At the Root of Debate Over Tax Increases: The Bubble

As Congress and the White House struggle to come up with a deficit-reducing budget, they are haunted by a complicated technical maneuver included in the 1986 overhaul of the federal tax code that has come to be known as “The Bubble.”

It is this arcane and confusing adjustment in income tax rates that lies behind much of the current heated political rhetoric over what is fair to taxpayers and what is not.

The bubble refers to the phenomenon that causes many middle-to-upper income Americans to pay a higher tax rate on some of their income than the rate paid by those at the top end of the income scale. When President Bush in the current debate raised the question of cutting the capital gains tax and resisted efforts to raise the tax rate for the wealthy, Democrats in Congress pounced on the bubble to make points that the Republicans favor the rich.

Some tax experts say the bubble actually adds a degree of progressivity to the tax code because those at the lower end of the income spectrum get the advantage of a lower tax rate, while others pay an increasing rate as their income rises.

But the experts also acknowledge that the arrangement is flawed because the wealthiest pay a lower rate on part of their earnings and thus appear to be getting a break at the expense of those with less income.

“It is complicated,” said John Barcal, associate professor of accounting at USC.

But he added that, in his view at least, the bubble controversy amounts to “much ado about nothing.”

Before 1986, there were 14 tax brackets with the top rate set at 50%. But the code also included many deductions that had the effect of mitigating the top marginal tax rate for many wealthy Americans.

Tax reform eliminated many of the deductions and set two tax rates--15% and 28%.

Then the political maneuvering began. Some in Congress thought well-off taxpayers should not take advantage of the lower rate. So, a surcharge of 5% was applied to taxes paid by some middle to upper-income Americans.

The result: If you are a single person with a 1990 taxable income of less than $97,620, the first $19,450 of your income is taxed at 15%. The portion between $19,450 and $47,050 is taxed at 28%. The remainder--the so-called bubble--is taxed at 33%, an additional 5%.

Those earning more than $97,620 continue to be taxed at 28% on all of their income.

The wealthiest don’t have to pay the 33%, but they also do not get the advantage of having part of their income taxed at only 15%.

The total average tax--as a percentage of income--never exceeds 28% for anyone. And most in the 5% surcharge bracket end up paying an average of less than 28%.