Esenwein, Gregg A.

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1 The child and dependent care tax credit might also influence a household’s federal income taxthreshold, but it is not addressed in this report because it is not widely used by households at thelowest end of the income spectrum.Congressional Research Service ˜ The Library of CongressCRS Report for CongressReceived through the CRS WebOrder Code RS22337November 29, 2005Federal Income Tax Thresholds for SelectedYears: 1996 Through 2006Gregg EsenweinSpecialist in Public FinanceGovernment and Finance DivisionSummaryOne principle of tax fairness or equity accepted by many is that households at thelow end of the income spectrum, especially those near the poverty threshold, should notbe subject to the federal income tax.  Federal income tax thresholds are high enoughthat,  with the exception of single taxpayers, the equity principle of exempting povertylevel households from income taxation has been achieved over time.  The introductionand subsequent increase in the child tax credit, however, have significantly increased theincome tax thresholds for households with children.  For households with children, theincome tax thresholds are now substantially higher than the comparable povertythresholds.  In fact, the child tax credit represents a departure from past policy practicesbecause it is not designed primarily as a means of differentiating between families ofdifferent size at or near the poverty threshold, but rather is designed to provide generaltax reductions to middle and upper income taxpayers with dependent children under theage of 17. The recent increases in the child tax credit are scheduled to sunset (expire) in 2011.As a result, it is likely that Congress will revisit the issue of the child tax credit because,absent legislative action, the credit will decline from its current law level of $1,000 to$500 in 2011.This report will be updated as new data become available or as events warrant.  The major structural components of the income tax code which influence the incomelevels at which households become subject to federal income tax include the standarddeduction, the personal exemption, the child tax credit, and the earned income tax credit(EITC).  Each of these items increases the income level at which an individual or familyincurs an out-of-pocket federal income tax liability.1CRS-2For instance, consider the case of a married couple with one dependent child underthe age of 17.  In 2006, the standard deduction for a married couple filing a joint returnwill be $10,300, each personal exemption will be worth $3,300, and the child tax creditwill be $1,000.  This family would reach the basic income tax threshold (the point atwhich they have an actual out-of-pocket tax payment) for their filing status and familysize at an income level of $20,200 (standard deduction of $10,300 plus three personalexemptions of $3,300 each).  Income under this amount would not be subject to tax whileany income over this amount would be taxed.Although income over $20,200 would be subject to tax, the child tax credit wouldoffset the first $1,000 of this couple’s income tax liability.  At this taxable income levelthe marginal tax rate is 10%.  That means that tax on income up to $30,200 would beoffset by the $1,000 child tax credit.  At this point, the EITC would come into play.  The maximum EITC for 2006 forfamilies with one child will be $2,747.  The maximum credit will be phased out forfamilies filing joint returns with incomes above $16,810, and will be reduced to zero forfamilies whose incomes exceeded $34,001.  The income tax threshold for the family inthis example will be the point at which the EITC is just enough to offset any pre-EITCincome tax liability, so that the net tax liability of the family is zero.  In the case of acouple with one dependent child filing a joint return the income level, in 2006, will be$32,537.  At this income level, the family’s pre-EITC (and post child tax credit) incometax liability would be $233 and the family’s EITC would also be $233.  The two wouldoffset each other, and the family would not have any net income tax liability.The federal income tax thresholds for singles, joint returns, and head of householdsfor selected years between 1996 and 2006 are shown in Table 1.  (The  derivation of  thesevalues is detailed in the appendix.)The data in Table 1 show that the biggest increases in income tax thresholds, in bothdollar and percentage terms, over the 1996 to 2006 period occurred for households whohad dependent children under the age of 17.  