There are a number of jurisdictions in the world where raising taxes would be useful, but people don't want them to because it will hurt. Here's an idea on how to possibly make it not hurt.
If tax brackets are constructed properly, people whose gross incomes increase will always have a higher net income, even if it puts them in a higher tax bracket.
However, if taxes increase, it's possible that people whose gross incomes increase or stay the same might end up with a lower net income than before, and that's where it really hurts. (If your gross income and net income both increase, you still feel like "YAY, more money!" If your gross income decreases your net income will also decrease and that will hurt, of course, but it will hurt regardless of taxes.)
Here's an example of how it works. For simplicity, I'm pretending there's only one tax bracket. The principle still applies with tax brackets, it's just that even fewer people would be affected.
Suppose your gross salary is $50,000 and your tax rate is 20%. $50,000*0.8=$40,000, so your net pay is $40,000.
Suppose they raise the tax rate to 21%, and at the same time you get a raise and your gross pay increases to $51,000. $51,000*0.79=$40,290. So your net pay is still higher than it was last year, even though your tax rate has increased.
Now suppose that, instead of $51,000, your gross pay increases to $50,500. Your net pay would be $50,000*0.79=$39,500, which means you'd be taking home less money than last year even though you got a raise. THAT would suck.
So what they need to do is have some kind of grace period for the people in these margins, whose gross income increases but net income decreases because of the tax hikes. Maybe for a year or five years or something reasonable, they could guarantee that if your gross income increases, your net income will not decrease. If your gross income decreases, your net income will remain the same proportion of your gross income.
Given the nature of inflation, unless the whole economy is tanking (which it might actually be...), this will affect very few people. In the example I gave above, the pay raise to $51,000 is a 2% increase, and 2% is generally the target inflation rate. So everyone who isn't falling behind will still get a net pay increase. All they need to do is put in a bit of a net income guarantee for those who are falling behind, and it won't hurt.
2 comments:
But this is actually the problem that marginal tax rates are meant to solve.
I don't remember where the margins are currently set, but I think it's something like $20,000, $40,000, and $80,000 (plus higher ones which we can ignore here). I don't remember the rates at each margin, but for the purposes of your example, let's call them 15% at $20,000, and 20% at $40,000, and 25% at $80,000. (The actual margins aren't quite so steep.)
You get the first $10,000 or so tax-free -- your personal elimination amount. So for your example, the person making $50k is only making $40k for tax purposes.
From that remaining $40k, the first $20k is taxed at 15%, which is $3000. The next $20k is taxed at 20%, which is $4000. Total taxes, $7000.
(Btw, I'm only including federal tax here -- provincial taxes of 10% or so is what drives our tax rates up to the 30-35% arena. But they work the same way. I'm just saying, you're not going to pay only $7k in income tax on $50k of income. But we'll stick with the example.)
Now, if the person gets a raise of $1000 a year, that $1000 is taxed at the next higher rate, 25%. So they're paying an extra $250 in taxes. Their total taxes are $7250, and their take-home pay is $43,750; previously their take-home was $43,000, so they're still feeling the increase.
Now, let's say we increase the tax rate by 1% at all the levels. For $50k in income, that turns into $7400 in taxes, and $42,600 in take-home pay. For the $51k income, it's $7660 in taxes, and $43340 after taxes. So the raise still has a positive effect, even though taxes have gone up across the board.
Finally, let's do the unthinkable and tax the rich. Let's leave all the brackets the same except the highest one in our example, which we'll bump up by an astounding 5%. That means that the $50k earner still makes $43,000, and the $51k earner makes $43,700.
Now, this is affected by the fact that we're working with an income that happens to be near one of the tax thresholds; obviously a $60k earner will be affected more than a $50k earner in our examples. But it does show that getting a raise that pushes your income (or more correctly, part of your income) into a higher bracket cannot reduce your overall income.
(By the way, I should add that a good portion of my income is in the higher tax brackets, and I pay a ton of personal and corporate taxes every year. But I still think that increasing income taxes at the higher margins is a good idea.)
Does the tax bracket model completely eliminate the possibility that if you get a very small raise and there's a tax increase at the same time, you'll be behind where you were before?
Let's suppose the person in your example gets a $1 raise. You said the 1% raise means the $50K=$7400 in taxes and $42,600 in take-home. The next dollar will be taxed at 26%, so they get to keep $0.74 of it. That means their take-home pay after a $1 pay increase and a 1% tax increase is $42,600.74, which is lower than the previous take-home of $43,000.
(Is my math right so far? I'm doing this on screen without pencil and paper.)
If my math is right so far, it means that, even with tax brackets, there is a small range where you could get a raise but still have less take-home. It probably would affect very few people (after all, a $1 raise is ridiculous) but I'm proposing an exemption for those it does affect.
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