The Obama Tax Plan: Who's in the Crosshairs?

By :: September 21st, 2010

President Obama’s plan to raise taxes on the nation’s highest income households may not quite mean what you think. A closer look suggests that fewer people may get whacked than either Obama or his Republican critics suggest. And for many of the victims, the club won’t be the president’s plan to raise rates to 36 percent and 39.6 percent. Those rate hikes may be getting most of the attention, but the real cudgel would be higher taxes on capital gains and dividends going to high-earners.

 First, let’s look at whom Obama’s plan would hit. As most everyone knows by now, ever since his presidential campaign, Obama has promised to retain the 2001 and 2003 tax cuts for households with income below $250,000 and individuals making less than $200,000. That seems clear enough, but candidate Obama never said what he meant by “income.” His budget helps to clarify the issue by defining income very generously but parsing the policy descriptions isn’t easy.

Consider different ways the president could have defined income to determine whom he’d hit with bigger tax bills. The broadest measure—total income—counts everything you get in cash, regardless of source, including taxes your employer pays and you never see. By that measure, just over 3 percent of households have income above the president’s thresholds (see graph). The president could instead have decided to use a narrower measure, “adjusted gross income,” which excludes income not subject to federal tax such as tax-exempt bond interest and much of Social Security benefits. Just over 2 percent of tax units have AGI that tops $200,000/$250,000.

Or the president could have gone one more step and dropped exemptions and deductions from his definition of income. That’s the familiar description of taxable income (pretty much the bottom line on your 1040) and it would protect another 0.2% of households from a tax hike.

But Obama’s budget plan is even a bit more generous than that. To make sure that no one making less than $200,000 really does get hit with a tax increase, the president had to extend the 28 percent bracket to cover more income. That would cut taxes for even the richest taxpayers by a few hundred dollars and provide a small cushion against higher levies for people just over the thresholds. When all the dust settles, the Tax Policy Center figures that just 1.7 percent of households would pay higher taxes under the president’s proposal than if Congress extended all the 2001 and 2003 tax cuts.

Just as interesting is why those 2.7 million high-income taxpayers would get hit. For most of them, the answer is not the high-profile increase in the top rates. Rather, it is Obama’s proposal to hike rates on capital gains and dividends. A close look at his plan shows that fewer than three in ten affected taxpayers would be hit by the 36 percent and 39.6 percent rates on ordinary income that have drawn the loudest complaints. Another change, the limitation on itemized deductions (Pease) and the phaseout of personal exemptions (PEP) would affect less than half. But nearly 95 percent of people facing higher tax bills would pay more tax on gains and dividends. Keep in mind, btw, that while Obama would raise the top rate on capital gains from 15 percent to 20 percent, he would also tax qualified dividends at 20 percent. If the Bush-era tax cuts are allowed to expire, the top dividend rate would hit 39.6 percent.

Knowing that less than 2 percent of households would face higher taxes, mostly because of their investment income, won’t calm the debate—and by itself certainly provides no justification for backing the president’s plan—but it’s always helpful to know the facts.

16Comments

  1. Anonymous  ::  7:20 pm on September 22nd, 2010:

    This also excludes discussion of the Inheritance tax.
    Frankly, the top rates could stay where they are for all I care as long as the dividend rates are allowed to expire and the Clinton roll back repealed. Giving capital a bonus simply caused a tech bubble and a housing bubble. Taxing dividends and capital gains as normal income would kill the possibility of future bubbles – not doing so leaves the door open.

  2. Anonymous  ::  7:38 pm on September 23rd, 2010:

    It may be true that “INCOME TAX” will not go up for those under the $200/250k income but what one has to look at is “How much do you have to spend and save”? There are many other items that are not called taxes but they are. Increases in fees and other income (for the government) producing means which is called by another name is still a tax. Another way Obama is making you (the genaric you) pay more is the fees, taxes and surecharges he has placed on business. So it still comes down how much of YOUR OWN MONEY can you keep?

  3. Anonymous  ::  7:44 pm on September 23rd, 2010:

    OK, anonymous, since you brought it up, why don't you tell us what are all these fees, taxes, and surecharges(sic), and do they affect the generic taxpayer, small business owners, medium-to-large corporations? Don't just do a drive-by troll – man up and be specific. Anything else is just noise, or worse – intentional misdirection.

  4. Anonymous  ::  8:14 pm on September 23rd, 2010:

    INDEED

  5. Anonymous  ::  8:31 pm on September 23rd, 2010:

    What happens when a retired couple on a fixed income of say, $40,000/year decide to sell the home they've owned for 30 years and move to Florida? If they sell it for $500,000 does that automatically make them “rich” and libel for the tax dollars in that new bracket?

  6. Anonymous  ::  8:35 pm on September 23rd, 2010:

    Also, why all of a sudden are we required to report how much an employer pays for Health Insurance coverages and included it as part of the total income? That could easily move someone into a higher bracket if they are close.

  7. Anonymous  ::  8:36 pm on September 23rd, 2010:

    Well, they keep the gains, which are less than $500K, tax free if they've had the house 2 years prior to sale, and it's their primary residence. Libel indeed, you>>>Obama.

  8. Anonymous  ::  9:03 pm on September 23rd, 2010:

    This is what I don't understand…less than 4% of the people in this country will be effected by Obama's intended tax rate hike on the $250K+ crowd. The other 96% of us will see no change. The entire Republican Party is fighting tooth/nail for 4% of us. What are they doing for the rest of us besides proposing a repeal of the law that will now allow me to get access to a respectable health insurance policy for my family? The rest of the “Pledge” reads like the campaign promises we've heard in every election season since I was old enough to vote. Why don't they tell us how they intend to do these things? It's like me saying…”Vote for me, I promise you world peace.” Do they really think we're all a bunch of idiots?

  9. Anonymous  ::  10:51 pm on September 24th, 2010:

    Interesting yes. However, what they don't mention is that the small percentage of individuals that does get hit by the rate increase in ordinary income is normally individuals who have businesses that pass through their business income (Sub S corporations and partnerships) to their individual tax returns . They will get the blunt of this increase. Think about it, if you take a larger share of their profits, there is a reduction in the amount of capital they have to expand or hire employees. What this administration fails to realize is that there is a lot of income in that group over $200,000 that is business income. It isn't just a bunch of fat cats that don't do anything to make their money. In addition, that increase in tax rate on investment income (dividends and capital gains) is a deterrent for investment when this country needs it the most. The government can't continue to buy every company that is short of cash or near bankruptcy .
    I did like the hypocrisy of the politicians definition of income. Quite funny and true. The problem is that this kind of political rhetoric leads people to believe that these people don't pay taxes or don't pay their fair share. I can tell you that they do. I am not sure why some people believe that the government can just tax whatever percentage they want on people over a certain amount and everything will be fine. You can see what a small percentage of taxpayers are over these amounts. If that percentage of people paid every dime they made to the government it wouldn't make a dent in their deficit and our economy as we know it would fail.

  10. Anonymous  ::  7:18 pm on September 28th, 2010:

    There are plenty of investment dollars in the system – most of them held by people who can crowd out investment by people with smaller incomes. I'm all for taxing investment by the richer at a higher rate, thank you very much, so that poorer people can have more of the wealth (which is currently too concentrated by any measure you want to use).

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