For example, married couples with childrenexperienced increases in their income tax thresholds ranging from 64% for marriedcouples with one child to140%  for married couples with four children.  The increase inthe income tax thresholds for head of households between 1996 and 2006 ranged from55% for households with one child to123% for households with four children.The increases in income tax thresholds for single individuals and married coupleswithout children were more moderate than those experienced by households withchildren.  Tax thresholds for single individuals only increased by 33% between 1996 and2006, while tax thresholds for married couples with no children increased by 43%.Income tax thresholds change over time because of two factors.  First, they changebecause of the annual inflation adjustments to personal exemptions, standard deductions,tax rate brackets, and the EITC.  Second, they change because of legislative changes tothe tax system.CRS-32 For more information on the child tax credit see: CRS Report RS21860, The Child Tax Credit,by Gregg Esenwein.Table 1. Federal Income Tax Thresholds: 1996 to 20061996 2000 2002 2004 2005 2006Single IndividualsEligible for EITC $7,547 $8,276 $9,156 $9,484 $9,739 $10,045Not eligible for EITC $6,550 $7,200 $7,700 $7,950 $8,200 $8,450Married CouplesNo Children $11,800 $12,950 $13,850 $15,900 $16,400 $16,900One Child $19,883 $23,380 $27,370 $30,435 $31,709 $32,537Two Children $23,672 $28,683 $33,210 $40,200 $41,000 $41,867Three Children $24,732 $31,350 $38,850 $49,967 $50,866 $51,833Four Children $25,793 $37,483 $45,850 $59,733 $60,733 $61,800Head of HouseholdsOne Child $18,260 $21,589 $24,857 $26,988 $27,553 $28,321Two Children $22,277 $27,143 $30,704 $33,939 $34,620 $35,524Three Children $23,336 $29,695 $34,233 $42,953 $43,587 $44,333Four Children $24,400 $33,783 $41,233 $52,713 $53,453 $54,300Calculations by CRS.  Assumes all children qualify for the child tax credit.The relatively large changes in the tax thresholds for households with children canbe traced to three main legislative changes that occurred over the 1996 to 2006 timeperiod.  These changes included establishment and subsequent increases in the child taxcredit, an increase in the size of the standard deduction for joint returns, and an increasein the width of the 15% tax bracket for joint returns.2  The Taxpayer Relief Act of 1997  established the child tax credit.  Initially, the creditwas set at $500 for each qualifying child under the age of 17.  Additional legislativechanges under the Economic Tax Relief and Reconciliation Act of 2001 increased thechild tax credit to $1,000.  The 2001 Act also increased the width of the 15% tax bracketand increased the standard deduction for joint returns.  Although these changes wereoriginally scheduled to be phased in over a number of years, subsequent legislation in2003 and 2004 accelerated implementation and made these provisions effective in fullthrough 2010. The end result of these legislative actions has been a significant increase in theincome tax thresholds for households with children.  Economic theory does not provideCRS-43 2004 represents the most recent poverty threshold data available.4 The 1986 act explicitly excluded single individuals from the goal of establishing tax thresholdsin excess of their respective  poverty thresholds.  Two reasons were given for excluding singles.First, increasing the standard deduction for singles would have introduced larger marriage taxpenalties into the tax system.  Second, it was felt that the income level of singles did not representa good measure of whether or not the living conditions of  these taxpayers was impoverished.For more information see:  Joint Committee on Taxation, General Explanation of the Tax ReformAct of 1986, May 1987, p. 16.an answer to the question of how the costs of child rearing should be accounted for underan income tax.  However, one principle of tax fairness or equity accepted by many is thathouseholds at the low end of the income spectrum, especially those near the povertythreshold, should not be subject to the federal income tax.  It has been argued that giventhe precarious financial position of these households, they should not be compelled to payfederal income tax, an action that would further reduce their level of subsistence.The Tax Reform Act of 1986 explicitly cited this principle of eliminating income taxburdens for families with incomes near the poverty level as the reason for increasing thedollar amounts of standard deductions and personal exemptions.  