Obama’s Deficit Reduction, Tax Math More Complicated Than He’s Implied

The arithmetic behind Obama’s new plan is far from simple. Daniel Stone digs into the obstacles.

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President Obama’s impassioned proposal to tweak the federal tax code sounds simple: collect more taxes from the wealthiest earners—those who can afford it most—and use the extra revenue to help balance the budget. It was, as he stated, simple math.

But the arithmetic behind his proposal to reduce the deficit is far more complicated and poses significant challenges as it passes through Congress.

The president lamented that millionaires and billionaires didn’t pay their fair share in the tax system, but tax-policy analysts instantly noted that Obama hadn’t drawn a key distinction between earned wages and investment income.

The wealthiest Americans now pay a substantially higher income tax rate than lower earners. Those who make more than $1 million annually pay the highest tax rate, just over 29 percent, in annual federal income tax. The brackets decline from there. Those who earn less than $1 million pay about 25 percent, and earners at the lower end, who make between $20,000 and $30,000, pay just 5.7 percent. Currently the top 20 percent of American taxpayers pay nearly 70 percent of all federal taxes, most of it in the form of estate tax and federal and corporate income taxes.

Obama’s proposed change for the tax code has been dubbed the “Buffett Rule,” named after Warren Buffett, the billionaire investor who often laments that he pays a lower tax rate than his secretary. That phenomenon exists because much of Buffett’s income is not earned but from investments, which are taxed at a much lower capital gains rate, about 15 percent.

Exactly how Obama would raise taxes for wealthy people is still unclear. “There are a lot of ways it can be done,” a White House official told The Daily Beast after the president’s remarks. One would be to increase income tax rates for the top brackets. Another avenue could specifically address capital gains, to impose higher levies on those with investments. Perhaps most ambitious would be to overhaul the entire tax code for all investment income. Obama implied that parts of the tax code should be cut entirely, noting that the full document is more than 10,000 pages and nearly 5 feet tall.

“There are lots of nice, interesting ideas of how to change the tax code—some big and some small—but being more simple or intuitive is not inherently the answer,” said Neil H. Buchanan, an economist and law professor at George Washington University.

In the backdrop of Obama’s tax-policy changes is a tougher political problem. The series of Bush tax cuts, the generous breaks imposed by the Bush administration in 2001, are set to expire at the end of 2012. When they do, income tax rates will increase for all American taxpayers, and the Alternative Minimum Tax will change. That prospect gives Obama an upper hand with Republicans, who shudder at the threat of raising any taxes.

But letting the Bush tax cuts expire for only the wealthiest Americans would set up unrealistic expectations for Obama, who would be asking House Republicans to help progressives while demanding they turn their backs on their own base.

Capital-gains taxes may prove more fertile ground for compromise. Investment income now tops out at a 15 percent tax rate, and Obama has argued that number should be higher. Yet though many millionaires and billionaires could likely afford a tax increase, fiddling with it also would affect people who invest in the stock market, including investors in the middle class, the group Obama has staked as central to the economic recovery.

The political realities set up logistical challenges on all sides.

“I don’t have a lot of confidence that Congress is going to do something either way,” said Roberton Williams, a tax analyst with Washington’s Tax Policy Center. “It’s not easy to do because we have so many entrenched interests and so many people have formed their lives around the tax code we have. Changing it is more complex than the president would imply.”