As I promised in last Friday’s TaxVox post, here is TPC’s estimate of the 2012 distribution of President Obama’s tax proposals in the 2009 budget, measured against the administration’s chosen baseline. That baseline looks a lot like current policy: extend the Bush tax cuts, index and make permanent the 2009 estate tax, and permanently patch the alternative minimum tax by indexing forward the 2009 parameters.

How does that shift the bottom line? Against the more expansive baseline, some people pay more tax, but they are way up the income scale.

By design, Obama’s proposals would yield virtually no tax change overall, but tax shifts would differ substantially across quintiles (top figure). The lowest 20 percent—or quintile—would see its after-tax income rise by just over 4 percent, the second quintile would get just over half as much, and the next two quintiles would reap after-tax income boosts of 1 percent or more. Only the top fifth would see its tax bill rise, pushing its post-tax income down 1.5 percent. That looks like a pretty progressive tax bill that would be roughly revenue neutral to boot—measured against a fiscally irresponsible baseline.

Break down the top quintile further and the progressivity continues further up the income scale (bottom figure). On average, tax units in the 80th through 95th percentiles would get small tax cuts. Only the top 5 percent would suffer a drop in after-tax income, and for the least well-heeled four-fifths of them, income would dip an average of just 0.7 percent.
Obama would reserve his largest hits for the big guys, clipping after-tax income by more than 5 percent for the top 1 percent. Candidate Obama promised not to raise taxes on the bottom 95 percent of households and his first budget makes good on that promise.

So what is it that makes this view of the president’s tax plan look so much more progressive than the one I showed last Friday? The answer is pretty simple: last week’s story combined the effects of the Bush and Obama tax plans. Bush cut taxes for everybody but heavily favored the rich. Obama first assumes that many of those regressive tax breaks will remain in place but then turns around and raises taxes on those at the very top of the income distribution.  Combine the two and almost everyone gets a tax cut.  If you accept the immortality of the regressive Bush tax cuts as a given, add Obama’s new refundable credits, and toss in higher tax rates for the highest-income taxpayers, you end up with a highly progressive mix.

Following last month’s release of the Treasury Green Book, the Tax Policy Center reworked its distributional analysis of the tax proposals in President Obama’s 2010 budget. We learned many new details about specific tax provisions, including the practical definition of who has enough income to face higher taxes. The bottom line? You have to have a lot of income to be in Obama’s crosshairs.

Compared with current law, almost everyone would get a tax cut in 2012 from the budget’s tax plan, as Howard Gleckman explained here on Tuesday. On average, households in each of the first four quintiles (or fifths) of the income distribution would see their after-tax income rise by between 4 and 5 percent; even those in the top quintile would get a 3-percent income bump. That’s not a lot of wealth sharing: a little shifts to lower-income households because Obama proposes to make refundable tax credits permanent, but the cuts run across the board.

Go a little higher up the income scale and you find that many people in the top quintile do well under the president’s plan. Those in the 80th to 95th percentiles would see their after-tax income rise more than 4 percent on average, and the 95th through 99th percentiles would get 3 percent more. Only when we reach the 1 percent with the highest incomes do the gains tail off and we have to climb to the rarified top one-tenth of one percent to see a small tax increase—yielding a 0.1 percent drop in after-tax income. That’s no surprise, of course. We heard repeatedly during the campaign that Obama would give tax cuts to 95 percent of working families.

I can already hear some of you objecting that I’ve biased my findings by measuring the budget proposals against current law, which includes a big tax increase after 2010 when most of the past decade’s tax cuts would sunset. Howard blogged on the choice of baseline earlier this week and subsequent comments churned through the alternatives. Next week, I’ll show you the graphs depicting how the tax changes stack up against the administration’s baseline—extend the Bush tax cuts, fix the estate tax at 2009 levels, and permanently patch the AMT (all for the tidy little cost of  $3.2 trillion from 2009 through 2019). If you want to peek at the results sooner, you’ll find the relevant table on our website.