This act increased thevalue of personal exemptions and raised the standard deductions for joint returns and headof households such that, in combination with the EITC, the income tax thresholds forthese taxpayers would be above their respective poverty thresholds. Given this principle, one can compare income tax thresholds to poverty thresholdsto see if this equity goal has been achieved over time.  Table 2 shows the 1996 and 2004poverty thresholds for singles and households with children.3 Comparisons of the data in these two tables reveals several trends.  First, the incometax threshold for single individuals was below their respective poverty threshold in both1996 and 2004.4 On the other hand, the tax threshold for married couples without children exceededtheir respective poverty thresholds in both 1996 and 2004.  In addition, the amount bywhich their tax threshold exceeded their poverty threshold increased over the period.  In1996, the tax threshold for married couples without children exceeded their povertythreshold by about 12%, but by 2004 the difference had increased to 33%.A more significant trend, however, occurred for families with children.  In 1996, thefederal income tax thresholds for families with children exceeded their respective povertythresholds by relatively comfortable margins.  By 2004, these margins had increasedsubstantially, especially for larger families.  For example, in 1996, the income taxthreshold for a married couple with four children was $25,763, while the povertythreshold for this same size/type family was $20,965.  So the tax threshold was about 23%higher than the poverty threshold.  By 2004, the income tax threshold for this family hadincreased to $61,800, while the poverty threshold had only increased to $25,241.  In thisinstance, the income tax threshold increased to 145% of the poverty threshold.  Theincome tax thresholds for head of households show similarly large increases relative totheir corresponding poverty levels. CRS-5Table 2.  Poverty Thresholds: 1996 and 20041996 2004Single Individual $8,163 $9,827Two Adults-No children $10,564 $12,649-One child $12,629 $15,205-Two children $15,911 $19,157-Three children $18,725 $22,543-Four children $20,965 $25,241One Adult-One child $10,815 $13,020-Two children $12,641 $15,219-Three children $15,967 $19,223-Four children $18,438 $22,199Source: U.S. Census Bureau. As these tables demonstrate, with the exception of single taxpayers, the equityprinciple of exempting poverty level households from income taxation has been achievedover time. In addition, however, there have been significant increases in the tax thresholdsfor households with children.  These changes in the relationship between income tax andpoverty thresholds for households with children can be attributed primarily to theintroduction and subsequent increases in the child tax credit.  In fact, the child tax creditrepresents a departure from past policy practices because it is not designed primarily asa means of differentiating between families of different size at or near the povertythreshold, but rather is designed to provide general tax reductions to middle and upperincome taxpayers with dependent children under the age of 17.The recent increases in the child tax credit are scheduled to sunset (expire) in 2011.As a result, it is likely that Congress will revisit the issue of the child tax credit because,absent legislative action, the credit will decline from its current law level of $1,000 to$500 in 2011. CRS-6APPENDIXDerivation of Federal Tax Thresholds(1) FT = PT - CT - EITCWhere:FT = Final tax liabilityPT = Pre-tax credit tax liabilityCT = Child tax credit EITC = Earned income tax credit(2) PT = B + t(Y - SD - PE - LB)Where:B = Base tax amountt = Marginal tax rateY = IncomeSD = Standard deductionPE = Personal exemptionsLB = Marginal tax bracket lower income limit(3) CT =NC * CAWhere:NC = Number of qualifying childrenCA = Child credit amount(4) EITC = MC - r(Y- Th)Where:MC = Maximum credit amountr = Credit phase-out rateTH = Credit phase-out thresholdCombining equations 1, 2, 3, and 4 yields:(5) FT = (B + t(Y - SD - PE - LB)) - (QC * CA) - (MC - r(Y - TH))Setting FT to zero and solving for Y yields:(6) Yth = ( tSD + tPE + tLB - B + QC * CA + MC + rTH) / (t +r)Where:Yth = Federal income tax threshold

Federal Income Tax Thresholds for Selected Years: 1996 through 2006

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Federal Income Tax Thresholds for Selected Years: 1996 through 2006

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