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Top Effective Marginal Rates under a 4-Percent Health Care Surtax by State

Written by TaxFoundation.org

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by TF Staff

Fiscal Fact No. 176

Funding for increases in the federal government's spending on health care continues to be debated in Washington. The newest funding proposal floated by the House Ways and Means Committee is a surtax levied on married tax returns with adjusted gross incomes (AGI) over $250,000 and single returns earning above $200,000. While there is speculation as to what the actual surtax rate will be, the 4 percent figure seems to be the focal point. 

A 4-percent federal surtax along with recent increases targeted at high-income taxpayers at the state level has led to concern over how high the top tax rates would be in each state, especially large states with very high top marginal tax rates like California and New York. Some researchers merely sum the rates at the federal, state and local level to give a statutory total tax rate. A more accurate method is to calculate the effective marginal tax rate. The effective marginal tax rate takes into consideration deductions and exclusions in order to present a truer measure of an individual's rate. Technically, it is the change in tax liability for a $1 increase in income.

This Tax Foundation Fiscal Fact presents calculations on the effective marginal tax rate on top earners, assuming the current state income tax rates remain (including those recently increased), the top federal taxable income rate rises to 39.6 percent as is scheduled to occur in 2011, and a new 4 percent surtax on AGI is imposed.

Table 1 Click Here

Source: Tax Foundation calculations, State Individual Income Tax Rates

Note: Top Effective Marginal Rate does not equal the sum of the first four rates due to deductions and adjustments, as described below.

Technical Notes
To calculate marginal effective tax rate, we added the top state tax rate to the top federal rate as scheduled to be in effect in 2011 under current law and under Obama's budget (39.6 percent) plus a 4 percent surtax and the top Medicare tax rate for the self-employed. We allowed for a deduction of the state and local tax rate (20 percent thereof assuming limitation on itemized deduction returns and taxpayer is outside the phase-out range) and the adjustment allowed against income from 1/2 self-employment tax (on both state/local and federal returns). For those few states that allow federal deductibility at high income levels, such a deduction was included in the calculation as well. New York City's rate merely includes the state rate plus the city rate.

These are not the highest possible marginal tax rates that a taxpayer can face. At some income levels for different types of taxpayers, due to the phase-outs of various tax credits, exemptions or deductions, effective marginal tax rates can be extremely high. Also, if one wanted to include the fact that many low-income transfer programs are means-tested and have phase-out ranges (or in some cases mere cliffs), the marginal disincentive to work can be very high. For more on this issue, see Kotlikoff and Rapson.

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