Pay Lower Taxes Now, Higher Taxes Later: President Obama’s Tax Proposals and Expiration of the Bush Tax Cuts

Obama’s Tax Proposals. Many will pay lower taxes now and higher taxes later whether or not President Obama’s Fiscal Year 2011 Revenue Proposals (translated: tax changes) becomes law. Outlined in generalities in more than 150 pages, President Obama proposes tax increases and tax decreases for businesses and individuals and many complex provisions whose precise impact and details will not be known for years.

Increases for Higher Income Tax Payers. Overall, the revenue changes produce a net increase in tax revenue to the federal government from 2011 to 2020 of $1,103,250,000,000 dollars. Of this, $969,467,000,000 or almost 88% of the new tax revenue comes from upper income individuals. This is done by exempting high income tax payers from the Bush tax cuts set to expire at the end of this year. The President proposes to reinstate the maximum rate of 39.6% on earned income from the Clinton administration as opposed to the 35% rate under the Bush tax cuts. This maximum rate would apply to taxable incomes over $373,650 for married persons filing jointly and single fliers. This 39.6% rate is projected to produce about a third of the new revenue to come from the increase of taxes on upper income people. There will be a top 36% rate, up from 33%, which will apply to married filed jointly with $250,000 of annual income (less the standard deduction and two personal deductions) and $200,000 for single filers, less the standard deduction and one personal exemption. In addition, for the $250,000/$200,000 income and above group, there will limitations on itemized deductions, phase out of the personal exemption, a 20% capital gains rate and limitation of the value of a deduction to a maximum of 28%. These items raise $642 billion over the next ten years, the other two thirds of the new $970 billion of revenue from upper income tax payers. Many people who think that they will not be in the $250,000/$200,000 brackets will be shocked when they find that when they sell real estate or stocks at a profit that this could move them into these brackets in the year they make these sales.

Extension of the Bush Tax Cuts. In a short paragraph on page 147 of the Revenue Proposals, President Obama proposes an extension of the Bush tax cuts for those below the $250,000/$200,000 and above brackets. As promised by him during his campaign, he said he would not raise taxes on the middle and lower classes. This extension of the Bush tax cuts, together with indexing of the Alternative Minimum Tax, will cost about $3.8 trillion of lost revenue over 2011-2020, or a loss of nearly four times the revenue increase from all of the other provisions in the 146 pages before the one page on the AMT and the Bush tax cuts. The largest item is a revenue loss of about $1.6 trillion resulting from the Bush tax cuts for middle and lower income tax payers. The Bush tax cuts took millions off of the tax roles and provided large tax rate reductions for lower and middle income earners; President Obama plans to continue these tax breaks. This results basically in an income transfer of about $970 billion from upper income taxpayers and $2.8 trillion from government deficits to middle and lower income taxpayers of about $3.8 trillion over ten years.

Will it Pass. Congress will have their own ideas about tax changes and there is a lot of talk about an omnibus tax bill. Such a bill will have tax increases, tax loopholes, closing of tax loopholes and hundreds of pages of nearly indecipherable tax talk. Republicans will probably vote as a block against the bill as a “tax increase” and the Republicans who vote for it will fear a tea party challenger in their Republican primary. Many Democrats will worry about reelection if they vote for a large tax increase. Of course, the fear of voting for a tax increase ignores that the President’s proposal is really the continuation of the Bush tax cuts for most people and these large tax cuts contribute substantially to the increasing deficit.

Best Guess. The bigger the tax bill, the more likely it will fail. From the standpoint of the budget deficit, if Congress is not able to agree on a tax bill in 2010, then the Bush tax cuts will expire at the end of 2010 and in 2011 and thereafter, there will be a huge increase in projected federal revenue. Unless there is a substantial decrease in the rate of increase in federal spending and a boom in the economy, the Bush tax cuts can not be sustained. Members of Congress can point out that they voted against the proposed tax increase bill. My best guess, based upon years in politics, is that no major tax bill will pass this year and the Bush tax cuts will expire at the end of the year.

Action Item. Whether the President’s proposals pass or the Bush tax cuts expire, you will be paying a lot more taxes in the future. If you have capital gains or income over which you have the option to be taxed in 2010, it may be a good bet to pay taxes now, rather than later. This is completely different from the usual advice that it is best to postpone paying taxes. Contact us and we will assemble your team of advisors to implement a tax strategy designed around your needs.