Note: This brief was originally posted July 23, 2008. Yesterday, Sen. Biden said “Bush’s tax cuts didn’t help the middle class at all.” Huh? Sorry, Joe — there were plenty of goodies in there for everybody. Read on …
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Summary: We’ve all heard the rants about the cuts in the top bracket rate, capital gains rate, dividend taxes, and estate taxes.
But, when was the last time that your heard a candidate (on either side) or a pundit (O’Reilly included) mention the new 10% bracket, larger and refundable child and earned income credits, negative income taxes, elimination of the marriage tax penalty, or expanded college benefits?
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The income tax cuts of 2001 and 2003 are shorthanded by the press and political candidates as “Bush’s tax breaks for the wealthy — who didn’t even want them”, and are blamed for an accelerating polarization of wealth distribution (i.e. rich get richer, poor stay poor).
Warren Buffet says his secretary pays more taxes than he does (really?). McCain says he’ll stay the course. Obama says that he’ll roll back the tax cuts if he’s elected and redistribute them to the “folks who need them the most”.
All of the rhetoric got me thinking. Somewhat embarrassed, I realized Ihat I didn’t know exactly what was in the Bush tax plan. (Quick Test: take out a sheet of paper and jot down the tax breaks enacted as part of the Bush plan)
Prompted by curiosity (and a modicum of selfish interest) I did some digging. Here’s what I found, along with my “take”:
The top marginal income tax rate was cut from 39.5% to 35% (applied to Adjusted Gross Income >$350,000)
– the 36% marginal rate was cut to 33% (TI > $161,000)
– the 31% marginal rate was cut to 28% (TI> $77,000)
– the 28% marginal rate was cut to 25% (TI > $32,000)
… a clear benefit to the top half of income earners; with the biggest benefit to the highest earners
Capital gains and dividend tax rates were reduced to 15% for high-earners, zero for low earners … more of a benefit to high-earners, but 1/3 of households own stock and more than 1/4 of returns (including many retirees) report dividend income … turned out to be a windfall for hedge funds and private equity via the “carried interest” loophole (more on that in a subsequent post)
A low-income 10% tax rate bracket was introduced … benefit to many low-earners previously in the 15% bracket
Child Care Credit and Earned Income Tax Credit were increased and made refundable … resulting in zero or negative tax due balances for millions of people (note: “refundable” means that any negative tax due is paid to the citizen — a very important policy shift)
Income limits were eliminated on personal exemptions and itemized deductions … the former helps low earners most — since it’s a higher proportion of income; the latter benefits higher earners most — since they are the ones who itemize deductions. (Note: roughly 2/3’s of tax filers take the standard deduction)
Marriage penalty was neutralized … benefits middle-earning couples most
College education benefits were liberalized, e.g. 529 plans, student loan interest deduction, tax-free employer paid tuition … benefits mid- and high-earners most (since their family members disproportionately attend college)
Estate taxes were reduced and to be phased out… only impacts wealthy folks with estates that are big enough to be subject to “death taxes”
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Details re: “Bush Tax Plan” – 2001 and 2003
Officially, the first round of Bush tax cuts were codified in the “Economic Growth and Tax Relief Reconciliation Act of 2001” which was approved by the Congressional conference committee on May 25, 2001; signed into law shortly thereafter; but phased in over a several year period. The key provisions of the law (as reported in the conference committee’s report):
Introduce a 10-percent rate bracket… reducing the rate from 15% to 10% for the first $6,000 of taxable income for single individuals ($7,000 for 2008 and thereafter), $10,000 of taxable income for heads of households, and $12,000 for married couples filing joint returns ($14,000 for 2008 and thereafter).
Reduce individual income tax rates … from 28 percent, 31percent, 36 percent, and 39.6 percent are phased-down over six years to 25 percent, 28 percent, 33 percent, and 35 percent, effective after June 30, 2001.
click table to make it bigger
Phase-out of Itemized Deductions and Restrictions on Personal Exemptions … by eliminating all limitation on itemized deductions and any restrictions on personal exemptions for all taxpayers by one-third in taxable years beginning in 2006 and 2007, and by two-thirds in taxable years beginning in 2008 and 2009, and by 100% for taxable years beginning after December 31, 2009.
Increase and Expand the Child Tax Credit… Increasing the child tax credit to $1,000, phased-in over ten years. and by making the child credit — subject to certain income limitations — non-taxable and refundable (i.e. payable to the person if the net tax liability is zero),
Provide relief from the “marriage penalty” … by increasing the basic standard deduction for a married couple filing a joint return; by increasing the size of the 15-percent regular income tax rate bracket for a married couple filing a joint return to twice the size of the corresponding rate bracket for an unmarried individual filing a single return.; and by increasing limits on the Earned Income Tax Credit.
