is not. In those cases, CBO assumed that 

the $1,000 in additional earnings is divided between 

spouses in proportion to their actual earnings. The calculated marginal payroll tax rate for the couple is the average of the rate that each spouse faces, weighted by his or 

her earnings.

CBO also included state income taxes in the distribution 

analysis. It estimated those tax rates by applying a set of 

state income tax calculators to a sample of federal tax 

returns, using state tax laws in place in 2002.10 That 

method provides a good estimate of state income tax 

rates, but it is more approximate than CBO’s estimates of 

federal income tax rates because of limitations in the federal income tax data.11

7. The analysis simulated taxes after adjusting for inflation and real 

income growth by deflating unindexed tax parameters by the 

nominal annual rate of per capita income growth and deflating 

indexed parameters by the real annual rate of per capita income 

growth. Applying those adjusted tax parameters to fixed 2002 

income yields the same effective tax rates that taxpayers would 

face, under current law, if income grew at a constant rate of 4.5 

percent per year and inflation was 2.2 percent per year.

8. That method produces many estimates of marginal rates that are 

hybrids of rates in the tax code. For example, for a taxpayer near 

the top of a tax bracket, part of the additional $1,000 could be 

taxed at one statutory rate and part at another. That situation 

would yield an estimated marginal rate that was the weighted 

average of the two statutory rates.

9. Certain government employees are the main class of workers 

exempt from either or both payroll taxes. All federal employees 

have been covered by HI since 1983, but many people who have 

been continuously employed by the federal government since 

before 1984 are not covered by OASDI and therefore do not pay 

OASDI taxes. Similarly, some employees of state and local governments (the relevant categories differ from state to state) are covered by a public retirement system other than OASDI. In 

addition, people continuously employed by those governments 

since before April 1, 1986, are not covered by HI. For more details 

about groups exempt from payroll taxes, see Congressional Budget 

Office, Differences in Wage and Salary Income Included in Various 

Tax Bases (June 2005).

10. Jon Bakija of Williams College created the state tax calculator 

used by CBO. For more details, see Jon Bakija, Documentation for 

IncTaxCalc: A Federal-State Personal Income Tax Calculator Covering the Years 1900-2002 (working paper, Williams College 

Department of Economics, December 2004), available at 

wso.williams.edu/~jbakija/.

11. Three factors limit the accuracy of the state tax estimates. First, a 

federal income tax return may lack the information necessary to 

calculate state income taxes. For instance, many states exempt 

pension income of state employees from taxation. Since federal tax 

law makes no such exemption, federal tax returns do not contain 

any information about the source of pension income, which 

makes it impossible to properly model state law. Second, federal 

tax returns contain the taxpayer’s home address, which may differ 

from the state in which the taxpayer owes taxes. CBO assumes 

that all income is earned in the home state, even though many taxpayers have to apportion their income among states. Third, the 

sample of federal tax returns that CBO used may not be representative of every state. Nevertheless, on balance, the benefit of having a more complete measure of marginal tax rates outweighs the 

fact that the state estimates are approximations. 
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 21

State and local income taxes are deductible on federal tax 

returns, and some states allow taxpayers to deduct federal 

income taxes on state returns. The simulations account 

for that deductibility, which reduces marginal tax rates 

for taxpayers with itemized deductions. For example, 

consider a taxpayer who faces a state marginal rate of 5 

percent and a federal marginal rate of 25 percent and who 

itemizes deductions. If that taxpayer earns an additional 

$1,000, his or her state taxes rise by $50. After deducting 

that $50, the person pays federal taxes on only $950 in 

additional taxable income. Federal tax liability increases 

by $237.50—less than the $250 rise that would occur 

without the deductibility of state taxes. 

After computing marginal rates for every taxpayer in the 

sample (and weighting the sample to represent the entire 

population), CBO ranked taxpayers with labor income 

by each of three marginal rates: for individual income 

taxes alone, for individual income plus payroll taxes, and 

for individual income plus payroll and state income taxes. 

CBO then divided taxpayers into 100 person- or dollarweighted percentiles. Person-weighted percentiles contain 

equal numbers of people; dollar-weighted percentiles are 

based on a taxpayer’s total earnings and contain equal 

amounts of earnings, although the number of taxpayers 

in each percentile varies.

