Since TAX 1937 FOUNDATION SPECLI L

March 1998 No. 77

By Claire M. Hintz Many elements of the tax code vary with a different tax liability than two similarl y Senior Economist marital status, including the amount of the situated single people. Tax Foundatio n standard deduction, the earned income tax A married couple filing jointly incurs a credit, and the tax rate schedule . All of these "" if their tax bill is highe r differences can cause a married couple to have than the combined tax bills that they woul d have paid if each could have filed singly . Similarly, a married couple receives a "mar- Figure 1 riage bonus" when the sum of the individual Distribution of Marriage Penalties and Bonuses by Size of Adjuste d tax liabilities had they filed singly is greate r Gross Income, 199 6 than their tax liability under a joint return . Marriage penalties result from the conflic t between three mutually exclusive goals of th e Less Than $20 k $20k-$50k More Than $50k tax system: • Taxes should be progressive (specifically , the progressive marginal tax rate structure) ; 70% • The tax code should be neutral with respect to marriage ; and • The tax code should treat families equall y 60% (families with equal incomes should have equal tax bills) . Different balances have been struck with 50% regard to these goals over time . Currently, the tax code is not neutral with respect to marriage . The Congressional Budget Office esti- 40% mated that 42 percent of married couples incurred marriage penalties and 51 percent °\° received bonuses in 1996. According to th e 30% study, the average size of a marriage penalty was $1,400 and the average size of a marriag e bonus was $1,300 . 20% 0\0 A Brief History of the l o% Marriage Penalty in the -3\° Federal Income Ta x The income tax expanded rapidly in th e 0% 1940s to finance World War II. As a result of Percent with Percent with Percent with the increasing number of families subject to Marriage Marriage Neither the income tax and higher marginal tax rates , Penalties Bonuses more states began to enact community property laws that allowed couples to spli t source : Congressional Budget office . their income in half and, as a result, pay lower 2

federal income taxes . Congress codified The EITC can impose marriage penalties o r income-splitting in 1948 by allowing marrie d give marriage bonuses to low-income filers couples to file joint returns using tax schedule s because the size of the credit does not depen d whose brackets were twice as wide as those on but varies with the number of for singles . The new law provided marriag e children. Combining the incomes and childre n bonuses for most couples. However, as a of a couple on a joint return can increase o r result of this change, a single taxpayer with th e reduce the credit they receive relative to th e same total income paid higher taxes than a credit they could obtain if each could file married couple. separately as single or as a . In 1969, responding to pressure from In 1993, the size and scope of the Earned single taxpayers who viewed the 1948 ta x Income Tax Credit was expanded, furthe r change not as a marriage bonus but as a increasing the potential of the EITC to create "singles penalty," Congress changed the law b y marriage penalties and bonuses . altering tax brackets so that the tax liability of Finally, there are more than 60 separat e a single person could be no more than twent y provisions in the tax code that vary wit h percent greater than the liability of a married marital status and most can produce marriag e couple with the same income . This change penalties or bonuses. These include th e created marriage penalties for couples in taxation of Social Security, limitations on which husbands and wives had similar in - capital losses and the home mortgage interes t comes . deduction . The Taxpayer Relief Act of 1997 Under this new rate structure, marrie d added new sources of marriage penalties and couples could no longer file as single individu- bonuses, including phasing out eligibility fo r als. They could file as married filing separatel y child credits and education credits differen- or as married filing jointly . If two marrie d tially for married couples and singles . people with similar incomes were pushed int o a higher bracket by this change than eithe r Sources of Marriage Penalties would have been in if they could have file d separately, the new law penalized the m and Bonuses relative to prior law . The size of marriage penalties and bonuses To help offset the marriage penalties tha t under current law depends on individual were created in 1969, the Economic Recovery income and how the income is split between Tax Act of 1981 provided a deduction for two - the couple, the number of dependents, and earner married couples of ten percent of th e the amount of itemized and standard deduc- earnings (up to $30,000) of the lower incom e tions. In general, married couples with highly spouse. disparate incomes receive marriage bonuses .' The two-earner deduction was eliminate d Couples whose incomes are more equal ten d only five years later as a part of the broadenin g to incur penalties . of the tax base by the Act of 1986 . Changes in the tax code are not solely The 1986 Act also collapsed the number of tax responsible for the greater incidence of brackets down from fourteen to two . This marriage penalties. Demographic changes flattening of the rate structure reduced the siz e have caused a significant increase in th e and number of marriage penalties and bonuses , number of couples who incur marriag e temporarily quelling calls for relief from bot h penalties. In the last twenty years, there has married couples and single taxpayers . been a rapid increase in the number of marrie d Changes in the tax code in 1990 and 1993 couples with two incomes and, in addition , exacerbated marriage penalties and bonuses there has been growing equality of incom e anew by increasing the number of statutory ta x between men and women . brackets from two to five . These changes , Within the tax code, the standard deduc- along with the increasing number of marrie d tion and the different widths of tax brackets couples with joint incomes and the increasin g for different types of filers are the primary equality of incomes between men and women , sources of marriage penalties and bonuses . have led to new calls for reducing or eliminat- The standard deduction of a single filer is 6 0 ing "marriage penalties . " percent of the standard deduction of a marrie d The Earned Income Tax Credit (EITC), en- couple. The breakpoints for th e acted in 1975 to offset the burden of the pay- 15, 28, and 31 percent tax brackets for single roll tax for low income working families with filers are also 60 percent of the breakpoints fo r children (and subsequently expanded to in- married couples filing jointly .' With thes e clude low-income single working adults), created ratios, two single filers have standard deduc- a new source of marriage penalties and bonuses . tions whose sum is greater than the standard