Suffice it to say for now that the tax proposals in President Obama’s 2010 budget are far from the massive redistribution of income we heard so much about during last year’s campaign.

A basic tenet of public finance holds that people tend to do less of something when it is taxed.  Raise income tax rates and some people will work less. Boost the gas tax and people will drive less. Hike the cigarette tax and people will smoke less.

That inexorable law of demand poses two problems for the taxman. First, taxes distort behavior as people move from taxed activities to those that are taxed less or not at all. Sometimes, as in the case of cigarette taxes, we want to discourage the taxed activity. In other cases, the tax only makes the economy less efficient.  Second, tax avoidance may reduce the revenue gained from a tax increase—or even negate it entirely.  For example, if gasoline sales plummet when gas taxes rise, we get less revenue to build and maintain roads.

But recent research suggests that taxes don’t always have to depress demand. People may not react to tax changes they don’t perceive. If the price change isn’t obvious, homo economicus goes on merrily consuming the same as before.

MIT economist Amy Finkelstein examined the behavior of motorists using toll roads with and without electronic toll payments. Because drivers don’t fork over cash to pay tolls when they use electronic transponders, they are less aware of the cost and their demand is less responsive. Toll revenues, Finkelstein found, are 20 to 40 percent higher with electronic toll payments than under the old cash-only system.

Raj Chetty, Adam Looney, and Kory Kroft compared consumer behavior when sales taxes were included and excluded from marked prices and found an 8 percent drop in demand when people saw the tax-inclusive price on the shelf instead of having the tax added at the cash register. The salience of taxes clearly matters: people don’t react to taxes they don’t see.

Tax complexity might also reduce tax awareness. For example, many taxpayers have no idea whether they will owe the alternative minimum tax (AMT) until their accountant or TurboTax tells them. If they don’t know it’s there, they won’t change behavior and the government doesn’t lose needed revenue. It is the same with the phase-outs of the personal exemption (PEP) and itemized deductions (Pease). They are effectively rate increases that few notice.

Of course, complexity can work the other way too. The energy conservation tax credits in this year’s stimulus bill subsidize the purchase of various “green” products that save energy, ranging from low-e windows to high-efficiency air conditioners. But, as Rosanne Altshuler has pointed out, it’s not easy to figure out whether a specific item qualifies. Sellers will no doubt advertise their qualifying products but more consumers might take the bait if the tax rules were simpler. Similarly, lots of evidence suggests that people don’t take full advantage of tax-deferred savings accounts because of confusing rules and the wide variety of choices available.

Furthermore, taxpayers may be so confused by the rules that they respond in perverse ways.  Some people think that the phaseout of itemized deductions actually reduces the value of additional charitable contributions and mortgage interest deductions.  It doesn’t.  AMT taxpayers may be confused about what is deductible and what isn’t.

I’m not arguing in favor of complexity. Taxpayers don’t trust a tax system they don’t understand. Complexity may reduce compliance, either because people have trouble following the rules or because they think others must benefit from obscure provisions and they should somehow pay less tax too. And we often do want tax provisions to affect people’s behavior.

Nonetheless, complexity may sometimes mask taxes and thus help to raise revenues in a relatively efficient way.

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.

Tax Day has come and gone and IRS commissioner Doug Shulman says refunds this year will total roughly $300 billion. About two-thirds of that amount had already gone out to early tax filers by the beginning of this month. That’s a significant amount of money and it could boost the economy—if recipients spend it. In today’s economic environment, that’s a big if.   more »

It’s never too early to plan for next year’s taxes. Let’s say you’re thinking about doing some energy-saving home improvements soon and want to know what federal tax credits are available and how they work. How would you find out? You might try the IRS website. I did but, unfortunately, couldn’t find any information about energy credits for 2009.   more »

Commenter dh has raised a provocative question in response to my post the other day about why I hate filing taxes: “I wonder if the use of tax software actually increased the complexity of the tax code. Perhaps the fact that AMT was reaching a large swatch of the population would (have) been addressed sooner if everyone was required to hire an accountant rather than buy a $50 program to figure it out.”    more »