Distribution of Statutory Federal Income Tax Rates

As noted above, statutory tax rates are a major component of effective marginal rates, and for many taxpayers, 

the two rates are the same. Almost one-fifth of taxpayers 

with earnings have no taxable income and face a statutory 

marginal rate of zero (see Table 2). Many of those taxpayers have total income that falls short of the combined 

standard deduction and personal exemption, but they file 

a return in order to receive a refundable credit or a refund 

for withheld taxes. Another one-fifth of taxpayers face the 

10 percent statutory rate, implying taxable income of less 

than $7,300 for single filers and $14,600 for joint filers. 

The 15 percent bracket contains the largest proportion of 

taxpayers: more than one-third. Most of the remaining 

taxpayers fall in the 25 percent bracket, and smaller numbers fall into the 28, 33, or 35 percent brackets or face the 

AMT. 

Dollar-weighted measures of statutory marginal rates, 

which give more weight to taxpayers with high earnings 

than to those with low earnings, may better reflect the 

effects of the tax system on labor income throughout the

Table 2.

Distribution of Individual Income Tax 

Returns and Earnings, by Statutory 

Marginal Tax Bracket, in 2005

(Percent)

Source: Congressional Budget Office.

a. Includes returns with no taxable income.

b. Taxpayers subject to the alternative minimum tax face a statutory rate of 26 percent or 28 percent.

economy than do person-weighted measures, which give 

everyone equal weight. Because income tax rates rise with 

income, dollar-weighted measures of statutory marginal 

rates are higher than person-weighted measures. The onefifth of taxpayers facing a zero statutory rate earned only 

3.8 percent of total labor income, whereas the 3 percent 

of taxpayers who fell into the 28, 33, and 35 percent 

brackets together earned more than 15 percent of wages 

(see Table 2). The person-weighted average statutory rate 

(the average rate that would apply if each taxpaying unit 

increased its income by an equal dollar amount ) is 13 

percent. The dollar-weighted average statutory rate (the 

average rate that would apply if each taxpaying unit 

increased its earnings by an equal percentage) is significantly higher: 20 percent. 

Distribution of Effective Marginal 

Federal Income Tax Rates 

Effective marginal rates vary much more than statutory 

marginal rates do. In CBO’s simulations, marginal tax 

rates on earnings ranged from -40 percent (the EITC 

phase-in rate for a family with two or more children) to 

over 50 percent (the top statutory rate plus several phaseouts). About 7 percent of taxpayers with earnings face 

 3.8 19.7 

 7.7 21.6 

 33.8 36.9 

 28.4 16.5 

 6.1 2.1 

 1.8 0.4 

 7.5 0.4 

 11.0 2.5 ____ ____

Total 100.0 100.0 

Statutory Marginal Rate

0a

10

15

of Taxpayers

 Facing That Rate

Share of

Total Earnings

Percentage Those Taxpayers'

25

28

33

35

Alternative Minimum Taxb
22 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

negative marginal federal income tax rates (see the top 

panel of Figure 6). Thus, if they were to earn more, their 

income taxes, net of credits, would decline or the net 

amount of money they receive from the tax system would 

increase. Those taxpayers are in the phase-in ranges of the 

EITC and the refundable portion of the child tax credit. 

Consequently, their marginal tax rates are clustered at the 

credit phase-in rates (-40, -34, -15, and -7.65 percent).

Another 9 percent of taxpayers face a marginal rate of 

zero. They either have no taxable income—meaning that 

deductions and exemptions exceed their adjusted gross 

income—or they have credits that completely offset their 

tax liability. Almost half of all taxpayers with earnings 

face marginal rates equal to the first three statutory rates: 

10, 15, and 25 percent. (Over one-fourth of taxpayers are 

in the 15 percent bracket.) Only about 3 percent of taxpayers have a marginal rate equal to the 33 percent or 35 

percent statutory rate. In all, about 40 percent of taxpayers have marginal rates that differ from statutory rates, 

either because of the various phase-ins and phaseouts in 

the income tax system or because an additional increment 

of income crosses tax brackets.

On balance, more than 60 percent of taxpayers with earnings have marginal income tax rates of 15 percent or less. 

