Last month,President Obama addressed Congress and explained the concept of the Buffett Rule, “People making more than $1 million a year should not pay a smaller share of their income in taxes than middle-class families pay. To assist the Committee in its work, I also included specific tax loophole closers and measures to broaden the tax base. Together with the expiration of the high-income tax cuts from 2001 and 2003, these measures would be more than enough to reach this $1.5 trillion target…They include cutting tax preferences for high-income households.”
The one big stumbling block to this strategy is that the President doesn’t actually write the bills that ultimately become the laws. Instead, the President only signs or vetos bills passed by Congress. If you grew up in the 70’s like I did, you probably remember the Schoolhouse Rock video,I’m Just a Bill. Please take a few minutes to watch this YouTube video for either nostalgic reasons or as a refresher course in basic Civics.
Let’s take a look at the recommendations made by the Obama Administration. Included in their report, the current Administration outlines their Principles of Tax Reform as follows:
1. Lower tax rates. The tax system should be simplified and work for all Americans with lower individual and corporate tax rates and fewer brackets.
2. Cut Inefficient and Unfair Tax Breaks. Cut tax breaks that are inefficient, unfair, or both so that the American people and businesses spend less time and less money each year filing taxes and cannot avoid their responsibility by gaming the system.
3. Cut the deficit. Cut the deficit by $1.5 trillion over the next decade through tax reform, including the expiration of tax cuts for single taxpayers making over $200,000 and married couples making over $250,000.
4. Increase job creation and growth in the United States. Make America stronger at home and more competitive globally by increasing the incentive to work and invest in the United States.
5. Observe the Buffett Rule. No household making over $1 million annually should pay a smaller share of its income in taxes than middle-class families pay. As Warren Buffett has pointed out, his effective tax rate is lower than his secretary’s. This rule will be achieved as part of an overall reform that increases the progressivity of the tax code.
To be perfectly honest, I don’t find anything too earth shattering in these Principles of Tax Reform. Tax simplification and the equitableness of the Tax Code have been two issues that Congress and each President have grappled with ever since the federal income taxes were enacted on a permanent basis back in 1913.
The Specifics:
President Obama’s address last month included some specific changes he would like to see Congress make to the Tax Code, including:
Allow the 2001 and 2003 high-income tax cuts to expire
Simply stated, by Congress not doing anything, the tax rates are set to increase in 2013 for ordinary income, capital gains, and qualified dividends. The President says that he only wants to see the tax rates increase for households with income in excess of $250k, however.
A summary of tax breaks enacted in 2001 are available in ourJuly 2001 Newsletter. You can read about the 2003 tax law changes in ourJune 2003 Newsletter.
Reduce the value of a deduction
President Obama’s second suggestion is to reduce the value of itemized deductions and other tax breaks to 28 percent for families with incomes over $250,000 and single individuals with income over $200,000.
Generally, tax deductions reduce a person’s tax liability based on that person’s tax bracket. Someone in the top bracket paying $10k of mortgage interest saves $3.5k in federal income taxes.
Under this proposal, even if a taxpayer is in the 33% or 35% tax bracket, the tax break for their deductions will be capped at 28%. A person in the top bracket, therefore, will pay an extra $700 in federal income taxes for each $10,000 of allowable deductions claimed.
According to the President’s proposal, “This limit would apply to: all itemized deductions; foreign excluded income; tax-exempt interest; employer sponsored health insurance; and selected above-the-line deductions.”
A Green Tinted Lining
As part of his address to Congress, President Obama proposed that Congress pass The American Jobs Act. The President would like to see this Act include a provision that would cut in half the Social Security taxes currently being withheld from each worker’s wages, as follows:
Cut the employee payroll tax in half next year for 160 million workers. Almost every working American pays payroll taxes, and middle-class Americans face a higher burden because more of their income comes from wages and salaries. The President’s plan will cut payroll taxes in half for employees next year. Rather than having 6.2 percent of their wages deducted in payroll taxes, workers will only pay 3.1 percent next year. This builds on the 2 percentage point payroll tax reduction that the President secured for workers in 2011—providing 160 million Americans the certainty of ongoing tax relief and increasing the amount of that relief by more than 50 percent.
With the Social Security Max currently at $106,800, this provision would save high-income taxpayers as much as $3,311 each year. For people in the top tax bracket, this break in Social Security taxes will offset the President’s proposed tax increase on the first $47,300 of deductions claimed.
Wait and See
President Obama’s proposal is just that, a proposal. All we know for certain is that the tax rules in place right now will continue through 2012. With the next Presidential election set for November 2012, who knows when Congress will be able to pass a bill addressing the post-2012 tax rules, and what changes to the tax laws that bill will contain.