Q&A: Fact and fiction in debate over Bush tax cuts

McClatchy NewspapersSeptember 17, 2010 

WASHINGTON — Whether to extend all of the Bush-era tax cuts is a dominant issue in this election season. In the time-honored fashion of politics, both sides are busy bending and stretching the truth.

New data from the nonpartisan Tax Policy Center, however, help separate fact from fiction. These numbers don't speak to the merits of lower or higher tax rates, they simply make plain who'd be affected by the proposed changes, and how.

Here's a closer look.

Q: President Barack Obama wants to extend the 2001 and 2003 tax cuts for everyone but the rich. Who does he consider rich?

A: Obama's proposal loosely defines them as individuals who earn more than $200,000 a year and families with incomes above $250,000 a year. The Treasury Department has narrowed this definition, noting that for tax purposes they're individuals with adjusted-gross incomes of $200,000, and $250,000 for families. Adjusted-gross income includes all income from wages and investments, then subtracts adjustments and exemptions.

Wealthy individuals have ways to reduce this number and shelter their income, so just because they have adjusted-gross income above the thresholds doesn't mean that they'd be paying taxes on all their income.

Q: How many of these people are there?

A: The IRS says there are about 153 million tax units — people who are single or joint filers, or married but not filing jointly. Some 3.2 percent of them — almost 4.9 million — have incomes above the $200,000/$250,000 thresholds.

About 2.2 percent of them, or about 3.37 million, have adjusted-gross incomes above the thresholds. Importantly, 1.9 percent — 2.9 million — have taxable incomes above the $200,000/$250,000 dividing lines.

Q: For that 1.9 percent of taxpayers, how would their taxes go up?

A: If tax cuts for the middle class are extended, the remaining 1.9 percent could see their taxes rise through changes in tax brackets, through reinstating limits on certain deductions and phase-outs, and through changing how capital gains and dividends are taxed.

Under Obama's proposal, the current top tax rate of 35 percent would revert to 39.6 percent. The next highest bracket, 33 percent, would revert to 36 percent. For the top 2 percent of persons with taxable incomes above the thresholds, capital gains and dividends would be taxed at a 20 percent rate. Right now, those at the lower end of the income ladder aren't taxed on capital gains and dividends, and high-income earners are taxed on those at 15 percent.

Q: So this would levy new taxes on the rich?

A: This is Washington, so the answer is it depends. The 2001 and 2003 tax cuts were temporary, passed with an expiration date, after which the prior tax code was to be restored. If that happens, dividend income for top income earners would be taxed again at the same rate as ordinary income, at 36 percent or 39.6 percent.

So one could argue that a dividend tax rate of 20 percent amounts to a huge tax cut, not an increase from 15 percent. The rich also would enjoy lower tax rates up to the first $200,000/$250,000 of adjusted gross income via Obama's extension of most Bush-era tax cuts.

Q: Won't small businesses be affected?

A: The simplest answer is that most wouldn't be. It's not so simple, though.

"The data we have are about taxpayers and not about business per se," cautioned Joseph Rosenberg, a researcher at the center, which is run jointly by The Brookings Institution and the Urban Institute, both center-left policy research centers.

Business income filed on individual tax returns is a challenge to interpret. What tax experts know for sure is this_ only about 765,000 of the 153 million tax units report positive business income on either a Schedule E or Schedule C tax form. They'd fall within the top two tax brackets under Obama's proposal.

This small group accounts for about 45 percent to 50 percent of the business income reported. Since business income is what's called pass-through income, it becomes part of an individual filer's total income, and is more susceptible to changes in tax brackets.

Q: What's that mean for job creation? Would it help or hurt jobs?

A: No one can say with certainty. Available tax data don't say whether these individual filers reporting business income are rich hedge fund managers with three employees, a law practice, a medical partnership or a small factory with 20 employees. It's also hard to distinguish between a wholly owned business and one that reports income that's claimed on several tax returns by several partners.

"We know nothing about employment" from the tax filings," said Roberton Williams, a senior fellow at the center.

Q: Is there reason to believe they aren't job creators?

A: Claims that small businesses would be hurt if tax cuts for the wealthy aren't extended are "substantially overblown," said William Gale, the center's co-director.

Gale notes that while tax brackets can change, what matters is the effective rate of taxation — the actual rate that businesses pay after deductions for wage income, expensing of equipment and depreciation of assets.

"Raising the tax rate doesn't increase the tax rate on investment" by small businesses if they can write off that investment for tax purposes, he said.

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