Fewer than 20 percent of taxpayers face marginal rates in 

excess of 25 percent, and about 7 percent face rates in 

excess of 30 percent. The lower-to-middle portion of the 

income range, where households tend to face the first two 

statutory marginal rates, is densely populated. The upper 

reaches of the income range, where statutory rates are 

high and phaseouts drive up marginal rates, contains 

fewer people. Consequently, many of the tax provisions 

that create high marginal rates apply to relatively few taxpayers. 

Because marginal rates generally rise as income does, 

ranking taxpayers in dollar-weighted percentiles shifts the 

distribution of marginal tax rates higher (see the bottom 

panel of Figure 6). The marginal rate at the 25th percentile is 15 percent under the dollar-weighted measure, 

compared with 10 percent under the person-weighted 

measure. The median marginal rate jumps from 15 percent to 25 percent when using dollar weighting, and the 

marginal rate at the 75th percentile rises from 25 percent 

to 28 percent. 

Distribution of Combined Federal 

and State Tax Rates

Payroll and state income taxes add significantly to effective marginal rates. With those included, substantially 

fewer earners—only 5 percent—face no tax (or a subsidy) 

on additional earnings, compared with 16 percent when 

only federal income taxes are considered (see the top 

panel of Figure 6). The taxpayer in the 25th personweighted percentile faces a combined marginal rate of 

23.5 percent, more than double the marginal federal 

income tax rate of 10 percent. Likewise, the median 

taxpayer has a combined marginal rate of 31.6 percent, 

compared with a federal marginal rate of 15 percent. Taxpayers at the top end of the distribution can face combined marginal tax rates of more than 65 percent.

Federal income taxes account for most of the variation in 

combined marginal tax rates, however. The pattern of 

combined rates essentially parallels that of federal individual rates. On average, federal individual income taxes are 

larger than the other taxes—in 2004, federal individual 

income tax receipts totaled $809 billion, and federal payroll tax receipts amounted to $686 billion, whereas state 

individual income tax receipts totaled just under $200 

billion.12 Federal individual income taxes also have a tremendous amount of variation, with effective marginal 

rates ranging from roughly -40 percent to more than 50 

percent. By contrast, payroll tax rates vary only from zero 

to 15.3 percent. State income tax rates also vary less than 

federal income tax rates: from around -2 percent to 10 

percent.13

Payroll tax rates significantly increase marginal rates but 

by a relatively constant amount. For most taxpayers, the 

inclusion of payroll taxes simply raises their marginal rate 

by the OASDI and HI statutory rates (adjusted to account for the employer’s share of those taxes). Only about 

5 percent of taxpayers are not in employment covered by 

OASDI or HI and hence do not pay federal payroll taxes. 

Another 5 percent or so earn wages above the OASDI 

taxable maximum and face only the HI marginal rate.

12. See Nicholas W. Jenny, State Finances Begin Recovery: Fiscal Year 

2004 Tax Revenue Summary, State Fiscal Brief No. 72 (Albany: 

State University of New York, Nelson A. Rockefeller Institute of 

Government, February 2005), available at www.rockinst.org/

publications/fiscal_studies/FB_72.pdf. The state figure is based 

on each state’s fiscal year, which generally ends on June 30.

13. Those figures are for the first and 99th percentiles, excluding the 

most extreme values.
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 23

Figure 6.

Distribution of Effective Marginal Tax Rates in 2005

(Tax rate in percent)

Source: Congressional Budget Office simulations using data from the Internal Revenue Service’s Statistics of Income database.

Notes: MTR = marginal tax rate. Numbers in parentheses indicate the percentage of taxpaying units or earnings facing that marginal rate.

The person-weighted measure divides taxpayers into 100 percentiles that all contain equal numbers of people. The dollar-weighted 

measure divides taxpayers into 100 percentiles that all contain equal amounts of earnings.

a. As a percentage of wages paid.

b. As a percentage of compensation before the employer’s share of payroll taxes has been paid.

