Under the Economic Stimulus Act of 2008, most Americans will qualify for and receive a tax-free check in the mail come May. Individuals will receive as much as $600, couples as much as $1,200, and people with children as much as $300 per child more. For most people who file a tax return, the IRS will process this year’s return automatically and send the rebate checks out within a month or so of April 15. (By the way, this rebate is separate from the question of whether you qualify for any April 15th refund because you paid more in 2007 federal taxes than you owed.) Unlike the 2001 vintage, today's rebate will not be counted as an advance on next year's tax refund.

However, the rebate is reduced or completely phased out beyond a certain income level. For individual filers with adjusted gross income above $75,000 or joint filers with AGI above $150,000, the rebate is reduced by five percent of every dollar above those thresholds. For example, individuals with AGI of $76,000 should expect a rebate of $550. This arrangement seems to reflect a desire to minimize losses in tax revenue and to confine the rebate to people viewed as more likely to spend it, thus stimulating the economy. The effect is that most individual filers with AGI above $87,000 or joint filers with AGI above $174,000 will receive no rebate.

As an example on the IRS website shows, these thresholds rise when children eligible for the additional $300 enter the calculation. With an AGI of $160,000, a married couple with two children would receive less than the $1,800 that would go to a comparable family with a lower income. Instead, the $1,800 would be reduced by $500 (five percent of the $10,000 excess of $160,000 over $150,000), leaving a rebate of $1,300. By the same token, the complete phase-out for a couple with two children would not occur until an AGI of $186,000.

An accidental insight from this phase-out mechanism is the way back-door measures can be used to increase the progressivity of the federal income tax. “Progressivity” means that people with higher incomes pay higher proportions of their incomes in taxes. This is the rationale for the graduated marginal rate structure of the federal income tax, as illustrated in the table below.

Much of the difference between AGI and taxable income (the income that is actually taxed) comes from deductions and exemptions. So the greater the value of your deductions for such things as charity, mortgage interest, and state taxes paid, the lower your taxable income relative to AGI—and the lower your tax bill.

However, in what has come to be known as a “stealth” tax, itemized deductions are partially phased out for joint filers with AGI in 2007 above $156,400—at about the level the rebate starts to phase out. As Tom Herman notes in a recent Wall Street Journal column (January 9, 2008), the phase-out cost taxpayers $45 billion in itemized deductions for 2005. Even personal exemptions are partially phased out at higher AGI levels, beginning at $156,400 for individual filers in 2007.

While not as random or arbitrary as the dreaded Alternative Minimum Tax, such stealth taxes do represent a kind of fiscal slight of hand. The effect is that upper-middle-income taxpayers may think their tax rates are lower than they actually are.

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