The last couple of days have seen a lively exchange between liberals and conservatives on federal income tax rates for next year. Should the current federal tax rates which have been in effect for the past 11 years be continued or extended for only taxpayers earning less than $200,000 or be allowed to increase for everyone to the rates in effect prior to 2001? Interesting question. Big policy differences, big economic consequences and big political decisions are involved.
Each side is skewering the other. Republicans believe increasing the rates will have a negative impact on the economy. Almost to the politician, they are united in opposing any income tax increase. The President and key Democrats think it is a matter of fairness to raise rates for higher incomes in a vaguely disguised lust for more federal revenue to mask massive deficits and propel the philosophy of redistribution of national wealth.
If current income tax rates are allowed to revert to Pre-Bush levels, every taxpayer will pay more taxes and perhaps even a few non-taxpayers will start to pay some modicum and token taxes. However, it was interesting in the President’s appearance on Monday, he did not mention any real details of his proposal. He did not mention, for example, the Alternative Minimum Tax. (ATM) Does he want to ameliorate its effect on millions and million of taxpayers? There are so many other nuances involved besides the actual marginal rate, like the marriage penalty, reduced rates on investment income and investment write-offs.
The President, now back on the campaign trail, also did not mention corporate jets, oil companies and carried interests for hedge fund managers. Those are many of his old time favorites. In other words, his proposal was incomplete and should be taken for the political sideshow it was. Mr. Obama is in total campaign mode, has been for some time and has no interest in seriously addressing any real problems.
However, there is a subject that should be mentioned and one, if not acted upon, will impact everyone by increasing taxes for all no matter what happens on the rates. It is the two percent reduction in employee payroll taxes first effective in 2011.
An employee’s wages are subject to the 12.4% Social Security tax up to the annual wage ceiling. Higher-incomes get socked with even high employment taxes for Medicare. Half the Social Security tax bill (equal to 6.2%) is withheld from employee paychecks while the employer pays the other half. Social Security taxes are a major tax hit. If you made $100,00 (slightly below the wage base) Social Security taxes were before 2011, $12,400 (12.4% x $100,000) split between the earner and the employer.
For the last two years, there has been a two percent reduction in the employee portion with the employer’s rate unchanged. This mean our beloved taxpayer has been getting in this example a $2,000 reduction in his overall tax bill.
The reduction in the payroll tax rate and decoupling it from the employers match is unprecedented. This type of policy has been resisted in the past since reduced taxes means the so-called Social Security Trust Fund will have less money. Even thought the government used some budget gimmicks to show an illusion of an undiminished Trust Fund, the reduction remains controversial.
Now here is the largely ignore dilemma. The payroll reduction tax break expires at the end of the year. So if you earn wages of $60,000 a year, your taxes will go up $1,200 next year. You will have $100 less disposable income per month.
Here is the other problem, continuation of the reduction will add to the federal deficit by $120 billion a year. If you couple this with the rate reduction and with an AMT fix, maybe throw a few of the $40 billion in other expiring provisions, the federal deficit goes from merely enormous and dangerous to gigantic and frightful for the 4th year in a row since the election of Mr. Obama.
The point of all of this is the fiscal and economic health of the country, the integrity of the tax system and ability of the country to try inch anywhere even in the direction towards budgetary sanity is a complexed mix of issues, all inter-related. It in not just about the Bush tax cuts, the top marginal rate or rich vs. poor. It is stupefied political nonsense to treat the situation otherwise.
Ending the employee payroll tax reduction will have an impact. It will affect the paycheck of everyone. It will have a huge economic repercussion. It is twice the money that is proposed to be taken out of the economy from the Defense Department sequester reductions beginning on January 2 that many are saying will have a huge impact on the economy.
I do not see much support at this time to continue to reduction. No one, even the President, talks about it. Therefore, all the more important to address the situation in totality. As for the deficit, well no one seems to care.