-40

-30

-20

-10

0

10

20

30

40

50

60

0 10 20 30 40 50 60 70 80 90 100

Federal Income Tax Ratea

Federal Income, Payroll, and

State Income Tax Rateb

Cumulative Percentage of Tax Returns with Earnings

Using Person-Weighted Measure

MTR < 0

(7%)

MTR = 0

(9%)

MTR = 10%

(8%)

MTR = 15%

(29%)

MTR = 25%

(12%)

MTR > 25%

(18%)

Federal Income and

Payroll Tax Rateb

-40

-30

-20

-10

0

10

20

30

40

50

60

0 10 20 30 40 50 60 70 80 90 100

Federal Income Tax Ratea

Federal Income, Payroll, and

State Income Tax Rateb

Cumulative Percentage of Earnings

Using Dollar-Weighted Measure

MTR < 0

(3%)

MTR = 10%

(3%)

MTR = 15%

(25%)

MTR = 25%

(18%)

MTR > 25%

(40%)

Federal Income and

Payroll Tax Rateb
24 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

State tax rates are much lower than federal rates and thus 

have a smaller impact on combined marginal rates. Eight 

states, including populous ones such as Florida and Texas, 

have no income tax, so taxpayers in those states face a 

state marginal rate of zero. Several states have earned 

income tax credits, but they tend to be much smaller than 

the federal credit. State rates also tend to be slightly progressive, gradually increasing as income (and federal income tax rates) rise. 

As with marginal individual income tax rates, the dollarweighted distribution of combined marginal rates is 

higher than the person-weighted distribution (see the 

bottom panel of Figure 6). Most of that difference comes 

from individual income taxes. Marginal payroll tax rates 

are lower under the dollar-weighted measure than under 

the person-weighted measure because people with the 

highest income (whose earnings exceed the OASDI taxable maximum) face a lower marginal payroll tax rate 

than do people with lower earnings. The 5 percent of taxpayers with earnings above that maximum account for 16 

percent of earnings. Marginal state income tax rates, by 

contrast, are slightly higher under the dollar-weighted 

measure than under the person-weighted measure, 

reflecting some increase in state tax rates as income rises. 

Effective Marginal Tax Rates by Income Group

Effective marginal rates on labor income differ both 

among and within income groups. Taxpayers with different earnings face different marginal rates both because 

statutory tax rates change with income and because some 

provisions of the tax code apply only over limited income 

ranges. Marginal rates can also vary with earnings if other 

tax-related characteristics are systematically related to 

earnings. For example, higher-earning taxpayers tend to 

have more income from investments (which generally increases the effective marginal rates on earnings) and more 

itemized deductions (which generally decreases effective 

marginal rates).

In addition, taxpayers with similar earnings can face 

widely varying marginal rates depending on their personal circumstances, because many factors other than 

earnings affect people’s tax liability. Taxpayers who can 

file jointly as a married couple may face different marginal rates than single taxpayers with the same amount of 

earnings. Taxpayers who have many children may face 

different rates than those with fewer children. Taxpayers 

with large amounts of nonlabor income face different 

marginal rates than those without such income, and taxpayers with large itemized deductions have different marginal rates than those with smaller deductions. 

To examine how effective marginal tax rates on labor 

income vary among and within income groups, CBO 

divided taxpayers into deciles (tenths of the income distribution) on the basis of their earnings and analyzed the 

range of marginal rates within each decile. Like the 

person-weighted measure described above, the deciles 

contain equal numbers of taxpaying units, considering 

only tax returns with some earnings. 

The median marginal tax rate rises rapidly over the first 

four earnings deciles, from a little more than 14 percent 

in the first decile to 31 percent in the fourth decile (see 

Figure 7). The increase is more gradual over the next four 

deciles, with the median marginal rate climbing to 34 

percent. It then jumps to 37 percent in the ninth decile 

and 40 percent in the top decile. That pattern largely reflects the progressive nature of federal taxes. Low-income 

taxpayers move rapidly through the EITC and into the 

regular tax system. Most middle-income taxpayers face 

the 15 percent statutory rate plus payroll taxes plus state 

taxes. Those taxpayers have a federal marginal rate of 28 

percent plus their state tax rate.14 Effective marginal rates 

climb for taxpayers at higher income levels because of 

higher statutory rates and the phaseouts of various credits 

and deductions. 

