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# McArdle Advocates 376,537.65% Marginal Tax Rate

 A Sentence to Ponder... Big Banks...

Here's what Megan McArdle advocated today:

eliminate the tax-deductibiity of health insurance benefits for people making more than \$150K a year in household income, \$100K for singles.

So now imagine that you're a married person with a family and you're making exactly \$150K a year. Your employer pays \$10K toward your health insurance. Of course, it's not subject to federal income tax, state income tax, or Social Security or HI tax. You and your spouse make a total of \$150K, split roughly evenly, so both of you pay the marginal payroll tax rate of 7.65%. You also pay a marginal income tax rate of 25% and a state income tax rate of 5%. So your total marginal tax rate is 25 + 5 + 7.65 = 37.65%.

Now you earn one more dollar. What happens? That whole \$10K employer contribution becomes taxable and so you pay tax on it at 37.65% or \$3,765. You made an extra buck and you paid \$3,765 extra in taxes. Oh, yes, plus \$0.3765. So you paid \$3,765.3765 in taxes. Your marginal tax rate on that dollar: 376,537.65%.

HT to Tyler Cowen.

Philo writes:

Surely, McArdle would want to phase out the tax deductibility of medical insurance benefits *gradually* as income increased. I wonder how high a marginal tax rate for couples making about \$150,000 she would find acceptable.

writes:

Well when you put in that way...

What do you really think about her proposal?

sean writes:

Matthew Gunn writes:

Gradual phaseouts don't help as much as one might think at first glance.

Marginal tax rate = (1+A)T where T is marginal tax rate without phaseout and A is the amount that becomes taxable if you earn one more dollar.

Even if you phased out a \$10,000 deduction over \$20,000 worth of income..... it would still increase marginal tax rates by 50%! A 40% marginal tax rate would become 60%!

writes:

Gunn, I'm not sure how much you would expect that phaseout to help at first glance.

I'm pretty sure in the kind of context in which McArdle was writing, leaving out details like phase-outs is both conventional and acceptable, in a way that a Congressional bill would not be.

The biggest problem with phase-outs is that they get layered on top of each other. The 60% rate is clear enough, and bad, but not terrible; if a bunch of other deductions are all phasing out at the same time, that gets considerably worse. I'd like a safety valve that allows you to pay \$2 to the federal government for the privilege of taking \$3 off the top so that, if you get hit with too many phaseouts at once, you can at least cap your marginal rate at 67%. I would want this to apply to state taxes as well, and to eligibility for Medicaid etc., up to and including the refund of social security taxes you paid on that \$3, but I imagine that could be difficult to do in a legal way.

In the kind of context where I'm writing, it's acceptable to round 2/3 to 67%.

Ryan Vann writes:

I'm perplexed as to why the goal is to get rid of tax deductibility to begin with. I thought we were trying to make insurance more affordable, not costs us more than it already does.

Aaron writes:

Ryan Vann,

Getting rid of tax deductibility is a way toward greater cost recognition and putting health care consumption on an even footing with consumption of everything else. As it stands, the tax deductability of health insurance means most workers would rather take an extra dollar in health benefits than an extra dollar in compensation, because the comp is taxed and the benefits are not. This leads to an overconsumption of health care. I purchase (through my employer) more healthcare than I otherswise would, my demand for health services are therefore higher than it otherwise would be, which pushes up the price of health services. This is analogous to the way mortgage interest deductions inflate the price of housing. It's a government subsidy on the purchase of something, which inflates its price because of increased demand.

writes:

The tax benefit for health-related compensation is distroting, which all economists should recognize, even if "RAISING TAXES" is a useful political bugbear.

I also took it at obvious that McArdle understands marginal tax rates and was using a shorthand that she assumed her audience would understand.

We shouldn't yank it away all at once, or tax it all at once. Look, try this for singles:

1. If you make over \$100,000,
2. you pay a tax of the lesser of 10% or your marginal tax
3. on your health care benefits over \$10,000.

That's for year 1. We can phase in the loss of the tax deduction over several years through some combination of decreasing the first and third italicized figures and increasing the second. By year 5 or so, everyone should be paying income taxes on all their health-based compensation.

spencer writes:

Ryann Vann==pay close attention.

The US has a problem that health care is so expensive.

So the libertarian solution for expensive health care is to make it more expensive.

Aaron rationalizes that by all kinds of glib analysis, but it still comes down to the point that they want to solve the problem of expensive health care by making it more expensive.

Note that Aaron asserts that individuals are buying more insurance than they want to. He opposes government making such judgments, but it is alright that he "KNOWS" that people are buying more insurance than they want to and he "KNOWS" what is best for them.

Just always be careful of anyone who claims they
"KNOW" what is best for everyone.

George X writes:

spencer wrote: The US has a problem that health care is so expensive. So the libertarian solution for expensive health care is to make it more expensive.

