Blowing Off the "Bubble"

At the heart of all the congressional squabbling over the budget is a bizarre quirk in the income tax code known as the "bubble."

The bubble was created in 1986. To simplify the tax code, the old graduated system (in which there were as many as 15 brackets, each subject to a differing marginal rate) was replaced by a new scheme with only two rates: 15% for low-income taxpayers and 28% for everyone else. But achieving that goal required some juggling. For most joint filers, for instance, income below $32,450 is taxed at the 15% rate. To ensure that those who make more kick in 28% on all their income, the government puts a larger bite on the high end of their earnings. So for the same joint filers, the marginal tax rate jumps from 28% to 33% on taxable income between $78,400 and $162,770. Then comes the odd part: it drops back down to 28% on income above that level.

Is that a break for the rich? Not really, most G.O.P. lawmakers insist. Unlike low- and middle-income earners, joint filers with incomes above $162,770 cannot claim personal exemptions. They are also taxed at the full 28% rate even on their income below $32,450. With those considerations factored in, both middle-income and wealthy earners are supposed to wind up paying the same marginal rate of 28% on their earnings over $32,450.

But try to explain that to people subject to the 33% marginal rate. Capitalizing on the widespread impression that the bubble gives a bonanza to the mansion-and-limousine set, House Democrats led by Ways and Means Committee chairman Dan Rostenkowski have proposed to puncture it. They would tax all income over $200,000 at the 33% rate and levy an additional 10% surcharge on income over $1,000,000. Though such hikes would apply to only about 740,000 taxpayers, the congressional joint tax committee reckons the change would bring in $4.2 billion in additional revenue in the current fiscal year and $44.3 billion by 1995. It also has the political appeal of imposing a higher rate on the rich than on the less affluent.

Most Republicans find the idea of raising income taxes anathema -- unless they can get a capital-gains tax cut in exchange. That swap was contemplated during the long-running budget summit, but discarded as politically unfeasible. It resurfaced briefly last week, when Republican Congressman William Archer of Texas claimed that Bush had said "without equivocation" that he supported Archer's plan for lifting the top income tax rate to 31% while slashing the tax on capital gains to 15%. Once again the trade-off was shot down. The main reason: Archer's plan would lower taxes on incomes over $ $200,000 by 6.6%. Given Democratic opposition to any formula that appears to favor the rich, Bush declared that pursuing such a compromise would be "a waste of time." Maybe so, but eventually Washington will have to find a plan that inflicts the pain of tax-paying on everyone -- including the rich.

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CREDIT: TIME Chart by Joe Lertola

[TMFONT 1 d #666666 d {Source: Tax Foundation and Arthur Andersen}]CAPTION: "The bubble"