This blog was first published by the Tax Policy Center, Urban Institute & Brookings Institution.
If this year’s presidential candidates have their way, lots of income will no longer be subject to federal tax. Donald Trump would exempt overtime pay from tax. Kamala Harris and Trump both agree that tips should be exempt. To be fair, there are lots of tax exclusions in the code already. But this form of tax subsidy is especially costly, regressive, and prone to abuse.
Fortunately, better alternatives are available. For example, a flat 15 percent subsidy would do far more for low- and middle-income workers than a tax exemption that would help high-income workers most.
Some tax basics
An income tax exclusion or deduction is worth much more to high-income than low-income taxpayers because the tax benefit is proportional to marginal tax rates, which rise with income.
Imagine you are a taxi driver who earns $5,000 in tips. Under either candidate’s proposal, your tips would be exempt from income tax. Deducting $5,000 sounds good, but it wouldn’t affect what you owe in taxes at all if you’re one of the 20 percent of filers in the zero bracket (earn less than the standard deduction) (see table), or if you do not file a tax return at all (not shown in the table). If you’re one of the 69 percent of filers in the 12-percent or lower tax brackets, excluding $5,000 would save you at most $600.
But if you’re one of the seven percent of filers in the 24 percent bracket—say you’re married to someone earning a lot more than a cabbie—the tax break would be worth $1,200. And if you’re lucky enough to be in the top (37 percent) bracket, excluding the tip income would save you more than three times what low-bracket filers would save…
Read the full blog HERE