President Obama’s New Tax Proposals & The “Buffett Rule”

How tax rates might change for the “wealthy” under the new plan

On September 19, President Obama laid out a plan to slash $4.4 trillion from the federal deficit by fiscal year 2021 – a plan featuring $1.6 trillion in tax increases for upper-income Americans and corporations.

• The Bush-era income tax cuts would expire in 2013 for high-income households (the highest tax brackets would presumably reset to 36% and 39.6%).
• The federal estate tax would return to 2009 levels in 2013 (a 45% rate with a $3.5 million exemption).
• Tax deductions would presently be reduced for individuals making $200,000 or more annually and households making $250,000 annually.
• The LIFO accounting method for business inventories would be invalid starting in 2013.
• The lower-of-cost-or-market-inventory accounting method for deductions on unsold goods would also be jettisoned.
• Investment partnerships would face higher taxes in future years.
• Deductions and credits for oil and gas activities would be removed.
• Tax rules for U.S. taxpayers subject to foreign taxes would be revised.^1,2,3,4

A poll shows broad public approval. President Obama had mentioned tax hikes to pay for his recently unveiled $447 billion American Jobs Act. By linking taxes on the wealthy to job creation, Obama appealed not only to his progressive base but also to the broad middle class.

A September 20 Gallup survey showed 66% of Americans in favor of raising taxes for individuals making $200,000 or more annually and families making $250,000 annually. Additionally, 70% of respondents liked the idea of getting rid of certain corporate tax breaks.⁵

Will there be a tax floor for millionaires? President Obama referenced creating a “Buffett rule” in a nod to Warren Buffett’s August 14 New York Times op-ed piece, in which Buffett mentioned that his 2010 federal tax bill amounted to only 17.4% of his taxable income and that Capitol Hill legislators seemed “compelled” to protect multimillionaires “as if we were spotted owls or some other endangered species.” Buffett and Obama both think that the rich should pay proportionately greater federal taxes.⁶

But do they already? According to the non-partisan Tax Policy Center, they do. The TPC says the average U.S. millionaire pays 20.1% of his/her total income back to the IRS in income and payroll taxes, compared to 16.0% for the average American. While many millionaires generate income from sources besides wages and make the most of charitable gifting strategies, it seems many are being taxed proportionately.⁷

Where would the floor be? While the President views the proposed “Buffett rule” as a key starting point for tax reform, few details have emerged about it. On September 19, Treasury Secretary Timothy Geithner remarked that “we’re not going to give the Congress a detailed proposal for how to meet that specific principle now because there’s lots of different ways to do that.”⁷

Daniel Indiviglio, a business writer for The Atlantic, recently spent a column exploring the hypothetical tax impact of a “Buffett rule”. He ran some numbers using 2009 IRS data (the most recent available) on adjusted gross incomes. He found that if the government had instituted a 35% minimum tax for all Americans who earned more than $1 million in 2009, an additional $37 billion in revenue would have been generated – certainly handy, but not exactly a big dent in what was a $1.5 trillion shortfall. Raise the floor to the pre-EGTRRA 39.6% and the number climbs to $66 billion. Even if millionaires had been hit with a 75% marginal tax rate in 2009, the additional 2009 revenue would have amounted to less than 20% of the 2009 deficit. (Effective tax rates for these millionaires might have been a lot lower – after all, the S&P 500 gained 24% in 2009.)⁸

The “Buffett rule” could be modified … or abridged … or forgotten. While many Americans would like to see millionaires pay equivalent or greater income tax than the middle class, putting such a rule into play would be tricky.

Many middle-class families can take advantage of a bundle of deductions and exemptions which can lower their effective tax rate. Then you have the possibility of a multimillionaire receiving 100% of his or her income from long-term capital gains or dividends (15% current rate) or tax-exempt interest. Figuring a minimum tax rate for millionaires becomes harder when you consider these factors; in fact, Tax Policy Center senior fellow Roberton Williams told Bloomberg that it might require a federal definition of “income”.⁹

The Obama-appointed National Commission on Fiscal Responsibility and Reform has proposed dropping the preferential capital gains tax rates as an element of a broad tax code revamp that would also reduce marginal tax rates. Bloomberg notes that “several bipartisan groups” including the NCFRR support this notion – and it might be the closest thing to a “Buffett rule” that emerges from the great tax and deficit discussion of 2011.

Citations.

1 - usatoday.com/news/washington/story/2011-09-19/Obama-deficit-reduction-plan/50470916/1 [9/19/11]     

2 - forbes.com/2010/07/22/expiring-bush-cuts-affect-personal-finance-taxes.html [7/22/10]                

4 - blogs.reuters.com/reuters-money/2010/10/04/estate-tax-uncertainty-planning-for-2011/ [10/4/10]            

5 - usnews.com/opinion/blogs/robert-schlesinger/2011/09/20/poll-most-americans-support-obama-deficit-plan-to-tax-rich [9/20/11]       

6 - nytimes.com/2011/08/15/opinion/stop-coddling-the-super-rich.html [8/14/11]               

7 - money.cnn.com/2011/09/20/news/economy/buffett_rule_milllonaires/index.htm [9/20/11]         

8 - theatlantic.com/business/archive/2011/09/chart-of-the-day-buffett-rule-wouldnt-bring-in-much-revenue/245404/ [9/20/11]  

9 - bloomberg.com/news/2011-09-19/-millionaire-tax-seen-easier-said-than-done.html [9/19/11]      

This material is derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. Copyright © 2011, Merit Wealth Management, LLC