“Read my lips: no new taxes.” George H.W. Bush

“If your family earns less than $250,000 a year, you will not see your taxes increased a single dime.” Barack Obama

George Bush’s infamous campaign promise probably haunts him to this day. Barack Obama now faces the same difficult task of balancing the budget while keeping his campaign promise not to raise taxes on the vast majority of Americans.

The United States 2009 budget deficit will approach $1.75 trillion. That amounts to more than 12 per cent of GDP. Eventually, somehow, someway, that’s gotta be paid for. How?

More like who.

The budget proposal that the Obama Administration released on February 26, 2009 calls for $989 billion in additional taxes over the course of the next 10 years. Starting in 2011, Obama would raise $636 billion from individuals and $353 billion from businesses over 10 years.

But, maybe more significant than the additional tax revenue, Obama is also proposing to shift the source of approximately $65 billion a year federal government receipts from individual income taxes to climate taxes.

Let’s take a look.

Tax Increases on Individuals

The tax code is about to get a bit more progressive. Obama proposes to raise approximately $635 billion over the ten years starting in 2011 from the highest earning tax payers. These tax increases are to be used as a down-payment on comprehensive health care reform.

$338 billion – The bulk of the increase in government revenue will come from the Obama Administration’s decision to let the Bush tax cuts expire after 2010 for married couples who earn more than $250,000 in gross income and singles who earn more than $200,000. The top two federal income tax brackets would rise to 36 percent and 39.6 percent from 33 percent and 35 percent, respectively.

$179 billlion – Obama’s budget proposal would cap at 28% the tax break for itemized deductions. Essentially, this means that those persons in the highest tax brackets, soon to be 36 percent and 39.6, will not receive a deduction for the full amount of their mortgage interest, state and local taxes and charitable contributions.

$118 billion – Obama proposes to raise the capital gains income tax five percent, to 20 percent. Approximately $24 billion of this amount comes from the Obama proposal to tax the profits of private-equity fund managers and venture capitalists as ordinary income instead of capital gains.

Corporate Tax Increases

The Obama Administration also intends to raise approximately $353 billion over ten years by raises taxes and eliminating deductions for businesses. Much of the increase comes from higher taxes on the overseas profits of U.S. based companies. Another significant portion will come from oil and gas companies.

$210 billion – Increased taxes on foreign profits of U.S. multinationals and crack down on offshore tax cheating;
$61 billion – repeal last-in, first-out (LIFO) accounting rules;
$24 billion – tax carried-interest as income;
$17 billion – Reinstate Superfund taxes, including excise taxes on oil;
$13 billion – repeal manufacturing tax deduction for oil and natural gas companies;
$5.3 billion – excise tax on Gulf of Mexico oil and gas;
$5 billion – codify “economic substance doctrine”;
$4 billion – information reporting for rental payments;
$3.4 billion – repeal expensing of tangible drilling costs;
$1 billion – increase to 7 years geological and geophysical amortization period for independent producers;

Carbon Taxes

Raising taxes on businesses and the high-earners can be fun. But what’s really interesting is that Obama is proposing to implement a carbon tax while making permanent his Making Work Pay Tax Credit and other social welfare provisions of the Obama’s 2009 Stimulus Package.

Obama is proposing the following permanent tax cuts in 2011.

$536 billion: Making Work Pay Tax Credit ($63 billion per year);

$33 billion: Earned Income Tax Credit ($4 billion per year);

$70 billion: Expand refundability of the Child Tax Credit ($9 billion per year);

$75 billion: Provide American Opportunity Tax Credit ($7 billion);

$55 billion: Expand saver’s credit and automatic enrollment in IRAs and 401(k)s ($3 billion per year);

The first four items were enacted as temporary measures under the stimulus package. The last one is something that Obama advocated during the campaign that I doubt requires a tax change. Its just an expectation that tax revenue will be lower because he expects to get more people to enroll in 401(k)s.

Essentially, this proposal is based upon recent realization about human nature. Currently, most employees are required to opt-in to participation in their 401(k) plans (i.e., you don’t contribute to your 401(k) unless you fill out all the paperwork). Many employees never do so or wait for years before participating.

Automatic enrollment provisions like the type Obama seems to be endorsing enroll the employee in the 401(k) unless they affirmatively opt out. Automatic enrollment has been shown to increase average national participation rates from 75 percent to between 85 and 95 percent. Among newer female employees, such programs increase participation rates from 35 percent to 86 percent and among newer employees with annual earnings less than $20,000, from 13 percent to 80 percent. (More…)

At least with respect to the Making Work Pay Tax Credit however, these tax cuts are tax cuts in name only.

Starting in 2012, Obama’s budget projects approximately $80 billion a year in “Climate Revenues.” The bulk of Obama’s carbon tax will be used to offset the loss of revenue as a result of the Making Work Pay Tax Credit extension. The excess revenue, estimated at $15 billion a year, will be dedicated to climate policy and clean energy technologies.

Obama is using one of the most powerful effects of the tax code, influencing behavior, while seemingly trying to be revenue neutral. The climate taxes force companies to take carbon output into account when making economic decisions. This will cause energy prices, among others, to rise. The Making Work Pay Tax Credit extension then mitigates the effects of these energy price increases.

Criticisms and Concerns

I like the switcheroo that Obama is pulling with the carbon taxes/MWP tax credit. I have some questions and concerns however.

Obama’s too hopey: We’ll ignore Obama’s overly optimistic GDP forecast for now. You can’t predict what’s going to happen ten years out anyway.

The Numbers are too confusing: From the LA Times,

Brian M. Riedl, a budget analyst at the Heritage Foundation, says Obama’s plan amounts to an unfair redistribution of the tax burden. He said that the top 20% of taxpayers now pay 80% of all taxes collected by the government. And 40% of households pay no income tax.

