The tax treatment of the family

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Article Highlights

  • Marriage is typically rewarded for single-earner couples and is often penalized for dual-earner couples with similar incomes.

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  • High taxes cause secondary earners to reduce their work substantially, imposing a large cost on society.

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  • Moving to a fully individual tax and transfer system may require rethinking the structure of welfare programs.

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Introduction

Proponents of same-sex marriage often argue that not recognizing same-sex unions is unfair because many federal and state laws treat married couples as a unit. One example is tax law: a married couple can file a joint tax return and pay taxes on the spouses’ combined income.

Taxing people as individuals would remove some of the important disparities between married couples and unmarried partners. While many other industrialized countries have individual-based income tax systems, the US system is family-based.[1] Family-based tax systems create a number of difficulties that both reduce prosperity and create inequality across households and individuals.

First, progressive family-based tax systems—like the current federal tax system—penalize income earned by the secondary earner. In a progressive tax system, the average tax rate rises with income. Primary earners and single people who earn small amounts of income face relatively low average tax rates. But because the progressive rate structure is imposed at the family, rather than the individual, level, a married couple’s average tax rate rises when the secondary earner begins to work. In other words, secondary earners—even those who earn small amounts of income—typically face high average tax rates. This feature of the tax system is economically harmful because secondary earners are most often married women who are very likely to cut back on work because of high tax rates. High average tax rates therefore discourage married women from participating in the labor market, reducing economic output and increasing gender inequality in earnings.

Second, the differential treatment of married couples and unmarried partners raises concerns about fairness. In some cases, two individuals pay more in taxes as a married couple than they would as two singles; in other cases, they pay less. Whether marriage is penalized or rewarded depends on the couple’s income level and how earnings are divided between spouses. Marriage is typically rewarded for single-earner couples and is often penalized for dual-earner couples with similar incomes.

While these marriage “bonuses” and “penalties” probably have little effect on the decision to marry, they raise important fairness concerns because unmarried partners do not receive the bonuses and penalties. These concerns have become more pronounced in recent decades as the number of nontraditional families, including unmarried partners and same-sex couples, has increased.

However, moving to an individual-based tax system also raises important concerns about fairness. First, just like the current tax system, many means-tested welfare programs are based on family income. Because these programs also create work disincentives for secondary earners and disparities between married and unmarried couples, it may be appropriate to shift them to an individual basis as well. However, basing welfare benefits on individual income could allow the nonworking spouse of a high earner to receive benefits, an outcome that is inconsistent with the purpose of these programs. This issue could be addressed either by continuing to base welfare programs on family income, as many countries with individual-based tax systems do, or by reducing the amount of means testing in welfare programs.

Second, an individual-based tax system creates disparities across families with similar incomes based on how income is distributed between the two spouses. For example, under progressive tax rates, a family in which both spouses earn roughly equal incomes would pay less in taxes than a family in which one spouse earns all the income. On the other hand, in an individual tax system, individuals in similar circumstances are always treated similarly. Therefore, we must consider whether fairness is best evaluated at the individual or family level.

We begin by examining the effects of individual- versus family-based taxation on the level of economic output, focusing on the work decisions of secondary earners. Next, we explore issues of fairness under family-based taxation compared with individual-based taxation. Finally, because it is important to think about the system of taxes and transfers as a whole, we discuss the issues involved in individual- versus family-based transfer programs. We argue that, despite the complexity of the issues involved, it is worth considering a switch to an individual-based system, particularly for taxes and universal transfer programs such as Social Security.

Read the full paper.

Notes

1. For details, see James Alm and Mikhail Melnik, “Taxing the ‘Family’ in the Individual Income Tax” (working paper, Andrew Young School of Policy Studies Georgia State University, Marietta, GA, 2004), table 3; and Herwig Immervoll et al., “An Evaluation of the Tax-Transfer Treatment of Married Couples in European Countries” (Institute for the Study of War, discussion paper No. 3965, Bonn, Germany, 2009), table A4.

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