SPECIAL 3 REPORT

deduction that they would receive as a mar- Table 1 ried couple filing a joint return . In addition , A Marriage Penalty because of the differential size of the tax Coupl e brackets, joint filers may (especially if thei r Paul Lisa Filing Jointl y incomes are nearly equal) have a portion o f their income pushed into a higher tax bracke t Income $40,000 $40,000 $80,00 0 than if they were unmarried .

Less Personal $2,700 $2,700 $5,40 0 Example 1 : A Marriage Penalty¢ Exemption(s ) Paul and Lisa, each earning $40,000 , Less Standard would owe $11,918 in taxes if they could file Deduction $4,250 $4,250 $7,10 0 singly instead of filing jointly . They incur a marriage penalty of $1,478 . (See Table 1, left.) Equals Taxabl e The difference in the tax liability is due to Income $33,050 $33 .050 $67,50 0 two factors: Taxed at 15% $25,350 $25,350 $42,350 • The standard deduction for marrie d couples is not twice that of a single filer . Taxed at 28% $7,700 $7,700 $25,15 0 Filing jointly, Paul and Lisa have a standard deduction that is $1,400 less than the tw o Total Tax Liability $5,959 $5,959 $13,395 single standard deductions that they could Marriage Penalty $1,478 claim if they were not married . At the 28 percent marginal tax bracket this smalle r deduction costs them $392 . • The difference in the breakpoints of th e tax brackets for single filers and marrie d couples is the second source of the marriag e Table 2 penalty for Paul and Lisa . Filing singly, th e A Marriage Bonus breakpoint for moving from the 15 percen t rate to the 28 percent rate is $25,350 . For a Coupl e s Bob Mary Filing Jointl y married couple filing jointly, this breakpoint i $42,350 . Because the tax brackets of marrie d Income $ 0 $80,000 $80,00 0 couples are not twice as wide as those fo r single filers, $8,350 of their income that would Less Personal $ 0 $2,700 $5,40 0 be taxed at 15 percent if they could file a s Exemption(s ) singles gets taxed at 28 percent, resulting in a n additional cost of $1,086. Less Standard Deduction $ 0 $4,250 $7,10 0 Example 2: A Marriage Bonus Equals Taxabl e Mary is a newly minted attorney earning Income $ 0 $73,050 $67,50 0 $80,000 . Her husband, Bob, is currentl y unemployed and has no income . Since they Taxed at 15% $ 0 $25,350 $42,35 0 are married and can file jointly, Mary and Taxed at 28% $ 0 $36,050 $25,15 0 Bob receive a marriage bonus of $4,11 4 relative to Mary filing as single . (See Table Taxed at 31% $ 0 $11,65 0 2, left .) Here, three factors generate the differen t Total Tax Liability $ 0 $17,508 $13,39 5 tax liabilities: Marriage Bonus $4,11 4 • Since Bob had no income and did not file a tax return, he could not use his persona l exemption . Bob and Mary filing jointly can use Bob's and the result i s a tax benefit of $837 ($2,700 X .31) ; • They also qualify for a greater standard deduction as a couple than Mary could claim for herself. This benefit is worth an additional $884 ($2,850 X .31); and • They benefit from the fact that the brack- ets for married couples filing jointly are wide r than those for single filers . In their case this means that $17,000 of their joint income was marry, their standard deduction is $7,100 . taxed at 15 percent instead of 28 percent, for a This represents an additional marriage penalt y tax savings of $2,210 . Further, again becaus e of $810 ($5,400 x .15) of the wider brackets available to married cou- ples, $6,100 was taxed at 28 percent instead of Example 4: Additional Sources of Penalties 31 percent, for a tax saving of $183 . and Bonuse s In addition to the primary sources of Example 3 : The Earned Income Tax Credit marriage penalties and bonuses illustrate d The Earned Income Tax Credit, intende d above, there are more than 60 additional to help low-income working families, can provisions in the tax code that treat married cause these families to incur large marriag e couples differently from single filers . For penalties because the size of the credit doe s example : the overall limitation on itemized not depend on the taxpayer's filing status but deductions, limitations on capital losses, rather depends on the number of children in exemption levels for the alternative minimu m the family . tax and phase-outs on personal exemptions al l Anita, a single mother with one child , effect married couples differently than single earns $18,000 a year. Her fiancé, Michael, ha s filers . Most of these provisions, depending o n two children and earns $21,000 a year . (See the circumstances of the couple, can creat e Table 3 .) marriage penalties or bonus . Two factors generate a marriage penalty i n For example, the new HOPE scholarship i s this example : a credit of up to $1,500 against federal income • Combined, Michael and Anita's incom e taxes for qualified education expenses in a exceeds the phase-out limit for the EITC . To student's first two years of post-secondary them, this represents a carriage penalty of education. The HOPE scholarship is phased- $3,269; and out for married couples with adjusted gross • In addition, if they do not marry, each gets incomes between $80,000 and $100,000 . For a standard deduction of $6,250 since they are single filers it is phased-out between $40,00 0 each the head of a household . After they and $50,000 .

