by Mark Robyn

Fiscal Fact No. 140

In recent months the Presidential candidates have been busy crafting and promoting their tax plans. In an effort to reduce the tax burden on America's seniors, Barack Obama has said that he will eliminate all income taxation for senior citizens making less than $50,000 per year. Putting aside the debate on whether this is a good policy, it might be worth exploring how such a policy would be implemented. It sounds simple enough: if you're a senior and your income is less than $50,000, then you don't pay income taxes (note that the threshold is for total income, which is greater than taxable income). But what happens when your income crosses that threshold? Obama's plan does not address this question, and it turns out to be an important question.

Consider an example. A husband and wife are both seniors with a combined income of $49,500. Under Obama's plan they would pay no income taxes. But then they decide to sell their coin collection. They sell the coins for $500 and report the capital gain to the IRS. Since only those making less than $50,000 are exempt, they expect they might owe a few cents on the excess $1 of income over $49,999. But when Tax Day rolls around they are hit with a tax liability totaling a whopping $3,585. Now instead of having an income of $49,500 and owing no tax, their income is $50,000 and they owe $3,585, putting their after-tax income at $46,415. They would have been better off not earning the extra money at all.

The reason this happens is that Obama's plan, as stated in his official campaign publications, throws taxpayers directly into the 15% bracket as soon as they cross the $50,000 threshold, making them fully liable for income tax on all of their taxable income (around $29,000 for seniors after the standard deduction and personal exemptions). As seen in the above example, the extra income actually has a negative net effect; the modest $500 gain turns into a net loss of over $3,000. In this way, the policy acts as a "cliff," suddenly slamming the taxpayer with a substantial tax bill and reducing his after-tax income well below what it would have been if his income had never increased (see Figures 1 and 2).