Obama and Taxes

Obama Plans To Redistribute Taxes
Four years under President-elect Barack Obama have the potential to produce a major shake-up in the distribution of tax burdens.
Obama’s proposed a "middle-class tax cut" became a key feature of his campaign. He used it successfully used to parry charges from Sen. John McCain, R-Ariz., that he would raise taxes. On the business tax side, large multinational firms that operate in low-tax jurisdictions are among the potential losers under the Obama White House. Obama wants to curtail companies' ability to defer taxes on income they earn overseas, claiming that the tax rules encourage moving jobs offshore.

Much of Obama's promised middle-class tax cut would come from a new refundable credit designed to offset payroll taxes on the first $8,100 of wages. The "Making Work Pay" credit would be worth up to $500 per wage-earner.

He also wants to exempt seniors earning less than $50,000 from income tax, increase the earnings base for calculating the earned income tax credit, and expand and make refundable the child- and dependent-care tax credit.

All those proposals would either cut taxes or increase payments to those at the lower end of the income spectrum.

At the upper end, Obama's proposals point to a very different scenario. He would allow the top two marginal tax rates ––now 33% and 35%––to rise to 36% and 39.6%, respectively. Based on 2009 thresholds, that would result in a tax increase on singles making $171,550 and above and married couples making $208,850 and above.

Upper income taxpayers in those brackets would lose other tax benefits: Obama would restore phase-outs of personal exemptions and itemized deductions, which were gradually repealed by 2001 tax-cut legislation.

Obama has proposed raising the tax rate on capital gains income to 20% from 15% for single taxpayers making more than $200,000 and for married couples earning more than $250,000. He would also apply a payroll surtax between 2% to 4% to earnings above $250,000, to bring those earnings into the Social Security wage base. Robert Carroll, vice-president for economic policy at the Tax Foundation, has estimated that Obama's proposed tax increases on income, combined with the payroll tax surtax, would push the effective marginal tax rate to 47.2% for a couple earning $500,000. The effective marginal rate is the tax rate on the last dollar of income earned. "If he were able to follow through, it would be a significant shift in distribution. [Obama] has been very clear on his objective to redistribute income," Carroll said.

On the estate tax, Obama supports extending 2009 levels, which would exempt all estates less than $3.5 million and tax inheritances above that amount at a 45% rate.

Congress will very likely pass some kind of estate tax legislation next year. Because if it doesn't act, the tax will be repealed altogether in 2010, before snapping back in 2011. That would create a ghastly choice for estate owners between death and taxes, a proposition lawmakers want to avoid.

Senate Republicans in recent years have had the votes to block a permanent estate tax fix along the lines of Obama's proposal and have pushed plans to lower rates and exempt more estate income. That ability is now severely diminished.

Taken together, Obama's individual tax proposals tackle head on complaints by Democratic politicians that years of GOP policies have exacerbated the gap between working-class Americans and the wealthy.

What they don't do, however, is generate revenue. The Tax Policy Center found that, when measured against current law, Obama's tax proposals would increase the deficit by a total of $2.9 trillion over 10 years. That's because the tax breaks for seniors and the middle class outweigh the tax hikes on the wealthy.

With the U.S. facing long-term shortfalls in Social Security and Medicare, and with the crush of other spending programs Obama hopes to enact, revenue will be the key constraint on Obama's ability to follow through on tax-cut promises.

That constraint also helped to doom former President Bill Clinton's plans for a middle-class tax cut.

"It's very hard to see how he'll be able to follow through with these lower- and middle-income tax cuts. It would be remarkable if he were able to pull that off," Carroll said.

Turning to business taxation, multinational firms could have much less flexibility deferring or reducing taxes by moving funds among low-tax nations overseas. For example, House Democrats are backing a plan that would deny firms the ability to deduct expenses connected with overseas income, until that income is returned to the U.S.

Ending deferral, or curtailing it, would most hurt companies that operate in low-tax jurisdictions like Hong Kong, Dubai, or Ireland, said Leonard Levin, a principal at the accounting firm Weiser LLP.

Those companies will face a tax penalty if they are no longer allowed to defer offshore earnings. U.S. firms whose overseas business is mainly concentrated in Western Europe or Japan, by contrast, can already use foreign tax credits to reduce much of their U.S. tax cost on overseas earnings. "Some major companies might not be too averse to elimination of deferral, if they could continue to use foreign tax credits," Levin said. Oil and gas firms could stand to lose more tax benefits. Legislation passed this fall limited the manufacturing deduction for oil and gas firms, while Obama has proposed to repeal it altogether for oil and gas.

At the same time, Obama has proposed some targeted tax incentives that could benefit U.S. employers and start-up firms. He wants to institute a zero-percent capital gains rate for investments in small businesses or start-up companies. How those two categories would be defined hasn't been explained.

And Obama has floated a $3,000 credit against business taxes for each new full-time job created. He has said he would entertain a cut in the corporate tax rate, but only to the extent that it can be financed by closing loopholes and repealing targeted tax breaks in the code.

––Dow Jones Newswires