Table 3 The Earned Income Tax Credit

Coupl e Michael Anita Filing Jointl y

Income $21,000 $18,000 $39,00 0

Less Persona l $8,100 $5,400 $13,50 0 Exemption(s )

Less Standard Deductio n $6,250 $6,250 $7,10 0

Equals Taxable Income $6,650 $6,350 $18,40 0

Tax Liabilit y Before Credit s $998 $953 $2,76 0

Per Child Tax Credit ($400 ) $800 $400 $1,20 0

Earned Income Tax Credi t $ 1,915 $1,354 $ 0

Total Tax Liability After Credits —$1,717 —$801 $1 .56 0

Marriage Bonus $4,079

5

Scott earns $75,000 . His wife, Wendy , Couples should not have to pay more earns $30,000 and goes to college full-time at taxes simply because they are married . The night. On her own, as a single filer, Wend y version of the bill sponsored by Reps . Jerry would be able to reduce her tax bill by $1,500 . Weller (R-Ill .) and David McIntosh (R-Ind .) Since her income combined with Scott' s restores marriage neutrality in this sense but i t exceeds the phase-out threshold they are thereby ends equal treatment of married unable to use the credit . couples . Married couples with the same total The Major Marriage Penalty incomes but different distributions betwee n spouses will have different tax bills . The Bills couple in Example 1 will choose to file a Because of the 1990 and 1993 tax change s combined return where each is taxed individu- that increased marriage penalties with the ad- ally and they will pay a total combined tax bil l dition of two new tax brackets and the expan- of $11,918 . The couple in Example 2, with sion of the Earned Income Tax Credit, there is the same total income as the first couple, wil l again pressure to change the balance of th e continue to file jointly and will have a tax bill tax code and shift it in favor of married couples . of $13,395 . This legislation also leaves al l There are two primary hills aimed a t marriage bonuses intact . eliminating the major causes of the marriage To an extent, the marriage penalty arises penalty. Both bills would give couples th e out of the complexity of the tax code . Unfor- option of filing a joint return with each spous e tunately to address the penalty, the Weller/ being taxed using the individual schedules an d McIntosh bill also creates new layers o f rates . The second bill gives couples the optio n complexity. It would require that the couple of splitting their combined income evenly calculate its tax bill under two alternative between them regardless of who earned it . A structures and then choose the one that results side-by-side comparison of the two bills is in the smaller tax liability . In addition, new presented below in Table 4. rules will have to be created to determine how

Table 4 Comparison of Provisions of Primary Bills Aimed at Eliminating Marriage Penalty

"The Marriage Tax Elimination Act" "Marriage Protection & Fairness Act" Weller (R-III .)/McIntosh (R-Ind .) : H .R . 2456 Income Splitting : Riley (R-Ala .), H .R . 3104

• Couples can choose to file a combined return under • Couples can choose to file a combined return unde r which each spouse is taxed using the individual which each spouse is taxed using the individua l schedules and rate . schedules and rate . • Taxable income for each spouse is one half of th e taxable income computed as if the spouses were filing a joint return . • Wage and salary income is apportioned according t o earner. • Income from property is apportioned according to ownership rights . • Deductions are allocated to the spouse to whom th e deductions relate . • Deductions for retirement savings, alimony, an d medical savings accounts are allowed to the spous e who has the income to which the deductions relate . • Each spouse claims one personal exemption . • Each spouse claims one individual standard • The standard deduction for a married couple i s deduction . increased to equal twice the standard deduction of a single individual . • All other deductions are divided in proportion to th e spouse's share of total joint income . • Credits are determined and applied as if the spouses • Credits are determined and applied as if the spouse s had filed a joint return . had filed a joint return .

