No Easy Fix to ‘Marriage Penalty’

Judy and Sean O’Connor understand only too well why married people complain that the federal tax code is unfair.

The young Los Angeles couple both work in the entertainment industry, pulling down nearly identical salaries. Until they wed in 1996, both received tax refunds each year. Now their combined tax bill has jumped by thousands of dollars, wiping out the money they had saved for a down payment on a home.

In tax parlance, the O’Connors are victims of the “marriage penalty.” This is the all-too-common phenomenon that causes millions of married, dual-income couples to pay dramatically more in federal income taxes than singles or couples with one income.

However, Congress might come to the rescue. In a 230-page tax bill passed last week by the House, legislators propose to cut the marriage penalty by boosting the standard deduction available to couples. The bill would require that the standard deduction for married people filing jointly always amount to twice the standard deduction for singles.

For the O’Connors, the measure could mean annual savings of about $400. That’s no fortune, and it certainly doesn’t eliminate the whole penalty. But the O’Connors would be happy to get it.

“We’ll take any benefit that we can get,” Judy O’Connor says. “Anything will help.”

Yet not all married couples would benefit if the measure passed. Indeed, the tax cut would help only about half of all dual-income married couples, in many cases eliminating only a fraction of the so-called penalty.

For Paul and Laura Coble, for example, the proposed law wouldn’t help a bit. Why? The Whittier couple have substantial itemized deductions--taxpayers choose between claiming either the standard deduction or itemized deductions--and the Taxpayer Relief Act of 1998 does not address the other 56 areas in the tax code that limit deductions and tax credits for couples just because they’re married.

“When I read about this, I thought: ‘Great! Finally!’ ” says Laura Coble. “But when I was given the details, I thought: ‘Oh, well. There it goes.’ We are working people and we are paying a tremendous amount of tax. Whatever good Congress thinks they are doing, when they set the limits, they set them so low that they never seem to help us at all.”

Tax Code Fix Would Take Major Overhaul

Indeed, while the proposed law attempts a simple solution, it underscores the complexity of fixing this long-standing but increasingly controversial issue. The sponsor of the tax proposal, Rep. Bill Archer (R-Texas), acknowledges that his measure would help only about half the nation’s 49 million married taxpayers. Even for them, the help is modest compared with the penalty.

Why so little so late? Because to completely fix the marriage penalty, the voluminous federal tax code would have to be scrapped.

“The marriage penalty is a reflection of the progressive income tax system itself,” says Ari Fleischer, a spokesman for the House Ways and Means Committee that Archer chairs. “A progressive income tax system, by its very nature, cannot be marriage-neutral.”

The tax code has long been justified, in part, as a tool for increasing fairness or adjusting financial burdens in society. Some now argue that the provisions on marital status should be reshaped to focus on helping families with children--or to penalize singles and families without children, depending on your perspective.

To understand all this requires some explanation of where the marriage penalty comes from and how it applies.

The U.S. tax system was designed on the theory that the more you earn, the more tax you ought to pay--both in raw numbers and as a percentage of income. As a result, when two working people marry and pool their incomes, they’re frequently thrown into a higher tax bracket, forcing them to pay more than they would have had they remained single.

For example, two single individuals, both earning $32,000, would each pay about $3,757.50 in federal income tax, or $7,515 between them. But if they were to marry, their $64,000 in combined income would boost their taxes by about $1,399.50 to $8,914.50.

While the disparity between what single and married people pay in tax has become more acute in recent years, the marriage penalty has been around nearly as long as the tax code.

The code was enacted in 1913 and revised in the 1920s, but pressure over the marriage penalty intensified in the ‘30s and ‘40s. Congress in 1948 began allowing married couples to split their incomes and file separate returns. It also restructured tax schedules so married taxpayers never paid more--and could pay up to 42% less--than singles earning the same total income.

Not surprisingly, single people then complained. So in 1969, Congress enacted relief for singles, which ended up penalizing some marrieds. (Although couples can still file separately, there is little tax benefit to doing so.)

But the really difficult issue is not the constant tug between marrieds and singles--it’s the fact that not all married couples are taxed alike. Indeed, some couples--mainly dual-income families where the man and woman earn similar incomes--suffer a marriage penalty, while others actually get a bonus.

Who gets the bonus? Couples with just one income and those with highly disparate salaries, according to the Internal Revenue Service, which delivered an extensive memo to Congress two years ago in response to questions from lawmakers about the marriage penalty.

In fact, whenever lawmakers try to eliminate the marriage penalty, they end up inadvertently creating a bigger marriage bonus for Ozzie and Harriet-style one-worker families--which begins to make single people testy again.

Which provisions in the tax code create this bonus?

First, there’s the standard deduction. In 1999, Congress projects that single people who do not itemize will get a $4,300 standard deduction. That amount is subtracted from income before taxes are computed. Married couples filing jointly will be able to subtract $7,200--$1,400 less than if this couple remained single and each took the $4,300 standard deduction ($8,600 combined). So if both spouses work, the current disparity causes couples to pay more tax than similarly situated singles.

However, because the married deduction is bigger than the single deduction--although not twice as big--single-income couples effectively get a bonus over similarly situated singles. (See accompanying graphic.)

Two-Income Couples Face Several Inequities

Then there are those progressive tax rates. Earn $30,000 as a single person and, after taking your standard deduction and a personal exemption credit, you’re in the 15% federal tax bracket. But put together two $30,000 salaries and suddenly a good portion of that income is taxed at 28%.

There also are literally dozens of so-called phaseouts that limit itemized deductions, personal exemption credits, adoption tax credits and eligibility to contribute to tax-sheltered accounts--such as Roth IRAs--that are also contingent on income levels. Because the income that triggers a tax-break phaseout is seldom twice the amount for marrieds as it is for singles, dual-income couples with similar incomes get hit time and again.

“We have a good marriage but, I’ll tell you, this makes you want to get a divorce,” says Newell Canfield, a counselor with the Los Angeles Unified School District.

Canfield won’t divorce for tax reasons. However, he says some friends of the couple have “separated”--establishing different mailing addresses, even though they live together and remain married--so they can file their taxes as singles. That saves these couples a small fortune in income tax, but it also puts them at risk of being charged with fraud.

“It’s crazy,” Canfield says.

Ultimately, Rep. Archer--and a handful of other tax reformers--would like to replace the current progressive income tax with a flat tax that would be levied on everyone equally. That would eliminate marriage penalties and bonuses. But flat-tax proposals are controversial because they could significantly boost the tax hit on the poor while dramatically lowering it for the wealthy.

Meanwhile, couples like the O’Connors watch and wait, hoping Congress will at least grant the modest relief that’s been proposed.

But that, too, is far from certain.

While the Taxpayer Relief Act of 1998 has received some bipartisan support, recent disputes over possible impeachment proceedings against President Clinton have damaged the fragile truce that Republicans and Democrats need to pass legislation, Washington insiders say.

Clinton has threatened to veto the tax cut because the money to pay for it--estimated at $80 billion over five years--could be diverted from the Social Security trust. And just to clear the Senate, the bill requires 60 affirmative votes, a significant hurdle.

Some Senate Democrats are calling for a far smaller tax cut.

Unless the political rift can be repaired, the O’Connors--and millions of couples like them--might have to choose between marriage and money.

Kathy M. Kristof is a syndicated columnist and author of “Kathy Kristof’s Complete Book of Dollars and Sense.” Write to her in care of Personal Finance, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail kathy.kristof@latimes.com.