Marginal rates vary widely within deciles, especially in the 

lower deciles. In fact, the variation within those deciles 

often exceeds the variation in median marginal rates 

between deciles. For instance, in the second decile, more 

than 45 percentage points separate the marginal rates at 

the 10th and 90th percentiles, and more than 12 percentage points separate the rates at the 25th and the 75th percentiles (see Figure 7). Much of the variation within the 

lower deciles is caused by the very low and high marginal 

rates associated with the phase-in and phaseout, respectively, of the EITC. Taxpayers in the EITC phase-in 

range can face marginal rates as low as -25 percent (a -40 

percent EITC rate coupled with a 15.3 percent payroll 

tax rate), whereas taxpayers in the EITC phaseout range 

can face rates as high as 45 percent (a 10 percent statutory 

rate plus a 21.06 percent phaseout rate plus the 15.3 percent payroll tax rate).

14. That 28 percent rate is measured as a percentage of income before 

the employer’s share of payroll taxes has been paid.
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 25

Figure 7.

Effective Marginal Tax Rates, by Earnings Level

(Tax rate in percent)

Source: Congressional Budget Office simulations using data from the Internal Revenue Service’s Statistics of Income database.

Notes: Deciles (tenths of the income distribution) were constructed by ranking tax returns by their level of earnings. Only returns with earnings were included. The dark line in the center (the 50th percentile) represents the median marginal rate for a given decile. The area 

between the 25th and 75th percentiles is the range containing the middle half of tax returns in each decile. The area between the 10th 

and 90th percentiles is the range containing the middle 80 percent of tax returns in each decile.

These results are based on 2005 federal tax law and 2002 state tax law. The marginal rates include federal and state individual income 

taxes and federal payroll taxes. They are computed as a percentage of compensation before the employer’s share of payroll taxes has 

been paid.

The Change in Marginal Tax Rates

If Current Laws Expire

Between 2001 and 2004, the Congress and the President 

enacted three major tax laws that affect marginal tax 

rates on labor income. The Economic Growth and Tax 

Relief Reconciliation Act of 2001 (EGTRRA) lowered 

statutory rates, increased credits, and lessened the impact 

of the marriage penalty and the alternative minimum tax. 

The Jobs and Growth Tax Relief Reconciliation Act of 

2003 (JGTRRA) accelerated some of the provisions in 

EGTRRA, reduced taxes on capital gains and qualified 

dividends, and temporarily raised exemption levels for 

the AMT. The Working Families Tax Relief Act of 

2004 (WFTRA) accelerated some of the provisions in 

EGTRRA and extended others in EGTRRA and 

JGTRRA. (For more details about those laws, see Box 2.) 

Most of the tax provisions in those laws are temporary, 

phasing in and out between 2001 and 2010 and then expiring at the beginning of 2011. Since the laws lowered 

effective marginal tax rates, such rates will rise significantly if the laws expire as currently scheduled. 

This analysis compares marginal tax rates under current 

law (including scheduled expirations) with an alternative 

measure under which each tax provision is set at its most 

generous scheduled level. The analysis refers to that measure as fully phased-in EGTRRA, even though some of 

the specifics of the measure were created by WFTRA or 

JGTRRA. For example, under EGTRRA, the phaseout of 

itemized deductions and the personal exemption is fully 

repealed only in 2010. By contrast, the highest AMT 

Lowest Second Third Fourth Fifth Sixth Seventh Eighth Ninth Highest

-20

-10

0

10

20

30

40

50

50th Percentile

10th Percentile

75th Percentile

25th Percentile

90th Percentile

Earnings Decile
26 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

exemption amount, set by JGTRRA and extended by 

WFTRA, is in effect from 2003 through 2005. CBO’s 

fully phased-in measure assumes the highest AMT 

exemption and the full repeal of both phaseouts, even 

though they will not apply at the same time under current law. Marginal rates both under fully phased-in 

EGTRRA and with EGTRRA’s expiration are simulated 

using 2005 income levels.

Across much of the income distribution, a hypothetical 

married couple with two children would see its marginal 

tax rate increase if EGTRRA expired. Some of the largest 

increases would occur for couples who are now affected 

by the refundability of the child tax credit—those with 

earnings between $11,000 and $24,000 (see the top 

panel of Figure 8). Under EGTRRA, the refundability of 

the child credit begins at the same point as the EITC plateau and continues into the EITC phaseout range, which 

mitigates the jump in marginal rates associated with the 

credit. For couples at that income level, effective marginal 

rates would rise by 15 percentage points if EGTRRA 

expired.

