Paul L. Caron

Monday, January 7, 2013

WSJ: The Stealth Tax Hike -- Why the New $450,000 Income Threshold Is a Political Fiction

Wall Street Journal editorial:  The Stealth Tax Hike: Why the New $450,000 Income Threshold Is a Political Fiction:

Anyone still need a reason to abandon "grand bargains" and deals negotiated between this President and GOP Congressional leaders? Here it is: The revival of two dormant provisions of the tax code means the much ballyhooed $450,000 income threshold for the highest tax rate is largely fake.

The two provisions are the infamous PEP and Pease, which aficionados of stealth tax increases will recognize immediately as relics of the 1990 tax increase. Those measures, which limit deductions and exemptions for higher-income taxpayers, expired in 2010. The Obama tax bill revived them this week. It isn't going to be pretty.

Under the new law, some of the steepest tax increases may fall on upper-middle class earners with incomes just above $250,000. Here's why:

During the negotiations, the White House won a concession from Republicans to allow phaseouts for personal exemptions and limitations on itemized deductions, starting at an income of $250,000 for individuals and $300,000 for joint filers.

The Senate Finance Committee informs us that in effect the loss of the personal exemptions, currently $3,800 per family member, can mean a 4.4 percentage point rise in the marginal tax rate for a married couple with two kids and incomes above $250,000. A family with four kids in that income range faces about a six percentage point marginal rate hike. The restored limitations on itemized deductions can raise the tax rate by another one percentage point. ...

Democrats are advertising the higher $400,000-$450,000 threshold as a victory for affluent taxpayers in blue states. But with PEP and Pease these Democrats are hammering their own constituents via the backdoor. ...

Mr. Obama purports this is merely "a return to the Clinton-era tax rates." But capital-gains rates will be about three to five percentage points higher than in the 1990s, the Medicare tax is higher, and his stealth tax will raise personal rates higher than advertised. Forget the golden Clinton memories. Mr. Obama is pushing the U.S. back to the Carter era.

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Pease and PEP are irrelevant for AMT payers, and people making $250k to $500k are more likely to pay AMT than people with higher incomes.

Pease and PEP are scored as raising revenue, so there must be a lot of people with incomes above $300k who will not pay AMT under the new rates.

Posted by: AMTbuff | Jan 8, 2013 12:28:58 PM

This article has me perplexed as to factual foundation on the statements made regarding the personal exemption. The article states the new law would cause "a 4.4 percentage point rise in the marginal tax rate for a married couple with two kids and incomes above $250,000". The applicable threshold is $300,000 for married filing jointly. The $50,000 difference affects a lot less people. There is a serious drop-off in the number of effected families when the amount is $300,000 mfj, not $250,000. See pgs 8 -10 of the law:
Additionally, the 4.4% marginal increase only occurs for taxpayers in the $398,350 - $425,000 adjusted gross income range. From $300,000 to $398,350 the additional tax is only 4.1%.While the difference of .3% is relatively minor, when coupled with the completely inaccurate use of $250,000 as the starting point, not the correct $300,000, the article reads differently. The article uses tenths of a percent, giving an air of precision and credence it does not deserve.
My calculation does not count the effect of the partial loss of deductions (vs exemptions) from the added income. (The article later does that accurately.) For example, the effect of an added $10,000 income to $310,000 AGI is as follows:
10,000/2500=4*.02=.08 (this is the discount on the exemptions) $3,900*4=$15,600 (this is the exemption for the four people) $15,600*.08*.33(marginal tax rate at this level)= $411.84 in added tax. $411/10,000=4.11% marginal tax rate increase. When the 35% rate kicks in at $398,350 the marginal increase is, in fact, 4.4%.
This stealth tax ends at $425,000 when the TP has completely phased out his deduction (2,500*50)
Please correct me if I have made a mistake here.

Posted by: JohnQPublic | Jan 8, 2013 12:16:00 PM

Aren't the effect of PEP and Pease somewhat limited by the likelihood that someone with that AGI is likely paying the AMT anyway? That seems particularly true for PEP since exemptions are eliminated under the AMT. Not sure how Pease factors in, but the elimination of many big deductions under the AMT would seem to counterbalance the phase out in the regular tax.

Posted by: TXMikeDC | Jan 7, 2013 8:04:29 PM

The AOTC (college tax credit) phaseout from $160k to $180k bumps the marginal rate by 12.5% per child. If you have 4 college students, you are better off not earning extra money in that range. Only the EITC phaseout is that punitive.

Posted by: AMTbuff | Jan 7, 2013 5:45:48 PM

The Child Tax Credit phaseout is equivalent to a 5% tax rate increase for parents with a combined income of only $110,000. Don't expect the WSJ editors to fulminate against that penalty, anytime soon.

Posted by: Bob | Jan 7, 2013 7:21:22 AM

McConnell not looking like so much of a Genius now huh kids.

Posted by: Rich K | Jan 7, 2013 6:03:04 AM