I still haven’t finished my taxes, probably because it is the civic duty I hate the most. It isn’t the paying that bothers me. It is the process. I hate that I have to give a private company $49.95 to help me perform a basic act of citizenship. I hate that I must sit in front of a computer for hours mindlessly typing in numbers. I hate that the Tax Code is an incomprehensible black box. The software asks for a number. I type it in. It appears on a form, and I, more or less, assume it is right. Mostly, I hate that the Tax Code is so damn complicated.    more »

At a fascinating TPC panel this afternoon, TPC’s Bob Williams, former CBO director (and McCain economic adviser) Doug Holtz-Eakin, former top Ronald Reagan tax adviser John (Buck) Chapoton, and Center on Budget & Policy Priorities executive director Bob Greenstein all wrestled with the nature—and future--of our progressive tax system.   more »

There are already signs that a key tax element of President Obama’s budget--his proposal to limit to 28 percent the value of all tax deductions—may not survive on Capitol Hill. And if it is allowed to die, Congress may find itself staring squarely at another hard-to swallow tax hike—trimming the tax exclusion for employer-sponsored insurance. Key Republicans have strongly objected to the curb on deductions. Powerful Democrats, including Finance Committee chairman Max Baucus (D-Mt), are less than enthusiastic. Charities that fear they will lose contributions are gearing up for a big fight, even though TPC estimates that gifts would decline by only about 2 percent. And in the face of this criticism the Administration has signaled that it may not fight very hard to save the proposal. "We recognize there are other ways to do this," Treasury Secretary Tim Geithner told the Finance panel yesterday.    more »

This won’t take long. If you are blue-collar wage earner, a low-income family with children, or a college student, you should love President Obama’s tax plan. On the other hand, if you are making more than $250,000, you may not be so happy: By 2011, you'd be paying a lot more tax than you've gotten used to over the past few years. To the surprise of absolutely nobody, Obama’s budget includes many of the tax changes he promised during the campaign. He’d make permanent many of the “temporary” tax cuts in the just-passed stimulus. Working families would continue to get an $800-a-year tax cut long after the recession ends, and they’d continue to enjoy the benefits of a more generous Earned Income Credit and a more refundable child credit. Obama is proposing tax reductions for low- and moderate-income families of almost $800 billion over the next decade.    more »

How much will the $300 billion in tax cuts approved today by the House Ways & Means Committee really stimulate the economy? They will help some, but don’t expect them to accomplish a lot. I’d give the overall plan a Gentleman’s C. Some provisions would channel money to low-income people most likely to spend it, but deliver the cash too slowly. Others distribute the funds relatively quickly, but give an awful lot to wealthier taxpayers who are least likely to spend it.    more »

Have you seen the new tax calculators produced by the Obama and McCain campaigns? The idea is simple enough—make tax real for ordinary voters. Instead of talking about trillions of dollars or 95 percent of working families, describe what an Obama or McCain presidency would mean for real taxpayers.    more »

A few more thoughts on "Barack the wealth spreader," as Sarah Palin now describes the Democratic nominee. I'm inspired in part by commenter D.F., who wrote this morning, "Tax rebates don't work. We need a flat tax." First off, John McCain is right when he says Obama's tax plan is redistributionist, if by that he means his rival would give his biggest tax cuts to the lowest earners. TPC calculates that Obama would cut the average tax rate for the lowest 20 percent of earners by more than 5 percent while he'd raise the rate by a roughly equal amount for the top 1 percent.    more »

John McCain says Barack Obama’s enthusiasm for refundable tax credits amounts to socialism. Wow. This is interesting for so many reasons. To start, the mother of all refundable credits is the Earned Income Credit, which is the largest poverty program in the U.S. and distributes $42 billion to more than 20 million low-income families. It was enacted during the Presidency of well-known leftist Gerald Ford, and has been expanded repeatedly ever since, most recently by President Bush in 2001.    more »