EGTRRA actually increased marginal rates for some 

taxpayers with income of less than $50,000 in two 

ways. First, the refundability of the child credit under 

EGTRRA means that taxpayers receive some child credit 

even when they owe no taxes, so they obtain the maxiBox 2.

Recent Tax Laws That Alter Marginal Rates on Labor Income

Three major tax laws enacted between 2001 and 

2004 significantly affect marginal tax rates on labor 

income. (A fourth law, the Job Creation and Worker 

Assistance Act of 2002, primarily affects business 

taxes.) The provisions of those laws phase in and out 

over multiple years and generally expire by 2011.1

B The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) lowered individual 

income taxes for all taxpayers by restructuring tax 

rates and brackets, increasing the child credit and 

dependent care credit, lessening the impact of the 

marriage penalty and the alternative minimum 

tax (AMT), and increasing the earned income tax 

credit (EITC) for married couples. Specifically, 

the law created a 10 percent tax bracket and lowered the rates for the top four brackets in four 

steps between 2001 and 2006. It raised the child 

credit from $500 to $1,000, also in four steps between 2001 and 2010. EGTRRA increased the 

maximum expenditure eligible for the dependent 

care credit from $2,400 to $3,000 per child, beginning in 2002, and raised the maximum credit 

from 30 percent to 35 percent of eligible expenditures. To ease the marriage penalty, the law widened the 15 percent tax bracket for joint filers 

from 167 percent of the bracket for single filers to 

twice that bracket in four annual steps beginning 

in 2005. It also increased the standard deduction 

for joint filers from 167 percent to 200 percent of 

the standard deduction for single filers in five annual steps between 2005 and 2009. Relief from 

the AMT came through an increase in the income 

exemption of $4,000 for joint filers and $2,000 

for single filers in 2001 through 2004. EGTRRA 

removed the limitation on itemized deductions 

and personal exemptions in three steps between 

2006 and 2010. Finally, the law increased the 

EITC for married couples by raising the income 

level at which benefits phase out by $1,000 in 

2002, 2005, and 2008 and by indexing the final 

value for inflation beginning in 2009. All of those 

provisions are set to expire in 2011, at which 

point the provisions of individual income tax law 

revert to those in effect before 2001.2

1. For a more detailed description of the changes in those laws 

and a schedule of how their provisions phase in and out, see 

Congressional Budget Office, Effective Federal Tax Rates 

Under Current Law, 2001 to 2014 (August 2004).

2. EGTRRA also expanded various education incentives and 

tax benefits for retirement saving and eliminated the estate 

tax (reducing it in stages between 2001 and 2009 and then 

fully repealing it in 2010). As with all other provisions in the 

law, those changes expire in 2011.
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 27

mum child credit at lower income levels. Additional earnings above that point face the statutory rate. Second, the 

longer income range over which taxpayers receive the 

maximum EITC under EGTRRA means that some taxpayers whose income would disqualify them from getting 

the EITC without EGTRRA instead face the EITC 

phaseout—and hence higher marginal tax rates. 

Taxpayers with income between $38,000 and $76,000—

a part of the income distribution that contains many 

households—face the 15 percent statutory bracket under 

either current law or fully phased-in EGTRRA and 

would see no change in their marginal rate with expiration. Taxpayers with income between $76,000 and 

$88,000 benefit from EGTRRA’s lengthening of the 

15 percent bracket; their marginal rate would jump from 

15 percent to 28 percent if EGTRRA expired. 

Higher-income taxpayers would generally face a more 

complex—and higher—schedule of effective marginal 

tax rates if EGTRRA expired (see the bottom panel of 

Figure 8). Those taxpayers benefit from the reduced statutory tax rates and the repeal of the phaseouts of itemized 

deductions and personal exemptions under fully phasedin EGTRRA. However, some higher-income taxpayers 

would see their marginal rate decline if EGTRRA 

expired. For example, EGTRRA doubled the size of the 

child credit and thus lengthened the income range over 

which it phases out. Taxpayers with income between 

$130,000 and $150,000—who would be ineligible for 

the child credit if EGTRRA expired—now face the 

higher marginal rate caused by the credit’s phasing out. In 

addition, by lowering regular income taxes, fully phasedin EGTRRA subjects taxpayers to the AMT over a much 

longer portion of the income range. Their marginal tax 

rate under the AMT, even with the phaseout of the AMT 

exemption, is still generally lower than it would be under 

the regular income tax if EGTRRA expired.

