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83 IRET Policy Bulletin 1 (2001)

handle is hein.taxfoundation/iretpbul0042 and id is 1 raw text is: March 12, 2001 No. 83 U, - PHASE-OUTS INCREASE TAX RATES AND TAX COMPLEXITY1 The tax code is littered with rules that phase out various deductions, exemptions, and credits as taxpayers' incomes rise. These rules create hidden increases in marginal tax rates for unsuspecting citizens and greatly complicate tax calculations. Some of the items that taxpayers lose with higher incomes are deductible individual retirement accounts, Roth IRAs, the earned income tax credit (EITC), the exclusion of social security benefits from taxable income, the child credit, education credits and deductions, a portion of itemized deductions, even the personal exemption. Phase-outs create troubling problems in the areas of economic efficiency, simplicity, and fairness. The economy's efficiency suffers because phase-outs raise marginal tax rates throughout the phase-out zone and thereby reduce incentives to work, save, and invest. For people close to hitting a phase-out threshold or already in a phase-out zone, phase-out-generated marginal tax rate spikes are a clear and perverse signal from the government not to work harder and not to save and invest more. Tax simplification is another victim. Phase-outs make the tax code more complicated, which raises tax enforcement and compliance costs by making the tax code harder to understand and by making tax liabilities harder to compute. The booklet that accompanies an individual's yearly tax forms contains an obstacle course of special instructions and worksheets testing whether various phase-outs affect the taxpayer and, if so, how much each relevant phase-out restricts the deductions, exemptions, or credits the taxpayer may claim. Further, although phase-outs are often called fair because they tend to increase tax progressivity, the arbitrariness and surreptitiousness of most phase- outs violate any reasonable standard of fairness. ' This paper expands and updates (to tax year 2001) an earlier IRET study on phase-out provisions in the tax code: Michael Schuyler, Phase-Outs Are Bad Tax Policy, IRET Economic Policy Bulletin, No. 71, January 1998. Institute for Research on the Economics of Taxation IRET is a non-profit, tax exempt 501(c)3 economic policy research and educational organization devoted to informing the public about policies that will promote economic growth and efficient operation of the market economy. 1730 K Street, N.W., Suite 910 9 Washington, D.C. 20006 (202) 463-1400 - Fax (202) 463-6199 9 Internet www.iret.org