The "expensive" in the first sentence refers to the proportion of GDP spent by all parties. The "expensive" in the second sentence refers to the cost directly borne by the end consumer.

Come on, spencer, you're a better thinker than this.

(As is David Henderson: I heartily agree with everyone who pointed out his "gotcha" of McArdle is a silly over-literal reading of an informal proposal.)

Keith E writes:

Get divorced. Live together. Pay fewer taxes.

You can still wear your rings.

Andy writes:

Clearly this is an exaggeration to make a point. The point I see is that "tax the rich, they can afford it" plans all have very high marginal tax rates and at some point they disincent earning (or reporting) income.

Which is fine if they just work for a company - but if they are small business owners who decide to cut back their hours because the take home income is no longer worth the effort and they have to cut employees hours or worse, cut employees then these marginal tax rates actually have a negative effect on unemployment and the economy.

writes:

We should not favor one form of consumption over others, nor one form of investment over others. If we followed that principle, what would politicians do? It will never happen.

Ryan Vann writes:

Aaron,

I think your analysis assumes to much. First, it assumes employer provided insurance benefits are preferred to dollar compensation primarily because of their tax advantage. I'm not convinced that is the case; apart from tax advantages employer provided insurance has cost saving advantages over private insurance, as well as guaranteed issue. As a result of this first assumption, you extrapolate another assumption, that there exists an excess demand for healthcare.

I'm not convinced this is so; it may very well be that demand is right where it aught to be (whatever that may mean) and that workers would demand wage increases to compensate for the increased tax obligations of their healthcare benefits. In other words, the tax advantage might bias total compensation demand inward. In this event, the demand for healthcare might not change at all, but the demand for more wages would.

writes:

"As it stands, the tax deductability of health insurance means most workers would rather take an extra dollar in health benefits than an extra dollar in compensation...."

Up to the point that we reach declining marginal utility. I could easily spend twice as much for a gold plated PPO plan as I do for a decent HMO, but I would much rather have the cash, even at a 40% tax rate.

Andrei Bolkonski writes:

Ryan Vann,

I think Aaron has it correct, here, and you are adding unnecessary complication. You are suggesting cost savings as an advantage of employer-based plans, but that is only if a highly similar market plan is compared, and if the consumer benefits from pooling. Someone who forgoes an employer plan may choose one that is less comprehensive and thus cheaper. They may also be young and low risk. Aaron's point is simply that on the margin, the tax deductibility incentivizes over-consumption.

Furthermore, studies of consumer behavior have consistently shown that customers largely forget the costs of premiums that are deducted automatically from their paychecks. The simple act of writing the check yourself forces you to acknowledge costs and therefore influences behavior.

Ryan Vann writes:

Andrei,

There is nothing complicated about my views. If you need a simpler explanation of what I am saying, let me put it this way: what is ostensibly a net tax increase on all compensation, could result in an increase in demand for gross wages. Whether or not dollars are preferred to benefits or not is immaterial to the net result of this tax increase would have.

With that said I am still not at all convinced that tax advantage of benefits explains significantly why compensation is allocated in the proportions it is. Seems to me there are so many additional reasons one would choose an employer plan over a market plan (I've underwrote a few of both), and it depends more on the situation of the person, as you've alluded to.

Your point about writing checks is well taken, but I don't see how one goes from taxing benefits as wages to having a private plan. The proposal isn't to ban employer plans, and I don't see why a significant amount of people would switch to a private plan just because their taxes suddenly went up.

Keep in mind we are talking about people in the 150K+ tax brackets, who are likely an older demographic (say 35-60) and most likely a) can justify/bargain a pay raise to compensate for the tax increase b)want guaranteed issue and reduced costs due to pooling that an employer plan provides c)even if they can't negotiate a wage increase have relatively fixed healthcare demands and wouldn't have an incentive to adjust their insurance plan. I just don't see this proposal doing anything other than increasing taxes on net.

In that regard, I think Prof Henderson is quite right.

writes:

On the other hand, that super high marginal rate disappears if your employer offers you another \$1 raise.

Prediction, people would refuse small raises that would push them over the \$150K mark until such 'pent up' raises became enough to merit taking on the extra taxes of their health plan. Companies would therefore see increased profits as they would keep 'marginal' raises to themselves. What would they do with those extra profits? Pay out as dividends (but stockholders are in the same boat, they might want unrealized capital gains rather than an extra \$1 in dividend income that might push them over the limit) or reinvest. Might make for an interesting business investment stimulus...hmmmm

But more importantly it demonstrates the nice feature of the Senate bill. By taxing very expensive health plans you accomplish the goal of ceasing to treat health spending as a blank check. But the marginal incentive problem is neutralized. If you're at \$149,999 take your raise as cash rather than a more expensive health plan (assuming you already have a very expensive plan).

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