Under Obama’s plan, he said, the top 20% of tax filers would pay 90% of all taxes, and the number of families who owe no tax would climb to near 50%. (More…)

Wow. That sounds outrageous.

Outrageous that the LA Times and the Heritage Foundation are complicit in deceiving us. Fortunately we know from analyzing Average Federal Tax Rates that households earning greater than $250,000 account for less than three percent of all households. Talking about the top twenty-percent of households only (intentionally) confuses the issue.

Roughly 3.8 million filers (or 2.8% of all returns) had adjusted gross incomes above $200,000 in 2006. That’s the maximum amount of people that may initially be affected by Obama’s tax proposals.

That’s for now, of course. We’ll see what happens later when he tries to “fix” social security.

The Mortgage and Charity Deduction: Obama’s tax plan would cut the mortgage interest deduction for high-income taxpayers by capping at 28% the tax break for itemized deductions.

Currently, homeowners in the highest marginal tax bracket get back 35 cents on their taxes for every dollar they spend on mortgage interest, state and local taxes and other items such as charitable contributions. Obama would raise the top rate to 39.6 and reduce the deduction to 28 cents on the dollar.

In other words, the highest earning individuals would only be able to deduct about 70% of their mortgage interest and charitable contributions.

This is not quite the dramatic change that it seems to be. Already, many people in high tax and property value states are subject to the AMT. This means that many of the wealthiest donors are already limited to deductions of 28 percent.

Moreover, although the exact relationship between tax rates and spending by the wealthy is not totally clear, at some level it will affect how big of a house they buy or how they finance it. This likely will have some effect on housing prices at the very top (i.e., not your house).

At some level it will also influence charitable giving. Again, there is conflicting evidence however. Conventional wisdom suggested that the higher the tax rate the higher the level of charitable giving. Actual practice over the last thirty years calls into question this relationship.

Yet, tax-rate cuts enacted in the 1980s raised questions about the magnitude of these estimates. The Tax Reform Act of 1986 increased the after-tax cost of giving, often significantly. There were concerns that if private giving were as sensitive to cost as implied by the existing research, lower tax rates would cause private giving to fall by an appreciable amount. The predicted drop in giving, however, did not materialize. With the exception of taxpayers in the highest income tax brackets, charitable giving remained quite stable. The implication was that giving may not be as sensitive to price incentives as indicated by some econometric models. (More…)

And

• Following the 1981 income-tax rate cut that went into effect in 1982, rather than declining because charitable deductions were less valuable on an after-tax basis, charitable contributions actually increased 24.3% (in inflation-adjusted 2007 dollars) over the next four years before dropping about 5% with the stock market crash in 1987 (see accompanying graph).
• A similar pattern was seen following the 1987 and 1988 tax rate cuts with another stock market decline in 1990 putting the brakes on the increase in giving.
• Even though deductions were more valuable after the 1993 tax rate increase, giving dipped 0.42% in 1994 and inched up only 1.51% in 1995.
• Giving spiked 10.2% following the capital gains rate cut in 1997.
• In the two years after the rate cuts in 2003, average inflation-adjusted salaries for the top 1% of earners rose 18.8% and 22.5%, respectively.2Inflation-adjusted charitable giving during this period, as measured by charitable deductions claimed on high-income tax returns, grew 23.1% and 21.3%.

(More…)

The wealthy have many reasons for charitable giving. One of them is taxes, but there are many others.

Wealthy donors’ motivations for giving demonstrate their desire to give back to their communities and to make an immediate difference in the world around them. Donors give based on their belief system as well as their loyalty to support certain causes and organizations, many of which have a mission to remedy an issue that may have affected the donor personally or someone close to them. (More…)

I guess what I’m basically saying is that I’ve found no good sources which factually demonstrate the effect that these tax increases will have on home prices and/or charitable giving.

Corporate Competitiveness: One thing that I definitely don’t like about Obama’s proposals is that they do not lower corporate tax rates. Even Sweden has lower corporate tax rates than the United States does.

KPMG, a well-known international accounting firm, released its annual survey of corporate and indirect tax rates for 2008, showing that the U.S. corporate income tax rate was higher than all other global regions, 14.1 percentage points higher than the global average and nearly 17 percentage points higher than the average among European Union nations.

In Tax Foundation Fiscal Fact No. 145, “KPMG Study Finds U.S. Corporate Tax Rate Higher Than Every Global Region,” Tax Foundation President Scott Hodge explains that America’s stagnant business tax system is potentially harmful to America’s economic competitiveness in the global marketplace.

“Of the 106 countries surveyed, only the United Arab Emirates (55 percent), Kuwait (55 percent), and Japan (40.69 percent) impose a higher corporate tax rate than the combined rate of 40 percent in the U.S.,” says Hodge. “What this says about America’s tax competitiveness is not good.”

According to the KPMG report, 23 countries have lowered their corporate tax rates this year, and no nation has raised its rate since last year. Last week, for instance, Sweden announced a series of proposals to improve its business climate, including a plan to cut its corporate tax rate from 28 percent to 26.3 percent. A September 17, 2008 Industry Week article, “Sweden Announces Income Tax Cuts to Boost Jobs,” explains, “Since coming to power in the autumn of 2006, the Swedish government has launched a series of measures aimed at inciting Swedes to return to the job market instead of living off of state subsidies.”

If you don’t believe that corporate tax rates have an effect on where businesses locate their headquarters, and thus where they pay taxes and where they employ people, see the Tax Foundation’s CompeteUSA page.

Is it Fair?

Well, is it?

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Details of Obama’s 2009 Stimulus Bill

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Average Federal Tax Rates, by Income Percentile

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How Do Today’s High School Students Compare to Their Parents?

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