In the end, tax deal will take biggest bite out of highest earners
Debate • Despite rhetoric, those making less than $500K would see smaller bite.
Published: November 25, 2012 01:08AM
Updated: March 6, 2013 11:33PM
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(AP Photo/Carolyn Kaster, File) Data from the Internal Revenue Service indicate that 237 of the country’s 400 highest earners also qualify as small businesses, as does President Barack Obama.

By most measures, the personal finances of Anne Zimmerman, a small-business owner in Cincinnati, have little in common with those of Oracle’s CEO, Lawrence Ellison.

Zimmerman runs an accounting business and a cloud-based Internet service company with combined annual profit of $250,000 to $500,000 in recent years. Ellison made nearly $15 million in salary, bonuses and perks in 2011, even without the $62 million he received in stock options from Oracle.

In the deficit-reduction debate consuming Washington under the “fiscal cliff” shroud, however, both Ellison and Zimmerman are grouped in the same, sprawling category, wealthy Americans targeted for tax increases.

President Barack Obama has focused efforts on raising revenue from the wealthiest 2 percent of taxpayers — individuals earning more than $200,000 a year and families with adjusted gross incomes above $250,000 — calling them “millionaires and billionaires who can afford to pay a little more.” Republicans have thus far resisted those efforts, countering that the high earners are job creators and that increasing their taxes would discourage hiring.

But for all the broad brush rhetoric of political debate, the rate increases and limits on deductions being discussed by the president and congressional Republicans are calibrated to take the biggest bite out of the highest earners. They would lead to a smaller increase for those who earn less than $500,000 a year. The figures are all adjusted gross incomes, and because some deductions would be preserved, a household would probably have more than $250,000 in total income, perhaps $300,000, before it would fall into the wealthy definition used by the president.

If all Obama’s tax proposals for wealthy Americans were enacted, they would raise $1.6 trillion over the next decade. And an analysis by the Tax Policy Center, a nonpartisan research firm, found that the increases would be heavily weighted toward the wealthiest. Taxpayers with adjusted gross incomes of more than $1 million would see average increases of $184,504, the study found, with higher taxes on the ultrawealthy bloating that average. Those with adjusted gross incomes from $200,000 to $500,000 would face a tax increase averaging $4,446, with people toward the lower end having only a modest increase and people on the higher end paying several times more.

A married couple with two children earning $300,000 would see its effective tax rate increase to 21.1 percent from 16.5 percent, according to an analysis by the Tax Policy Center. A married couple with two children earning $2 million would see its effective federal income tax rate rise to 26.8 percent from 21.6 percent.

To Zimmerman, the Cincinnati businesswoman, that amount sounds reasonable.

“I’m not going to change my business decision-making process based on a few percentage points of tax increases,” she said. “If it helps get the country on a better path, well, we’re all in this together.”

But some conservatives and business advocates warn that the proposed increases could stall the sluggish economic recovery.

“There is a price that comes with these tax increases on the very wealthiest because that is where the capital is concentrated,” said William McBride, chief economist at the Tax Foundation, a conservative research firm. “That price is economic growth and hiring.”

About 4 million of the 114 million American households face a possible tax increase. And while they are a narrow slice of the overall population, they are nonetheless a swath of well-to-do Americans so varied that they defy easy categorization. Census data indicates that they cut across a broad range of occupations: doctors, auto dealers and dilettantes, professional athletes and financial planners, family farmers, entrepreneurs, two-income couples, corporate executives and hedge fund managers.

Although they are dispersed across the country, they live in the highest concentrations in South Florida, the suburbs of the Northeast and the West, and in major cities like New York, San Francisco and Los Angeles.

Because the profits of many companies are taxed as the owners’ individual income, the group facing increases also includes 3 percent of all small businesses, such as Zimmerman’s. But the U.S. tax code is such a blunt instrument that small business may encompass anything from the neighborhood florist shop to the multibillion-dollar private equity company KKR and the Tribune Co. Data from the Internal Revenue Service indicate that 237 of the country’s 400 highest earners also qualify as small businesses, as does Obama.

Decades ago, the tax code made distinctions between gradations of wealth by using more income brackets. In 1970, there were 14 tax brackets for the top 2 percent of earners, with a top rate of 91 percent. Today there are just two brackets, 33 percent and 35 percent. Meeting recently with Republican congressional leaders, Obama said he would not sign any bill to extend those top rates, which were lowered by President George W. Bush. That means the top rates would revert to the higher levels of the Clinton era, 36 percent and 39.6 percent (the higher rate would be charged on the portion of income that exceeds the threshold of $200,000 for individuals and $250,000 for families). Republicans have said they will oppose any deal that raises the rates.

But both sides have agreed in principle on raising revenue by reducing or eliminating loopholes, tax subsidies and deductions at the high end of the income scale. Even if the top rates do not rise, the efforts to limit deductions would make the tax system more progressive, with the biggest impact felt by those at the very top in incomes.

Negotiations over the coming weeks will determine whether a compromise can be reached between the president and the Republicans. If not, automatic spending cuts and tax increases will take effect Jan. 1, triggering the fiscal cliff.

One of the most closely watched variables will be whether Obama wins support for increasing the tax rate on dividends and long-term capital gains, which now top out at 15 percent. Obama’s budget calls for the tax on capital gains to rise to a maximum of 20 percent and for dividends to be taxed at the same level as ordinary income, which could increase to 39.6 percent. Because investment income for those with adjusted gross income of more than $200,000 will also be subject to a 3.8 percent Medicare tax beginning in January, as part of the new health care law, the total federal tax on dividends could rise to 43.4 percent and on capital gains to 23.8 percent.

Those capital gains and dividend tax increases probably will have the most impact at the very highest reaches of the income scale because wealthy Americans derive more of their earnings from investments.

An analysis by the Tax Policy Center found that in 2011, people in the top 0.1 percent of earners saved an average of $356,000 in federal income taxes because of the preferential rate for capital gains. Middle-income Americans were spared an average of just $23 because of the lower taxes on capital gains, the study found.

“Capital gains are extremely concentrated by income,” said Len Burman, a former Treasury official who has written extensively about taxes on investment income. “There’s no source of income more focused on the very, very wealthiest. A lot of people own stocks indirectly through their 401(k)s. But most Americans can’t afford to own any shares directly.”

Another policy change that has some support from both parties is a plan to limit the total amount of deductions. Obama’s proposal would treat deductions for the wealthy as if they were in the 28 percent tax bracket, reducing their value. But the negotiations have also considered a plan championed by Mitt Romney during his unsuccessful bid to unseat Obama. That would cap the amount of deductions any taxpayer could claim — amounts including $17,000 and $28,000 have been discussed publicly.