On balance, the expiration of EGTRRA would shift the 

distribution of marginal rates higher (see Figure 9). 

EGTRRA’s lower statutory rates, marriage-penalty relief,

Box 2.

Continued

B The Jobs and Growth Tax Relief Reconciliation 

Act of 2003 (JGTRRA) accelerated the pace at 

which some EGTRRA provisions phase in, reduced taxes on capital gains and qualified dividends, raised the AMT exemption, and increased 

first-year depreciation deductions. Specifically, 

the law broadened the 10 percent tax bracket in 

2003 and 2004 and lowered the tax rates for the 

top four brackets, starting in 2003, to the levels 

that EGTRRA had set to begin in 2006. It also 

raised the child credit to $1,000 in 2003 and 

2004 (from the $600 and $700, respectively, that 

would have occurred under EGTRRA). It widened the 15 percent tax bracket for joint filers in 

2003 and 2004 to twice that for single filers and 

set the standard deduction for joint filers equal to 

double that for single filers in those years. 

JGTRRA also raised the AMT exemption in 

2003 and 2004 to $58,000 for joint filers and 

$40,250 for single filers—higher than the levels 

set in EGTRRA by $9,000 and $4,500, respectively. For 2003 through 2008, the law lowered 

the tax rate on capital gains and qualified dividends from 20 percent to 15 percent for taxpayers 

above the 15 percent bracket and from 10 percent 

to 5 percent (and to zero in 2008) for taxpayers in 

lower brackets. The provisions of JGTRRA all expire in 2009 or earlier.

B The Working Families Tax Relief Act of 2004

(WFTRA) accelerated some of the provisions in 

EGTRRA and extended others in EGTRRA and 

JGTRRA. It raised the child credit to $1,000 in 

2005 to 2009 and increased the amount of the 

credit that is refundable in 2005. The law also extended the marriage-penalty relief and 10 percent 

bracket at the levels set by JGTRRA through 

2010. Finally, WFTRA kept the AMT exemption 

at the level set by JGTRRA through 2005.
28 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

Figure 8.

Effective Marginal Federal Income Tax Rates for a Married Couple 

with Two Children Before and After the Expiration of EGTRRA

(Percent)

Source: Congressional Budget Office.

Notes: This example assumes that the taxpayers are a married couple filing jointly with two dependents. All of the couple’s income is from 

wages earned by one spouse. The couple has itemized deductions worth 18 percent of income and claims the greater of those deductions or the standard deduction. (Forty percent of the itemized deductions are assumed to be state and local taxes, and the rest are 

charitable contributions and mortgage interest.)

EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; EITC = earned income tax credit; CTC = child tax credit; 

IDP = itemized-deduction phaseout; PEP = personal-exemption phaseout; AMT = alternative minimum tax.

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 100,000

-50

-40

-30

-20

-10

0

10

20

30

40

50

Marginal Tax Rate Under 

Fully Phased-in EGTRRA

Marginal Tax Rate with 

EGTRRA's Expiration

Income up to $100,000

EITC

Phase-in

(-40%)

EITC Phaseout and

15% Bracket (36.06%)

EITC Phaseout

and Refundable

CTC (6.06%)

15% Bracket

25% Bracket

100,000 150,000 200,000 250,000 300,000 350,000 400,000 450,000 500,000

0

10

20

30

40

50

Income of $100,000 to $500,000

25%

Bracket

28% AMT Rate and Exemption Phaseout (35%)

28% AMT Rate

EITC Plateau

and Refundable

CTC (-15%)

25% Bracket and

CTC Phaseout (30%)

26% AMT Rate

and Exemption

Phaseout (32.5%)

31% Bracket

and IDP (31.93%)

28% Bracket

and IDP

(28.84%)

EITC

Plateau (0)

EITC Phaseout and

10% Bracket (31.06%)

EITC Phaseout (21.06%)

28% Bracket

28% Bracket

39.6% Bracket

and IDP (40.79%)

36% Bracket

and IDP

(37.08%)

36% Bracket, IDP,

and PEP (40.77%)

31% Bracket, IDP,

and PEP (35.1%)

28%

Bracket

+CTC

(33%)
EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME 29

Figure 9.

