The Taxable Unit, or Who Pays The Tax?
In order to maintain fairness, the tax system assesses rates based on the household composition of the taxpayer(s). The most basic taxpayer is a single worker, with no children. This is the starting block for most rates. But when the taxpayer becomes married, it no longer seems fair to tax two workers in brackets set for one worker - but they are also combining their incomes, so it doesn’t really seem fair to give them twice the threshold, either. So hybrid thresholds are formed for married households. The hybrid thresholds favor partners with greater earning disparities, which encourages marriages among wealthier taxpayers and discourages marriages among taxpayers who are poorer.
The relationships discussed briefly here are explored in more depth in Edward McCaffery’s book Taxing Women.
The single (unwed, not necessarily without a boo) taxpayer with no dependents (which are usually children) is the simplest taxable unit. This person works to support herself alone. It is fairly straightforward to set tax rates for this person and these are the rates used for How Much Is Taxed? The examples given here are all based on the assumption that a taxpayer is unwed with no dependents. It is the simplest way to think about it.
A married couple sees rates on their combined income that are between the rates for one and two single taxpayers. This makes sense, when considering how the income can be split between each spouse. The specific amounts can be found with a simple internet search.
Earnings follow an exponential relationship, so it is less common that spouses earn the same income at higher brackets where this makes the biggest difference. If one spouse works and the other maintains the home, then getting married is just a tax discount. If both spouses work but there is a significant pay disparity, then the same forces apply, but somewhat less so. If each spouse earns about the same amount, then marriage increases the amount this couple owes in taxes.
One Working Spouse
When there is one working spouse and one staying at home, the higher bracket thresholds become a discount for this person’s income. If this person is earning $100,000, then before marriage she is in the fourth tax bracket and pay 24% on her top taxed income. After marriage, her income drops to the third bracket and she only pays 22% on her top dollar, in addition to paying a lower percentage on every other dollar. As the income rises, the lower percentages they pay on every dollar add up significantly; a single person earning $100,000 owes $15,000 in taxes while a married couple earning $100,000 owes $9,000 in taxes.
In addition to this, the couple gain the benefit of imputed income. The spouse that is staying at home isn’t earning any money, so he is not taxed, even though much of what he does will be to add value to the home. His upkeep will prevent the home from falling into disrepair and allow it to gain value with the market; if this spouse were working, this would be outsourced with after-tax dollars. This becomes more significant when children are around; instead of paying for a nanny with after-tax dollars, this spouse is doing the work himself and saving income that way.
Because a high-earning spouse likely has a lower-earning partner, the current structure of marital taxes encourages marriage among the wealthy.
Two Working Spouses with Pay Disparity
When both spouses work but there is a significant pay disparity between the two spouses, then similar dynamics are at play. A couple earning $80,000 and $20,000 would see the same combined taxes as above. Married, they owe approximately $9,000 in taxes. Filing individually, $10,000 would be owed on the $80,000 income and nearly $1,000 would be owed on the $20,000 income; together, this couple pays about $2,000 less each year by getting married.
A household with two working spouses also loses the benefit of an imputed income; home repairs, instead of being performed by the spouse, are now paid for with after-tax dollars. Child care now means paying for a nanny with after-tax dollars. If the spouse earning $20,000 took care of the children, they would save $3,000 in taxes; that means that the couple is losing money by this spouse working if the nanny (and housing upkeep) costs more than $17,000 per year. ($20,000 income - $3,000 taxes = $17,000)
Two Working Spouses with Equal Pay
When both spouses earn a similar income, then the combined rates actually increase the taxes that the couple owes. As with the above example, a married couple earning $100,000 per year owes around $9,000 in income taxes. If each individual earned $50,000 and was not married, each would owe just over $4,000 in taxes, for $8,000 total; getting married costs this couple $1,000 in taxes every year. This couple also loses the benefit of an imputed income, as above; the best strategy for this couple might be to just not get married in the first place.
The lower the salaries are, the more they fall into this category. That means that the way that the tax code is currently set up discourages marriage among people living in poverty.
Children are expensive and were historically used by high-income couples to reduce their income taxes. In order to adapt, the tax code adopted a two-part strategy; the parents get deductions for their children (as “dependents”) and their children are taxed in their parents’ bracket until they are 14 years old.
The deduction for children gives taxes back to the parents, which gives them further resources with which to invest in the children. This deduction rises with inflation; in 2019, the deduction is $3,750. This deduction is especially important for lower-income and middle-income families, if a parent is living paycheck-to-paycheck and everything is spent (most Americans), then $3,750 more means $3,750 more that is spent.
By taxing children in their parents’ bracket until they are 14, the tax code does not take away parents’ ability to give to their children, it just takes away the taxation incentive to do so. Children are no longer a place to funnel business expenses for lower tax brackets. Instead, children are now considered an extension of the parents for the sake of income, and anything funneled to the children is taxed as if it hadn’t been.
Next: Read When Are We Taxed?