Tuesday, January 1, 2013

New year, new taxes, and an exercise in statutory interpretation

The Senate has passed a bill to avert / delay the so-called Fiscal Cliff. The bill's main feature is to make "permanent" most of President Bush's 2001 tax cuts, except that it creates a new 39.6% tax bracket starting at $400,000 for individuals and $450,000 for married couples filing jointly.

This morning I read a report that the bill included a radical provision that would impose a uniform (rather than marginal) tax rate of 35% on all the income of high-earners:
Finally, rather than (or in addition to) simply slapping the old Clinton 39.6% top tax rate on incomes above $450,000 for joint filers, the economist David Malpass of Encima Global reports that "For incomes above $450,000, the bill also appears to take away the lower tax brackets, applying a 35% rate to all income up through $450,000." New Yorkers know this as a "benefits recapture" provision, and if Mr. Malpass is correct that it's there, it's not pretty.
There was no link to Mr. Malpass's report or how he came to this conclusion, so I went to the text of the bill itself, which I've embedded here for your reading pleasure:

Mat 12564

The relevant provisions start at the bottom of page 6 of the document (line 22, specifically) where the 35% bracket is defined. It says:
(i) the rate of tax under subsections (a), (b), (c), and (d) on a taxpayer's taxable income in the highest rate bracket shall be 35 percent to the extent such income does not exceed an amount equal to the excess of—(I) the applicable threshold, over (II) the dollar amount at which such bracket begins, and
(ii) the 39.6 percent rate of tax under such subsections shall apply only to the taxpayer's taxable income in such bracket in excess of the amount to which clause (i) applies.
Let's break this down. First, clause (i) applies to the rate of tax in the "highest rate bracket" under "subsections (a), (b), (c), and (d)." To what does this refer? It's not super clear, but in fact this is a reference to subsections (a)-(d) of 26 U.S.C. §1. These subsections define, respectively, the different tax brackets for: (a) married individuals filing joint returns; (b) head of household filers; (c) unmarried individual filers; and (d) married individuals filing separately.

To cut to the chase, the bill says that for each of these classes of filers, the tax rate shall be 35% for the income between the dollar amount at which "the highest rate bracket" begins and the dollar amount defined as "the applicable threshold." To understand this, let's look at  at 26 U.S.C. § 1(a) as currently drafted:
If taxable income is:The tax is:
Not over $36,90015% of taxable income.
Over $36,900 but not over $89,150$5,535, plus 28% of the excess over $36,900.
Over $89,150 but not over $140,000$20,165, plus 31% of the excess over $89,150.
Over $140,000 but not over $250,000$35,928.50, plus 36% of the excess over $140,000.
Over $250,000$75,528.50, plus 39.6% of the excess over $250,000.
For married couples filing jointly, the "applicable threshold" is $450,000 (see page 8, lines 1-2 in text above). Under 26 U.S.C. §1(a), the "highest rate bracket" begins at $250,000. Thus, the 35% rate bracket applies to income above $250,000 (that is "income in the highest rate bracket") as long as it does not exceed "the applicable threshold" ($450,000) minus "the dollar amount at which [the highest rate bracket] begins" ($250,000). In other words, a 35% tax applies to the $200,000 in income earned between $250,000 and $450,000. Then the 39.6% bracket applies to income above $450,000 under clause (ii).


In conclusion, the economist Mr. Malpass seems to be mistaken.

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