Fun With Taxes

I have been reading some interesting comments about the potential impact of rolling back the infamous Bush tax cuts from 2001 and 2003. Remember these tax cuts are a primary reason we have a long term Federal deficit. One of the key features of those cuts was to reduce the tax imposed on each bracket. For instance the top rate of tax was reduced to 36% from the prior 39.6%. The really ugly aspect of the cuts was that they were subject to a sunset law: they expire at the end of this year and so, if they are not extended, taxpayers will be subject to a hefty tax increase next year as we revert to the Clinton era tax schedule.

In our current economic malaise it is probably not too sensible to allow the cuts to expire, and so Congress is gearing up to extend them for a while, and maybe even make some permanent. That’s where the fun begins.

The Obama administration is pressing to have the high end tax rates revert to their pre-Bush levels, and to leave the lower ranges unchanged. This is being positioned as a tax increase on the wealthy and as continued relief for the “middle class”.

The problem with this is that it ignores basic arithmetic.

Yes, people in lower tax brackets will be left unaffected. But those folks in the top tier, those with taxable incomes over $250,000 will still be much better off than they were under the Clinton regime.

Why?

Because they are also subject to taxation in the lower tax brackets.

Those lower brackets are being left alone for all tax payers, not simply the lower level wage earners. Someone making $500,000 will still get the benefit of the first tranche of income being subject to 10% as it is under the Bush law, rather than 15% as it was under the Clinton law. The same goes for all the other intermediate income ranges up to the $250,000 threshold. It is only income above that threshold that will be subject to an increase in tax. All the rest, the first $250,000, will still be taxed the Bush way.

The effect of this is that the “relief” given to the middle class by keeping the Bush cuts in place, actually benefits the rich much more than anyone in the middle class.

Someone earning between $200,000 and $500,000 will be $6,743 better off if only the top levels of tax are restored to their pre-Bush levels, than if the entire structure, lower levels and all, are restored. Meanwhile a truly middle class family in the $50,000 to $75,000 range will is $1,132 better off.

So even though the proposal is being positioned as a tax hike for the rich, the fact remains that the main effect of the Bush tax cuts stays the same: they were designed to benefit the rich disproportionately. Obama’s proposal doesn’t unwind that bias at all.