The tax package tentatively agreed to by congressional leaders and the White House would burst a tax anomoly known as the "bubble" under which upper income earners pay a higher marginal rate than the richest Americans.
Under current law, individuals earning between $47,050 and $109,100 in 1990, and couples filing jointly with incomes between $78,400 and $185,730, pay a special 33 percent rate on the income within those ranges. Beyond the upper limits of those ranges, the marginal rate drops back to 28 percent. Despite the bubble, the average tax rate rises throughout all tax brackets and never exceeds 28 percent.
Under the proposed changes, people within the bubble, as well as people with higher incomes, would pay a new marginal rate of 31 percent. As a result, there would be three income tax rates: 15 percent, 28 percent, and 31 percent.
The tax portion of the tentative package, if left unchanged, would also include these provisions:
THE NEW "BUBBLE": The proposed bill would create a new "bubble," at higher income levels than the old bubble, so that within a certain income range the effective marginal tax rate would be higher than that paid by the wealthiest Americans.
For individuals, the new bubble range would begin at $100,000 and end at $225,000. For couples filing joint returns, the bubble would begin at $150,000 and end at $275,000.
Within that range, people would lose $17.20 of every personal exemption for every additional $1,000 of income. At the top of the range, personal exemptions, projected to rise to $2,150 next year, would be completely phased out.
The effect is the same as adding 0.53 percentage points to the marginal tax rate for every personal exemption for people within the bubble range. Thus, for a couple filing jointly with six children, the phasing out of personal exemptions would be similar to having 4.24 percentage points added to their 31 percent rate.
THE PEASE PLAN: This plan for trimming deductions is named after Rep. Donald J. Pease (D-Ohio). In the proposed form, it would disallow deductions equal to 3 percent of a person's adjusted gross income over $100,000. It would not, however, place any ceiling on deductions.
For example, if a person had income of $150,000 and $40,000 worth of deductions, the plan would disallow $1,500 worth of deductions -- 3 percent of $50,000, which is the amount his income exceeded the $100,000 threshold. That would cost such a taxpayer an additional $465 in taxes under the proposed new 31 percent top rate.
However, it does not have the same effect as increasing the marginal tax rate. A simple increase in the marginal tax rate would increase the incentive for taking additional deductions. For people with very large deductions, a simple increase in the marginal tax rate could cost less because it would only affect taxable income. The Pease plan is calculated on the basis of adjusted gross income, which is higher than taxable income.
A person with $150,000 in income and $50,000 in deductions would pay an extra $465 in tax under the Pease plan because of the loss of some of his deductions. If, instead of the Pease plan, the top marginal income tax rate were simply increased by 0.93 percentage points for income over $100,000, the same taxpayer would have paid no new tax.
The Pease plan would hit the roughly 4.3 million individuals and couples who file tax returns with more than $100,000 a year in income. Virtually everyone in that range itemizes deductions.