Tax preferences

Tax Preferences

by digby

One of the reasons I read the New York Times business section is to see their helpful financial hints for rich people who are freaking out about taxes. They know their readers, I guess. Anyway, today's paper has an excellent representative of the genre:

If you’re among the households with earnings of $200,000 to $350,000 or so, you can be forgiven at this point for thinking that you have a giant target on your back.

This week, President Obama once again took aim at what he calls “tax preferences” for these high-income households, proposing two changes that would affect the low six-figure set starting in 2013.

First, he would let former President George W. Bush’s tax cuts expire for higher-income households. Second, he would limit the rate at which high-income taxpayers — married people with over $250,000 in household income filing a joint return and singles with more than $200,000 — can reduce their tax liability to a maximum of 28 percent. This limit would apply to all itemized deductions, among other things, if President Obama gets his way, which would have the effect of causing many people to pay more in taxes.

Forget for a moment that President Obama will almost certainly not get his way, given that even bills to help American victims of natural disasters don’t get a rubber stamp in Congress anymore. And let’s save for another day the debate over whether people with incomes like this deserve any sympathy.

What gets lost in all of the hand-wringing over the proposed tax increases is that many of the people this is aimed at wouldn’t pay a whole lot more. And families who work at it just a bit, using employer-sponsored flexible spending and other accounts to pay for things like day camp and the commuter train and visits to the therapist, could offset that 2013 tax increase and then some.

I know this will make at least some of you mad, as it does every time I bring this up, but I don't think we should "set aside for another day" the fact that 200k per year for one person and 300k for a family is a lot of money compared to what most people make in the nation, and even in New York City. As I've noted before, the median income in New York is around 80k, which is less than half of this hypothetical New Yorker makes at 200k. By any average American's standards, these people are doing very well:

The family includes a married, heterosexual couple earning $350,000 combined annually that received no raises from 2011 to 2013, lives in the suburbs of New York City and has two children. They pay $20,000 in real estate taxes each year and $24,000 in annual interest toward their mortgage, make a total of $30,000 in 401(k) contributions and give away $9,000 in charitable contributions in all three years.

Let’s assume that the annual A.M.T. patch continues to occur each year — the patch adjusts the calculation that accounts for inflation to avoid ensnaring even larger numbers of taxpayers. (That assumption is a pretty safe one, though who would have predicted that you could elect to pay no estate taxes in 2010?) With the patch, this couple will pay tax at the A.M.T. rate in 2011 and 2012. Their total federal taxes in each of those years will be $65,604.

If the Bush tax cuts expire in 2013, they’ll no longer be paying the A.M.T. rate. But their income taxes will be only $66,981, just $1,377 more than 2012.

That number does not take into account the president’s proposed 28 percent deduction limit. Ms. Trimble said that there was a lot of debate in tax circles about precisely how it would work in practice.

But if the proposal simply means that you calculate taxable income for 2013 and then pay 28 percent of it, you get $69,633, or just $4,029 more than the family would have paid in 2011 and 2012. (Also, $900 of that increase in 2013 isn’t even attributable to the expiration of the Bush tax cuts or the 28 percent cap; it comes from the recent increase in taxes on higher-net-worth households to pay for Medicare, which goes into effect in 2013.)

So the hit isn’t all that bad. And you can make it go away entirely and then some by finally signing up for (and maxing out your set-asides in) those flexible spending and other accounts for health and dependent care plus public transportation or parking. With these accounts, your employer makes it possible to put aside money before it takes out income taxes (or to make a deposit in a way that qualifies you for a deduction).

So the president's proposal to limit deductions would ask this family to pay an addition 4k a year in taxes --- except they won't actually have to pay it because they can take advantage of loopholes designed to shelter money for health care expenses(I presume they have good health insurance already) and transportation costs. And I guess they can write off the costs of sending their kid to camp.

This is partly what the politicians are talking about when they say they want to cut "tax expenditures," many of which were put in place as incentives to certain good behaviors and others in place of government programs, which went out of fashion some time back. Some of them are good, some of them are useless, but as long as these sorts of loopholes benefit people of these means, I don't think they're going anywhere. After all, most American elites are living at this level or above and most of them think of themselves as standard middle class workers. It's very hard for me to believe these loopholes will go away permanently even with the promise of lowering tax rates. These people like them. They want them. I'm guessing we'll see them come back almost immediately.

And once again, I ask the question: suppose we eliminate these "tax expenditures" but lower tax rates in return so that this constituent doesn't actually have to pay higher taxes. (That's the argument all the tax reformers are making: "simplify the tax code so we can lower rates!") How does that close the deficit?