Taxation and the Family: What is the personal exemption?

Personal exemptions provide that only a person’s income above some defined basic level is subject to tax. They thus help ensure that the poorest of the poor pay little if any income tax. The personal exemption has been a basic feature of the modern individual income tax since it was enacted. In 1913 it was set at $3,000 (equivalent to $63,690 in 2007 dollars), so that very few persons were expected to pay tax. The 2007 personal exemption, at $3,400, is substantially lower in real terms, but the tax code has added other features since 1913, such as the standard deduction and various tax credits, that have partly offset the exemption’s decline in value.

• The value of the personal exemption depends on an individual’s marginal tax rate. For instance, a single taxpayer who would otherwise owe 15 percent on his or her first $3,400 of income saves $510, whereas a single taxpayer in a 35 percent bracket saves $1,190. Thus, under a progressive income tax, exemptions are worth more to upper-income filers than to low-income filers. The rate structure itself can, however, be adjusted to compensate for that effect and achieve any desired degree of progressivity.
• Since 1990, the personal exemption has been phased out at higher income levels. Current tax law reduces the phase-out for the 2006-09 tax years and removes it entirely in 2010 before returning it to full force in 2011.
• The alternative minimum tax (AMT) denies taxpayers the use of personal exemptions. As a result, larger families are more likely to owe AMT than smaller families.
• In 2004 tax filers reported $6.8 trillion in adjusted gross income (AGI) and claimed $801 billion in personal exemptions (although not all exemptions could be fully used to reduce tax). Returns that owed tax reported $6.3 trillion of that AGI and claimed personal exemptions totaling $508 billion.