OCTOBER 2012: FINANCE
Author: Lew Wessel | Photographer: Photography by Anne
I’m going to try the impossible here: to lay out the facts on what the two presidential candidates are proposing to do with your individual income taxes. No opinion, just the facts, so you can make an informed decision when you cast your vote in November. If, after reading this article, every Republican concludes that I’m a Democrat and every Democrat thinks that I’m a Republican, then I know I’ve done my job.
By way of disclosure, much of my research on this topic is based on reporting by the non-partisan Tax Policy Center (TPC), a joint venture of the Urban Institute and the Brookings Institution. I also went to each campaign’s website to verify and recheck the TPC information. Below is as clear a picture as I can offer of what the two sides are saying they have in mind for your future taxes.
President Obama’s tax plan keeps the current system in place and continues the current tax rates and preferences for couples making less than $250,000 per year and individuals making less than $200,000 per year. For those making more than those threshold amounts, the income tax burden will increase substantially through both an increase in tax rates, changes to preference items and new taxes. The estate tax will continue under his proposals.
Governor Romney’s tax plan is ultimately to work toward a “fundamental redesign” of the tax system leading to a “lower, simpler” tax burden. Initially, he proposes extending all of the Bush tax cuts and reducing those tax rates even further for all taxpayers. He would eliminate taxes on investment income for everyone earning less than $200,000 per year and would eliminate the estate tax.
As a reference point, the current top two marginal income tax rates are 33 percent (taxable income between $218,450 and $390,050 for a married couple) and 35 percent (taxable income above $390,050). Obama would keep all current individual tax rates the same as they are now, except for these top two rates, which he proposes to increase to 36 percent and 39.6 percent. In keeping with his promise not to increase taxes on couples making less than $250,000, the 36 percent rate would not start until $250,000 for a married couple; those couples earning between $218,450 and $250,000 would remain in the 33 percent bracket. Note: the top rate of 39.6 percent, which will begin at $390,050 adjusted for inflation, was the top rate in effect prior to the Bush tax cuts of 2001.
Romney would reduce all tax rates currently in effect by 20 percent, so that the top marginal tax rate would be reduced from 35 percent to 28 percent and the bottom rate of 10 percent would go to 8 percent. He would fully pay for those additional rate cuts by eliminating or reducing various “tax breaks.” To date, he has not specified which of those tax breaks (e.g. mortgage interest, charitable deductions, etc.) he intends to target.
Capital gains and qualified dividends
The current tax rate on long-term capital gains and qualified dividends is 0 percent for those in the 10 and 15 percent marginal tax brackets and 15 percent on all other taxpayers.
Obama would continue these rates for all taxpayers except for those in the top two tax brackets described above. For those taxpayers, the capital gains rate will increase to 20 percent, and qualified dividends will be taxed at the full ordinary rates of 36 or 39 percent. This is, once again, the tax treatment prior to the Bush tax cuts. Note that the increase in the taxation rate for qualified dividends for these top tier taxpayers will more than double from current levels under this proposal.
Romney proposes to keep the current 15 percent tax rate on capital gains and dividends for higher income taxpayers and eliminate all taxes on capital gains, dividends and interest on those making up to $200,000 per year. Note further that in vice presidential candidate Paul Ryan’s “Road Map for America’s Future,” there would be no taxes on capital gains, dividends or interest income for any taxpayer.
Estate and gift taxes
In 2012, the estate and gift tax exemption is $5,000,000 per individual. This exemption is “portable,” meaning that if one spouse doesn’t use all of his or her exemption, the other can add the unused amount to their exemption. Thus, married couples are effectively able to transfer $10,000,000 with no estate or gift tax. Transfers in excess of these amounts are taxed at 45 percent. Only 3,000 or so deaths per year, about 1 in 800, will result in a taxable estate under this law. If nothing is done and the Bush tax cuts expire, the exemption will go back to $1,000,000 and a 55 percent tax rate; the result will be about 42,000 taxable estates per the TPC.
Obama proposes to reset the estate tax exemption to 2009 levels: $3,500,000 with a 45 percent top rate. Portability would be made permanent so that couples would effectively get a $7,000,000 combined exemption. This would result in only about 6,000 taxable returns.
Romney proposes to eliminate the estate tax, but continue the tax on lifetime “gift” transfers above $1,000,000 with a tax rate of 35 percent.
