Wednesday, December 05, 2007

Rethinking Marriages' Tax Advantages

When I first moved in with my then girlfriend, and now wife, I quickly realized two things. First, this was the smartest thing I had ever done. And secondly I experienced a massive increase in my material standard of living. Some of that was my wife has far better tastes than I do but most of the increase was due to economic factors. I had just finished graduate school in the middle of the job loss recovery and my wife had one more year to go, so it was not because our income was extravagant. Instead economies of scale took over.

We rented a small one bedroom apartment for a little bit less than the rents for our two previous tiny places. But it was not the rent savings that were significant but all of the ancillary factors; buying food to cook for two people was much cheaper than buying for a single person, increased population to amortize the cost of a video rental, an electrical bill that was only slightly more than my old electrical bill, a cheaper heating bill than either of our old places [we had good windows and insulation], a single internet connection instead of two connections, a single renter's insurance policy instead of two... These advantages have only compounded since we have gotten married and bought a house. The quasi fixed costs of living increased far slower than household size so we effectively had higher disposable or at least not immediately accounted for cash flow as a co-habitating and now married couple than we would have had as single individuals.

The Michigan State University study on the environmental impacts of divorce lends some strong support to this idea by its finding that single people living alone consume more resources per capita than people living together.
The reason is simple — it's all about efficiency, says Jianguo Liu, lead author of the study who has the Rachel Carson chair in ecological sustainability at the university's department of fisheries and wildlife.

"In the divorced households, the number of people is smaller than in married households," Liu told "The resource efficiency used per person is much lower than in married households....n the United States, they found that divorced households spent 46 percent more per capita on electricity and 56 percent more on water than married households....if divorced households could have the same resource efficiency as their married counterparts, they would need 38 million fewer rooms, use 73 billion fewer kilowatt hours of electricity and 627 billion gallons of water in 2005 alone.
Other news reports highlighted the fact that these findings applied more generally to cohabitating couples as more resource efficient than single individuals and that single individuals once they became part of a long term couple showed nearly identical resource consumption patterns as other live-in partners. So the study is not a finding on divorce, but a finding on the economies of scale and fixed costs of living.

So how does this relate to the tax code? Well, marriage is also favored by the tax code. Her work benefits can easily cover me, and vice versa and we'll pay less in taxes than two single people with the same exact profile as us. But does this make sense as I feel that we have more disposable income than that counter factual scenario which means that marginal utility of our last dollar is probably a bit less than the marginal utility of the last dollar of a nearly identical single person. The nearly identical single person just has a much bigger chunk of their income covering nearly fixed costs.

If one believes in progressive taxation, one believes that there is a declining marginal utility of income and expenditures. This leads one to believe that tax rates should be at least equal if not effectively higher on income that has fairly low marginal utility than on dollars that have higher marginal utility. In the United States that is reflected in the fact that everyone has a personal exemption, and children are tax advantaged as they significantly decrease the disposable income of their caregivers. It is further reflected by the bracketing of rates -- someone who makes $500,000 most likely has a lower marginal utility for that last dollar than someone who makes $12,000 for the year, and thus should be taxed at a higher rate.

So should marriage be tax advantaged if the presumption of cohabitation in most cases is held? From a progressive taxation perspective on the probable marginal utility of income, there is an argument against this advantage.

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