The \$250,000 Question

During the 2008 presidential campaign, much was made of candidate Obama’s proposal to boost taxes on “high-income” taxpayers. Campaign attack ads warned those folks—couples with income over \$250,000 and others with income over \$200,000—that a big tax increase was on the way. Joe the Plumber complained that the tax increases would stifle his unborn entrepreneurial dreams.

Well, it turns out that many people with incomes well over a quarter million are not “rich” by Obama’s definition.

You see, it all depends on the definition of “income” which was unclear until last week.  Does the \$250,000 refer to adjusted gross income, taxable income, wages and salaries, or something else? The 2009 Treasury Green Book, a detailed guide to Obama’s tax proposals, finally answers the question. Obama has defined a whole new income concept.

The Green Book explains that the administration’s tax proposals will increase the top two rates from 33 and 35 percent to 36 and 39.6 percent and raise the threshold to get into the new 36 percent bracket. For couples, that bracket would start at taxable income of \$250,000 minus the standard deduction and two exemptions. For singles, the starting point for the new 36 percent bracket would start at taxable income of \$200,000 minus the standard deduction and one exemption. The changes would not take effect until 2011, but for illustrative purposes, Bob Williams calculated the cut-offs for 2009. For married taxpayers the taxable income cutoff would be \$231,300 (\$250,000 minus the standard deduction of \$11,400 and two exemptions of \$3,650 each) and for a single taxpayer that cut-off would be \$190,650 (\$200,000 minus the standard deduction of \$5,700 and one exemption). If your taxable income is below those limits, you will not be subject to the higher rates under Obama’s plan.

But most of us don’t consider our income in terms of what’s taxable. We calculate that value on our tax returns, starting with a broad measure of income and then subtracting various exclusions, exemptions, and deductions. We first total wage and salary income, taxable interest and dividends, business income (after expenses), capital gains, rents, royalties, taxable pension and individual retirement account distributions, unemployment compensation and some Social Security benefits. Already we’ve left out tax-exempt interest and some Social Security income. But then we subtract other items, including alimony payments, moving expenses, some retirement savings (IRA contributions, for example), and, if we’re self-employed, health insurance premiums and one-half of the self-employment tax.

What’s left is “adjusted gross income” (AGI), the basic measure of income on a tax return. But you’re not through yet—you next deduct one exemption per family member and larger of the standard deduction or itemized deductions to calculate taxable income. Most high-income people itemize, and their itemized deductions, which include income and property taxes, mortgage interest, charitable contributions, are usually far greater than the standard deduction.  As a result, most people won’t be hit by Obama’s tax increases until their incomes are well over the advertised levels.

Our tax model shows that for 2009, average taxable income for married taxpayers with AGI between \$250,000 and \$300,000 is about \$215,000, well below the \$231,300 cutoff for Obama’s proposed tax increase. Average deductions and exemptions for this group of taxpayers is \$58,000. A whopping 98 percent of taxpayers in this income range itemize their deductions. This means that a lot of married folks with adjusted gross income in excess of \$250,000 (and singles with adjusted gross income in excess of \$200,000) don’t need to worry about their taxes going up.

What’s more, many taxpayers in this income range are on the alternative minimum tax (AMT).  They’re not affected by the new tax increases unless the rate increases push them off the AMT.  (Indeed, many get a tax cut since Obama proposes substantial cuts in the AMT).

So, moderately rich people, relax. Obama doesn’t really want you. The only problem, of course, is that the expansive definition of income comes at the expense of even bigger deficits. The CBO projects they will be \$9 trillion over the next decade. Somebody—likely our decidedly unrich children and grandchildren—will have to pay that back, with interest.