Since the Bush tax cuts are in the news again, I’m taking the opportunity to reprise one of my favorite posts from the archives. The original was posted on Sept. 11, 2008 …
The punch line: “wealthy” starts at a number higher than $250,000 and higher marginal tax rates for the real high earners might be a good idea.
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Maybe, just maybe, the answer is $5 million
Background: At the Obama-McCain Saddleback debate, the candidates were asked: “What’s rich?” Both gave glib answers. Obama got a pass, McCain didn’t. Thinking about it, McCain may have been right.
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After Saddleback, Senator McCain was repeatedly hammered for his $5 million dollar answer to Rick Warren’s “what’s rich?” question.
Interestingly, but not surprisingly, Senator Obama got a free pass for his parallel laugh line — even though the annual royalties on 25 million books probably exceed $5 million. Perhaps. the conversion from books to dollars is sufficiently nuanced that folks didn’t notice.
Even liberal columnist Paul Krugman, acknowledges that McCain was just joking when he flipped the $5 million dollar figure at Pastor Rick.
In a recent New York Times op-ed titled “Now, that’s rich”, Krugman concedes the point and puts it into context. Specifically, he references the book Richistan by Robert Frank of The Wall Street Journal. According to Krugman, Frank “declares … that country is divided into levels, and only the inhabitants of upper Richistan live like aristocrats; the inhabitants of middle Richistan lead ample but not gilded lives; and lower Richistanis live in McMansions, drive around in S.U.V.’s, and are likely to think of themselves as “affluent” rather than rich.”
Perhaps, the stage-pensive Obama should take pause and reflect on Prof. Krugman’s observations. Senator McCain gave Senator Obama a huge gift. No, not the new applause line that Obama keeps repeating in his stump speech. It’s bigger than that. It’s a clue to attracting — or, at least, to avoid alienating — about 5 million voters who, in a close election, may be what the pollsters call “statistically significant”.
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Let me explain.
Boiled down to its essence, Senator Obama’s complicated tax plan reduces to taking an average of about $20,000 in additional annual income taxes from about 5 million people, and redistributing the loot to 200 million others — $500 (or more) per person in annual tax credits.
Some of the 5 million targeted “givers” earn as low as $200,000; some are in Warren Buffett’s category, earning $40 million or $50 million or more. Obama’s plan doesn’t differentiate among them. The freshly minted MBA working 80 high stress hours in a high cost, high tax locale (think, New York or San Francisco) – paying off a hundred grand or more in student loans — just gets lumped in with Bill Gates.
Now, what if Senator Obama were to adopt Senator McCain’s perspective and define “rich” as starting at $5 million ? What would it take to raise a redistributable $100 billion from them ?
Well, according to recently released IRS data, there were about 41,000 tax returns filed in 2006 with adjustable gross income greater than $5 million. Those returns averaged over $15 million in AGI and $13.5 million in taxable income. As a group, the over $5 million crowd accounted for almost $600 billion in annual taxable income.
So, if he wanted to, Obama could leave the folks earning $200,000 to $5 million alone, and raise the $100 billion by introducing an uber-high income tax bracket for everybody reporting more than $5 million — upping their effective tax rates to about to about 37% (from their current 20% effective income tax rate). To get there would require a 50% top bracket marginal income tax rate (up from 35%). And, since about 75% of the uber-high-earners income comes from capital gains and dividends, which are insulated from the Alternative Minimum Tax calculations — the capital gains and dividends rate would have to upped to about 30%, and rolled into the AMT.
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Before dismissing the notion out-of-hand, consider that a $5 million top bracket fits in a historical context, and has some well-aged precedents.
Since 1913, the top bracket income threshold has averaged about $650,000 (unadjusted for inflation), ranging from $29,750 in 1988 (Reagan’s last year) to, yes, $5 million (from 1932 to 1941). In order to fund WWII, the top bracket income threshold was cut in 1941 to $200,000 — which, coincidentally, inflates to about $5 million in 2008 dollars.
Besides generating a $100 billion redistribution pool, a top bracket with a high rate and high income threshold addresses a few of Senator Obama’s other oft-repeated concerns. On the campaign trail, Obama often showcases Warren Buffett’s lament that his secretary’s 30% tax rate is higher than his 18%. That gap only narrows a bit under Senator Obama’s current plan (her’s drops to 29%; his goes to 22%).
Under an uber-income rate bracket structure, the Buffett injustice would remedied, and along with it, private equity and hedge fund loopholes would be closed, and the fattest cats would start paying their fair share despite the holes in the AMT. Sure, these uber-earners will be tempted to search harder for tax shelters — in the U.S. and offshore — but that’s a risk that Obama says he’s willing to take.
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If Senator Obama wanted to moderate the risk somewhat, he could scheme between the extremes by creating multiple new brackets. Maybe a bracket starting at $500,000 with a 40% marginal rate, a 42.5% bracket starting at $1 million, a 45% bracket starting at $2.5 million, a 47.5% bracket starting at $5 million, and a 50% bracket starting at $10 million. By my math, this multiple bracket structure would give Senator Obama his $100 billion, too. The point: there are many ways to skin the (fat) cats.
Comedians say that, at their core, many jokes have a ring of truth. Senator McCain’s $5 million jest may have provided Senator Obama with an out-of-the box idea for rebalancing incomes: deep-drilling the super-rich. The introduction of an uber-income bracket would make Obama’s tax plan more palatable to about 3% of the voting population. And, Mr. Buffett would get his wish come true. In military parlance, I think that’s called friendly-fire.
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The Homa Files 
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