Note: With the elimination of the estate tax, beneficiaries would likely no longer be entitled to a “stepped-up” basis on inherited property. Let me explain. Under the current estate tax law, most inherited property is “stepped-up” to the value it had on the date of death, so that the beneficiary of that property would recognize no capital gain if the property, such as the home of the deceased, were immediately sold. With no estate tax in place, beneficiaries will likely inherit assets, such as a home, with the same tax basis as the deceased, and this could potentially result in huge capital gains upon sale of that asset. Thus, while Romney’s proposal will significantly reduce the estate tax burden for the very wealthiest families, the lack of “step-up” may ultimately result in a higher tax burden on many beneficiaries of estates that fall below the $7,000,000 Obama threshold mentioned above.
Affordable Care Act taxes
Beginning in 2012, as part of the Affordable Care Act, there will be an additional 3.8 percent tax on investment income for couples earning more than $250,000 per year. This tax will be on the lesser of investment income or the amount a couple’s adjusted gross income exceeds $250,000. There will also be an additional 0.9 percent payroll tax on the employee only—no increase on employer FICA contributions—for employment or self-employment income above $250,000 for a couple and $200,000 for an individual.
Romney has vowed to throw out “Obama Care” as his first presidential action and thus eliminate these additional taxes.
Other tax proposals
Obama will allow the reinstatement of the personal exemption and itemized deduction phase-outs that were in place prior to 2001, but will begin them now at the much higher level of $250,000. This will effectively increase the top marginal tax rate to 40.79 percent. He will also cap the benefit of itemized deductions at 28 percent.
Obama will, in addition, expand and make permanent both the American Opportunity Credit for higher education expenses and the Child and Dependent Care credit. He will expand the Earned Income Credit.
Obama will keep the Alternative Minimum Tax in place with indexing; Romney will eliminate it.
“Deep Throat” says in the movie All the President’s Men, if you want to figure out what’s really going on, “follow the money.” This is certainly true in this presidential election. The various tax proposals of the two candidates paint a strikingly clear picture of two very different visions of our country, our economy and our future.
Romney’s tax proposals significantly reduce the tax burden on the wealthiest Americans, by reducing the tax on investment income, lowering the top tax rate to 28 percent, and eliminating the estate tax. On the surface of it, he will reduce the taxes for all taxpayers with an across-the-board 20 percent reduction in tax rates and elimination of taxes on capital gains, dividends and interest for those making under $200,000 per year. Clearly, his tax proposals are meant to offer the maximum amount of encouragement and reward for investment and the accumulation of wealth. Vice presidential candidate Ryan’s “Roadmap” would explicitly eliminate all sources of governmental revenue from investment earnings and estate and gift transfers. The question of course is how Romney plans to pay for these very significant tax reductions. What spending cuts will have to be made and/or what “tax breaks” will have to be eliminated? We know that the wealthy will benefit greatly from these reductions, but how will middle and lower income taxpayers be affected?
Obama’s tax proposals do not increase the taxes of any couple earning less than $250,000 or any individual earning less than $200,000, but they do significantly increase the tax burden on those making more than those threshold amounts. He raises the top marginal tax rate on those taxpayers earning over $390,000 per year from 35 to 39.6 percent, and, more significantly, raises the top tax rate on dividends from 15 to 39.6 percent and capital gains from 15 to 20 percent on these higher earning Americans. He keeps the estate tax. On the surface of it, these proposals will raise a significant amount of extra revenue and help balance the budget as well as fund various spending programs. The question, of course, is whether these proposals will significantly discourage investment and capital formation and ultimately stall or even seriously damage the economy.
The good news
A closer look at the tax policies of the two presidential candidates reveals that they are thoroughly consistent with each candidate’s major policy themes. Obama has consistently stated that there is much the government can and should do for the 99 percent of Americans earning less than $250,000, and he feels that wealthier taxpayers should be able to comfortably pay for most of that effort. He clearly does not believe that his tax proposals will inhibit economic recovery.
Romney has consistently called for a smaller role for government and has championed the role of investment by entrepreneurs and business leaders in leading the country back to economic prosperity. He believes that taxes on investment activity inhibit economic growth and job creation.
It seems like a very clear choice is being offered to voters in 2012. No surprises. No confusion. All you have to do now is make up your mind and cast your ballot.
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