Whether or not you liked George Bush, his budgets over the past four years have consistently called for more tax cuts and extensions for expiring tax provisions which would otherwise hike taxes. Last year, Bush extended the lower marginal tax rates on ordinary income and the preferential rates on capital gains and dividend income. The goal of these tax cuts was to raise individual incomes, add jobs to the economy and lower unemployment. Well, no luck so far on reaching those goals. On Friday we learned of 240,000 more job losses last month and a national unemployment rate of 6.5%. So now the question becomes, what can we expect from President elect Obama? Lots of people on Wall Street are scared of a scenario in which Obama raises taxes shortly after getting into office presumably in the middle of a recession. Herbert Hoover did the same thing in the early 1930’s. It led to the Great Depression. Are we in a similar predicament? What can we expect over the next four years from Barack Obama in terms of taxes?
First, it should be noted that in light of the recent economic downturn, it’s possible that Obama’s tax plans will get deferred for a year or two. Because his overall plans are to raise taxes on higher-income earners and lower taxes for the middle and lower-middle classes, his tax plans aren’t viewed as a ‘stimulus.’ And because of the recent stock market declines, Obama and his advisors might pay more attention to monetary policy and new legislation to stimulate growth over his longer-term economic agenda. Now, if you asked him, he would tell you that the large majority of workers in this country will pay lower taxes under his administration, not more. His tax increases would hit hardest those with earnings over $200,000, and those businesses which have pass-through taxation and therefore would fall into this category as well. Because over 95% of Americans would actually have their taxes reduced under his plan, he views it as a ‘net tax cut’ to Americans. The effects are debatable but that fact I believe to be true.
Obama proposes raising the tax rate (married filing jointly) to 36% from 33% for each dollar of earned income between $200,300-$357,700. For each dollar over $357,700 he proposes raising the rate to 39.6% from 36%. He also wants to increase the capital gains and dividend tax from its current 15% rate to 20%. Estimates from Deloitte & Touche are that a family of four with $500,000 in income from wages, interest and capital gains would pay approximately $3,100 more in taxes under the Obama plan. Unmarried individuals and those filing separately would get hit with the tax hike at $164,550 rather than at $200,300.
The way in which middle and lower-middle income people would see a tax cut is largely through his Making Work Pay Credit (MWPC) and other tax credits. The MWPC would essentially create a tax credit equal to 6.2% of the first $8,100 of annual earnings for workers making less than $75,000 per year. The credit, which amounts to roughly $500, would basically refund the employee’s portion of Social Security tax. Obama also proposes replacing the Hope Credit (max $1,800) with the American Opportunity Tax Credit (max $4,000). Like the Hope Credit, it wouldn’t apply to all 4 years of college and would have income restrictions as well. The earned income tax credit, which generally helps the lowest earnings individuals in the US, would be expanded under the Obama plan.
Obama has recently proposed other potentially stimulating fiscal policy as well. For example, he mentioned letting people withdraw 15 percent of their IRA or 401k balances up to $10,000 without paying the 10% IRS early withdrawal penalty that generally applies to withdrawals before age 59 1/2. While clever in that it would almost certainly increase consumer spending, it’s really not a wise idea in my opinion. As it is, people don’t save enough money. Letting people crack their nest eggs is probably setting a bad standard. If our savings rate were 10% as a nation, maybe we would be more open minded about this kind of suggestion.
Time will tell how these various proposals ultimately come together. Obama has his plate full in terms of managing the broader economic environment, from the $750B bailout package to the looming failure of the American automobile industry, to aging workers and an outdated Social Security and Medicare system. At the very least, the next four years will be interesting.
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