Provide Education Benefits… by increasing the annual limit on contributions to education IRAs to $2,000; by expanding the reach of 529 tuition programs; by extending the non-taxibility of employer paid tuition; and by raising income phase out levels for deductability of student loan interest.
Phase-out and Repeal of Estate and Generation-Skipping Transfer Taxes:
click table to make it bigger
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In 2003, a second round of tax changes was enacted in the “JOBS AND GROWTH TAX RELIEF RECONCILIATION ACT OF 2003” which:
Accelerated the phase in of the 10% bracket, the reduction in other bracket rates, the child care tax credit, and marriage penalty relief.
Provide reductions in taxes on capital gains and dividends … reducing the 10- and 20-percent rates on capital gains on assets held more than one year to five ( zero, in 2008 ) and 15 percent, respectively. and providing that dividends received by an individual shareholder from domestic and qualified foreign corporations generally are taxed at the same rates that apply to capital gains.
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Source Reports
http://www.jct.gov/x-50-01.pdf
http://www.house.gov/jct//x-54-03.pdf
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July 23, 2008 at 1:15 pm |
I did some rough analysis of Sen. Obama’s proposal to increase capital gains taxes from 15% to 28% a few months ago. Using IRS data from 2005 (latest available at the time), a “typical” retiree showing less than $50,000 in AGI could experience more than $400 in additional capital gains taxes – that has the same income affect of raising gasoline prices 80 center per gallon.
Around 30% of returns with Adjusted Gross Incomes (AGI) under $50,000 showed taxable interest in their return. They averaged $1,368 in interest payments per return, thus Obama’s higher tax rate would cost them an additional $178 in taxes. Fifteen percent of this group claimed ordinary dividends, averaging $1,837 per return. That translates into an additional $238 on dividends paid to people with less than $50,000 in AGI.
These two categories easily describe hundreds of thousands of retirees. They don’t show AGI because they are living off pension payments, Social Security, retirement accounts and investments. Most responsible investors will tend towards bonds, CD’s and dividend paying stocks – i.e. things that generate interest payments and dividends. There is also a negative wealth affect as the assets in their portfolios will likely decline as their after-tax values are diminished.
This is “playing with averages” so there’s some slop in this analysis, but ti does show “tax fairness” comes with a price for everyone.
July 23, 2008 at 6:52 pm |
Ken-
Slicing and dicing tax data can quickly exponentially grow in complexity, but I suspect you’ll find a way through the morass. One suggestion:
Compute Income tax, Payroll Tax, and Social Security tax as a function of income level, then sum those to an total tax and calculate the implied tax rate as a function of income.
Several interesting insights there, but a couple that you’ll see;
1) effective total tax rate actually drops between $100K and $150K AGI (payroll tax drops off before the jump to the 33% tax bracket overtakes it). For each marginal dollar earned, you actually pay less taxes as a % of income.
2) The effective tax rate VERY slowly rises between $150K to $500K+, and the net change is not that large; can’t recall the numbers but we’re talking around 7% or so.
3) Conversely, under $100K, there are HUGE jumps in effective tax rate as your income increases. Thus there are strong tax rate increases for marginal income growth under $100K, but weak tax rate increases above $100K.
There’s a world of difference between % of population that owns stock and the % of total stock owned as functions of AGI. Lower capital gains massively benefit high AGI citizens when weighted for amount of stock owned.
This is almost like being back in your class.
July 28, 2008 at 10:00 am |
One, Warren Buffet pays less than his secretary on a marginal basis because his income is taxed almost entirely as capital gains, while her’s is income. The same case applies to private equity currently, although I question how long this situation will last. I have mixed feelings as to whether private equity should be taxed as income or capital gains.
Two, I believe Chris made a mistake in his calculations, namely by assuming a retiree’s interest would be taxed as capital gains. I believe that gets taxed as income, so Obama’s capital gains increase wouldn’t affect it. The ordinary dividends would indeed be subject to a higher tax rate.
Three, I think raising the capital gains tax and offsetting that with a lower business tax, which I believe is one of Obama’s proposals, makes a lot of sense. Businesses have much more income mobility, so the lost revenue (and potentially lost economic activity) of a business tax is much higher. Consider the amount of revenue repatriated during that one year corporate tax holiday a couple of years ago.