Distribution of Effective Marginal Federal Income Tax Rates Before and After 

the Expiration of EGTRRA

(Tax rate in percent)

Source: Congressional Budget Office simulations using data from the Internal Revenue Service’s Statistics of Income database.

Note: EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001.

and expanded child credit have reduced marginal rates for 

a majority of taxpayers. However, some taxpayers—such 

as those phasing into the EITC or in the 15 percent 

bracket—would see no change in their marginal rates 

with expiration because fully phased-in EGTRRA does 

not alter those aspects of tax law. Smaller numbers would 

see their marginal rates decline if EGTRRA expired.

The average taxpayer’s marginal federal individual income tax rate would climb by 2.7 percentage points—

from 14.0 percent to 16.7 percent—with EGTRRA’s 

expiration. The dollar-weighted average marginal rate 

would increase even more—by 3.3 percentage points, 

from 22.2 percent to 25.5 percent.

-40

-30

-20

-10

0

10

20

30

40

50

0 10 20 30 40 50 60 70 80 90 100

With EGTRRA

Fully Phased In

With EGTRRA's

Expiration

Cumulative Percentage of Tax Returns with Earnings

(Person-weighted measure)

Distribution of Marginal Income Tax Rates 

for Different Populations

For the analysis in this paper, the Congressional Budget Office (CBO) calculated effective marginal tax rates 

using information from a sample of 2002 federal individual income tax returns, supplemented with data from the 

Census Bureau’s Current Population Survey. The calculations considered only tax returns that reported earnings. 

Because the analysis focuses on marginal tax rates on 

labor income, ideally it would consider potential workers 

as well as people with labor income. However, the population of people who could enter the labor force is impossible to identify precisely. This appendix compares the 

distribution of marginal tax rates for three different 

groups: people with earnings, people who filed a tax 

return, and all households.

None of those categories exactly matches the desired 

population. The narrowest group—taxpayers with labor 

income—excludes people who could be part of the workforce but are temporarily not working. Both of the 

broader groups—people who filed a tax return and all 

households—include some potential workers, but they 

also contain many people who are out of the workforce 

permanently because of retirement or disability. For example, half of the households that did not file a tax return 

in 2002 were headed by someone elderly, and almost 90 

percent of those households received Social Security benefits. Much of that group is likely to be permanently retired. In addition, a significant share of the nonelderly 

households reported income from Supplemental Security 

Income, a program for people unable to work. Marginal 

tax rates on labor income for people who are permanently 

out of the workforce are of little use in understanding 

how the tax system affects decisions about working. 

Measuring the marginal tax rate on labor income for 

potential workers who currently do not have such income 

is problematic. The rate for a $1,000 increase in their 

income (the increment used in CBO’s analysis) may not 

be the most relevant marginal rate because they are unlikely to enter the workforce only to earn $1,000. A more 

meaningful measure would calculate the marginal rate on 

their potential earnings, but little information exists 

about the potential earnings of people who are not 

working.

The distribution of marginal tax rates for everyone who 

filed a federal income tax return is very similar to the distribution for those with earnings (see Figure A-1). People 

without labor earnings who file tax returns tend to have 

some taxable income (such as from pensions, dividends, 

or interest) and face marginal income tax rates that are 

similar to those of people with earnings. Expanding the 

analysis to also consider people who did not file a return, 

however, does shift the distribution. A significantly 

greater percentage of that group faces a marginal tax rate 

of -0.765 percent (the phase-in rate of the earned income 

tax credit for people without children) or zero, meaning 

that their total income falls below the combined standard 

deduction and personal exemption.

APPENDIX
32 EFFECTIVE MARGINAL TAX RATES ON LABOR INCOME

Figure A-1.

Distribution of Effective Marginal Federal Income Tax Rates 

for Different Populations

(Tax rate in percent)

Figure A-1. Distribution of Effective Marginal Federal Income Tax Rates for Different Populations

Source: Congressional Budget Office simulations using data from the Internal Revenue Service’s Statistics of Income database and the 

Census Bureau’s Current Population Survey.

-40

-30

-20

-10

0

10

20

30

40

50

0 10 20 30 40 50 60 70 80 90 100

Cumulative Percentage

Taxpaying Units with Earnings

Taxpaying Units Filing a Return

All Households