Tax proposal falls short

September 16, 2011

President Obama spoke of the need to “cut tax loopholes for millionaires and billionaires” as a way to pay for his proposed jobs bill in his Sept. 8 speech to Congress. For emphasis, he cited the fact that billionaire Warren Buffett’s tax rate is lower than his secretary’s.

But a few days later, when he formally revealed the details of his plan, Obama called for limiting tax deductions for singles earning more than $200,000 a year and couples earning more than $250,000 annually.

Talk about a major disconnect.

Trimming back tax deductions on families with incomes of more than $250,000 is a far cry from targeting millionaires and billionaires, and does little to correct the type of inequities endured by Buffett’s secretary and other taxpayers in her relatively humble income category .

Under Obama’s $447 billion jobs bill, single taxpayers earning more than $200,000 and couples earning more than $250,000 would face a 28 percent limit on their itemized deductions for mortgage interest, charitable deductions, and state and local taxes, among other deductible expenses.

The president’s plan also changes the way carried interest — the amount hedge fund and private equity fund managers make based on their firm’s performance — is taxed, from treating it as long-term capital gains taxed at a mere 15 percent to treating it as income subject to tax rates of up to 35 percent.

Many tax and finance experts applaud the change on carried interest. But they say the provision to trim itemized deductions on families earning more than $250,000 has serious shortcomings, for three major reasons:

●It doesn’t impose nearly enough of an additional tax buden on the likes of Buffett, Bill Gates and Mark Zuckerberg, even though those financial titans and others have said they would be willing to pay more.

Capping itemized deductions is just a “partial step” toward wringing out the inequities in the Byzantine federal tax code, says Chuck Marr, director of federal tax at the Center for Budget and Policy Priorities in Washington.

The Obama proposal doesn’t address the major reason for the kind of tax inequity that exists between Buffet and his secretary: the preferential tax treatment of capital gains and dividends. The tax rate on dividends and long term capital gains is 15 percent, while the top income tax rate is 35 percent.

The super-wealthy can easily cut their effective tax rates to half of the 35 percent income tax rate by drawing modest incomes and using their long-term gains to live on, according to Marr.

In 2008, the 400 highest earning taxpayers had an average income of about $245 million, and their average effective tax rate was 18 percent. That means they were paying a lower rate than married couples earning $69,000 and singles earning $34,500.

●A family earning $250,000 isn’t necessarily wealthy. Sure, $250,000 a year is a substantial income that would put you in the top 1.5% of all taxpayers. Pulling down an income of 250 grand a year would certainly feel like a fortune in many parts of the country, especially in these troubled economic times.

But if wealthy means having a comfortable financial cushion, a couple earning that much while living in a major metropolitan suburb, raising a couple of kids, paying the mortgage and utilities, and saving for college and retirement may seem more middle class than wealthy.

This isn’t the first time the president has cited $200,000 and $250,000 as the starting point of the nation’s wealthy class. The Obama administration tried unsuccessfully to raise taxes on this group of higher earners at the end of last year, and succeeded in doing so in passing the 2010 health care reform bill. The tax increases under that bill go into effect in 2013.

A study by the Fiscal Times in December found that a family with two children earning $250,000 with average expenses actually came out in the red at the end of the month in seven out of eight locales, after factoring in a long list of federal, state and local taxes. The study assumed the family did everything that financial planners recommend, such as maxing out on 401(k)s and saving for college.

The areas included in the study were Huntington, N.Y.; Washington; Alexandria; Bethesda; Pinecrest, Fla.; Naperville, Ill.; Plano, Tex.; and Glendale, Calif. In all but Plano, $250,000 came up short.

“Wealth has more to do with what you have accumulated, more so than what you made this year,” says Keith Banks, president of Bank of America US Trust.

And who can count on sustaining an income level in today’s weak job market? “We’ve seen scary things happening to people who thought they had an annuity stream for an earnings standpoint, and that’s not even close to reality,” Banks says.

●Cutting tax deductions on mortgage interest at time when housing values are depressed may be harmful to working families and the housing market, says Gary Hayes, managinig director at CBIZ Tofias, a tax advisory firm in Boston.

He points out that this change would hit families just over the $250,000 income threshold hard, while having far less impact on multi millionaires, who often don’t have mortgages anyway because they pay in cash for their properties.

“It will be a blow to two-earner families,” Hayes says. “It puzzles me that this was proposed.”

Exactly what a better proposal would look like depends on whom you talk to. Lindsey Cooper, a tax attorney in Charleston, S.C., and former trial attorney at the Department of Justice Tax Division, favors “going after capital gains,” he says, suggesting that a higher capital gains tax rate kick in for taxpayers with gains above a certain level. “That certainly wouldn’t hinder the American dream,” he says.

Other proposals target wealth through higher estate taxes and lower estate tax exemptions, or by enacting taxes on investment transaction costs.

Senator Bernie Sanders of Vermont, favors raising taxes for higher earners, but he sets the threshold much higher than Obama, at $1 million.

Solving the inequities in the tax code is clearly no simple task. But a timid plan that barely affects many super-wealthy taxpayers and puts greater pressure on hardworking high-income families is badly in need of a second draft.

Hube is a columnist for the Fiscal Times, an independent news organization that provides original reporting and analysis on fiscal and economic matters.

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