“I say that, at a time when the tax burden on the wealthy is at its lowest level in half a century, the most fortunate among us can afford to pay a little more.”
— President Obama, April 13, 2011
“The president says he wants to eliminate deductions, but he also wants to raise rates. That includes raising the top rate to 44.8 percent.”
— Rep. Paul Ryan (R-Wis.), May 16, 2011
Ryan’s speech to the Economic Club of Chicago on Monday caught our attention with its figure of a top marginal tax rate of almost 45 percent. Generally, the media’s coverage of the president’s 2012 budget has focused on Obama’s desire to return the top tax rate to 39.6 percent, the same as it was before the Bush-era tax cuts.
The top rate is currently 35 percent. So when President Obama said in his speech on fiscal policy last month that the wealthy (those making above $390,050 a year) would “pay a little more,” we thought he meant an extra 4.6 percent. But Ryan is suggesting the increase is much more than that.
The president framed his statement by claiming the tax burden on the wealthy is “at its lowest level in half a century.” It’s certainly among the lowest periods, but not the lowest, according to a 2010 Congressional Budget Office study that examined average tax rates over the past three decades.
The most recent data is from 2007, which shows the average tax rate for the top 1 percent is at 29.5 percent. That’s lower than any period since 1990, when the average rate was 28.8 percent. The lowest rate was 25.5 percent in 1986 for the top 1 percent. So Obama is stretching it to claim this is “the lowest” in a half century.
Meanwhile, how does Ryan get the top tax rate to reach nearly 45 percent? His staff provided the following explanation:
New top rate with expiration of Bush tax cuts : 39.6 percent
Plus “PEP/Pease provisions” reinstated : 41.6 percent
Plus net 2.3 percent Medicare tax on wages/salary : 43.9 percent
Plus 0.9 percent Medicare tax from health care law (2013) : 44.8 percent
These are somewhat complicated concepts. We will try to explain without boring you.
The first category refers to tax provisions that Bush eliminated but which would be reinstated under Obama’s budget plan. Currently, taxpayers reduce the income subject to tax with personal exemptions and itemized deductions, but PEP and Pease impose limits on those benefits as income rises.
“PEP” refers to Personal Exemption Phase-out. “Pease” refers to the late Rep. Don Pease (D-Ohio), who pushed through the legislation limiting itemized deductions.
Ryan calculates that reinstating “PEP and Pease” would add about 2 percentage points to a wealthy person’s tax rate. The precise calculation can vary, but Ryan’s estimate appears to be in the ballpark.
Ryan then adds Medicare payroll taxes to his total rate. Unlike Social Security, there is no wage cap on Medicare taxes. Currently, employees and employers split the cost of the 2.9 percent Medicare tax, though many economists say it makes sense to assume some of the employer’s tax payments result in lost wages for the employee. Ryan does that to come up with a “net” tax rate of 2.3 percent. (However, we should note, this is an existing tax; it is not new under Obama.)
Interestingly, when some conservatives complain that half of all Americans do not pay income taxes, they are not counting payroll taxes, which is the main tax paid by lower-income Americans. We have not seen Ryan make this claim; it certainly would be inconsistent for him to count payroll taxes here and not in other circumstances.
Meanwhile, starting in 2013, the new health care law adds a surtax on high earners — an additional 0.9 percent tax on incomes over $200,000 for individuals and $250,000 for couples filing joint returns.
For someone making $390,050, thus triggering the 39.6 percent tax rate, that means at least an extra $1,260 in Medicare taxes just from the health care law. (The health care law also imposes additional taxes on investment income, but we won’t get into that now.)
Adding up all of these figures, you get to an effective marginal rate of nearly 45 percent. One can quibble with some of the assumptions, but tax experts we checked with found Ryan’s calculations to be reasonable.
Why are marginal rates important? In theory, if the rate gets too high, it reduces the incentive to earn another dollar. The top marginal rates have been as high as 90 percent in U.S. history, but it has also been as low at 28 percent (under Ronald Reagan). At 45 percent, that means nearly half of each additional dollar a high earner makes would go to taxes.
Put another way, Ryan shows that Obama’s budget would effectively boost the marginal rate for high earners by a hidden 7.5 percentage points, or an increase of 20 percent. For every $100,000 of additional income, about $45,000 would go to federal taxes. (State and local taxes would eat up more; there are no additional Social Security taxes at this income.)
Only a small number of taxpayers would be affected by this, of course. Most Americans would see little change in their taxes, as they would keep paying the Bush tax rates. Obama also proposed a permanent fix for the alternative minimum tax, which often hikes taxes for upper-middle-income taxpayers.
But, for the very wealthy, the new taxes could be significant. The Tax Policy Center calculates that the top 1 percent (with income above $643,000) would pay an average of $76,000 in additional taxes. The top 0.1 percent (above $3 million) would pay an average of $414,000 in additional taxes.
The Pinocchio Test
Paul Ryan’s attention-getting figure adds up and appears credible, so Ryan earns the rare Geppetto Checkmark.
Meanwhile, we are going award one Pinocchio to President Obama for claiming that the wealthy would pay “a little more.” That phrase is relative, but the hidden 7.5 percentage points identified by Ryan strikes us as more than pocket change.
UPDATE, 2 PM: Calculator run amok! An earlier version of this post had an extra zero for the amount of additional Medicare taxes someone would have paid under the health-care law once they reach the 39.6 tax bracket. Sorry about that.
UPDATE, MAY 26:We answer reader questions on this column.