SPECIAL 6 REPORT

taxpayers must allocate deductions an d Conclusions exemptions. The redeeming aspects of this As long as the tax code must struggle with new complexity are that the calculations are the balance between a progressive rat e purely voluntary and that it can lead to sub- structure, marriage neutrality and equal stantial tax relief. treatment of families, there will be tensio n The Income Splitting approach to marriage between married couples and single filers. penalty relief is more simple : All income , Although they deliver tax relief to marrie d assets, deductions, and credits are split dow n couples, all of the proposed solutions to th e the middle . The income splitting approach marriage penalty leave marriage bonuses intac t eliminates marriage penalties due to differ- (thereby setting the stage for future demand s ences in the width of tax brackets and stan- for relief by single filers) and none addresse s dard deductions and delivers a tax cut to al l the complex list of other deductions, credits married couples . Under income splitting, all (including the EITC) and phase-outs that can married couples that have the same incom e affect tax liability (and create bonuses o r will have the same tax bill, regardless of whic h penalties) based on marital status . spouse earned the income . The income- Completely eliminating all marriag e splitting bill is a subsidy for all married couple s penalties and bonuses would require that the relative to single filers, taking the tax cod e more than 60 provisions of the tax code that further from neutrality with respect to marriage. affect single filers and married couples differ- ently be altered or eliminated . This is probably Other Marriage Penalty Bills only possible in the context of fundamenta l There are two other less ambitious and tax reform . less well-known bills aimed at redressing th e marriage penalty . H.R. 2593, sponsored b y Endnotes Representative Wally Herger (R-Cal .), would For Better of Worse: Marriage and the restore the two-earner deduction for marrie d ' Federal Income Tax, Congressional Budget couples that was repealed in 1986 . Office, June 1997. This legislation would allow a couple to z In general, a split of income that i s deduct ten percent of the lower earnin g greater than 70/30 will produce a marriag e spouse's income (up to $30,000) from their bonus . adjusted gross income . The maximum deduc- A breakpoint is the dividing point tion is $3,000 and could reduce a couple' s between marginal tax brackets . For example, taxes by up to $1,198 (if they were in th e for single filers the 15 percent tax bracket SPECIAL REPORT highest tax bracket). This tax reduction would applies to the first $25,350 of the filers taxabl e (ISSN 1068-0306) is go to both couples who currently incu r income. Therefore, the breakpoint between published at least 10 times penalties as well as those who receive bo- yearly by the Tax the 15 and 28 percent tax brackets for singl e nuses. As written, this may be an inefficien t Foundation, an independen t filers is $25,350 . For married couples filing 501(c)(3) organizatio n way to deliver tax relief to those couples wh o jointly, the 15 percent tax bracket applies to chartered in the District o f pay penalties. However, if the exclusion i s Columbia . the first $42,350 of taxable income . The applied solely to couples in penalty situations , breakpoint for the 36 percent bracket for 4-12 pp. this could be a relatively simple and cost- single filers is 82 percent of the breakpoint fo r Annual subscription: $25 .00 . effective way to deliver some tax relief t o Individual issues $5 married couples . The threshold for the 39 .6 . these couples . percent bracket is the same for all filers . The second bill, H .R. 2718, sponsored b y The Tax Foundation, a All examples use 1998 tax rates, deduc- nonprofit, nonpartisa n Representative Joe Knollenberg (R-Mich .), tions and exemptions . The numbers in these research and public would eliminate one source of the marriag e education organization, has examples have been rounded up to the neares t penalty by increasing the standard deduction monitored tax and fisca l dollar . activities at all levels of for married couples to twice that of singl e government since 1937 . filers. This legislation would allow couples t o e ©1998 T ax Foundatio n exclude $1,400 more from their taxabl income than they currently can . It would Editor and Communications slightly increase the marriage bonuses of Director, couples with only one earner by increasing th e Stephen Gold benefit of the difference between the value o f Tax Foundation, /250 II the deduction available to a single filer and that Street, NW, Suite 75 0 available to a married couple. Washington, DC 2000 5 (202) 783-276 0 bllp://www.taxfoundation.org taxfnd@intr. net