Bloomberg News

Democrats Keep Tax-Raising Focus on Top 2% of Households

September 04, 2012

Democrats Keep Tax-Raising Focus on Top 2% of U.S. Households

Protesters hold signs during a demonstration outside of the Wells Fargo shareholders meeting in San Francisco, California. Photographer: Justin Sullivan/Getty Images

The Democrats’ plan for U.S. tax policy comes down to two simple, politically popular statements: Raise taxes on the rich. Protect tax breaks for everyone else.

The approach championed by President Barack Obama would make the tax code more progressive and generate more than $2 trillion for the government over the next decade, compared with extending current rates, according to the Congressional Budget Office. Turning those ideas into law won’t be easy, because of the potential economic harm from higher taxes and the fact that Obama’s second-term tax agenda is largely composed of changes he hasn’t been able to get through Congress.

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The president has been trying to advance tax increases for top earners in a political environment where raising anyone’s taxes is “somewhere between extremely difficult and impossible,” said Lawrence Zelenak, a tax law professor at Duke University in Durham, North Carolina.

The Democratic position on taxes creates rhetorical and political challenges. Obama is defending middle-class breaks while trying to limit the same benefits for high-income taxpayers. Democrats are calling for tax increases while unemployment exceeds 8 percent.

The party also has to explain how it can achieve its fiscal goals by requiring only 2 percent of taxpayers to pay more when everyone else earns more than three-quarters of U.S. income.

“Speaking as a proud member of the upper-middle class, you’ve got to increase taxes on the upper-middle class if you want to make a real dent on the tax side on the deficit,” Zelenak said.

Income-Tax Cuts

To get the $2 trillion in revenue, Obama wants to let the George W. Bush-era tax cuts expire for income above $250,000 a year for married couples and above $200,000 for individuals. He also wants to cap tax breaks for that group at an effective rate of 28 percent, generating more than $584 billion over a decade by limiting their breaks for mortgage interest, charitable contributions, municipal-bond interest and employer-provided health insurance, among others.

Letting the Bush tax cuts expire for the highest earners would push the top rate on ordinary income to 39.6 percent from 35 percent. In addition, Obama would raise the top capital gains tax rate to 23.8 percent from 15 percent, including a 3.8 percent tax on unearned income of the top taxpayers that was included in the 2010 health care law.

Dividends, Estates

The rate on dividends would go to 43.4 percent from the current 15 percent. The estate-tax exemption would drop to $7 million per couple from $10.24 million and the top rate would go up to 45 percent from 35 percent. Obama’s positions on dividends and estates have already been challenged by Senate Democrats, who didn’t include estate-tax language in the bill they passed in July and set the top rate on dividends at 23.8 percent.

The president maintains that there would be little economic damage from returning to the tax rates for top earners that were in effect during the administration of President Bill Clinton, when economic growth was stronger.

“Here’s the kicker: We created a lot of millionaires, too,” Obama said in Dubuque, Iowa, on Aug. 15. “The economy, when you look back on American history, always works best when the middle class is doing well.”

Obama doesn’t talk frequently on the campaign trail about the proposed limits on top earners’ tax breaks or the higher rates on unearned income, neither of which were in place during the Clinton years. Republicans say higher tax rates for top earners hurt job creation because many business owners pay their companies’ taxes on their individual tax returns.

Democrats’ Stance

Democrats haven’t made a full proposal for a tax-code overhaul. They have taken more of a defensive stance against Republican proposals to cut tax rates and broaden the tax base. Middle-class households receive most of the tax benefits for health care and education, and that’s what Republicans have put at risk, says Representative Sander Levin of Michigan, the top Democrat on the House Ways and Means Committee.

Instead, Democrats are trying to define the fight around what they call necessary and important deductions, attempting to shift the terms of the debate from simplification and loopholes.

The biggest tax breaks -- including those for mortgage interest, charitable contributions and employer-provided health insurance -- tend to benefit the middle and upper-middle class. Democrats are seeking to defend those benefits without supporting a tax code the public dislikes.

Overhaul Proposals

The top Democratic and Republican tax writers in Congress agree an overhaul is necessary, and the November election will help shape the direction of any legislation. Republicans propose reducing tax deductions and credits to allow Congress to enact lower tax rates. Democrats want to preserve more tax deductions and use any savings to cut the federal budget deficit.

“I don’t think there’s a huge appetite anywhere for huge changes that would cause people to lose health insurance or sink people into poverty,” said Seth Hanlon, director of fiscal reform at the Center for American Progress. The Washington group is typically aligned with Democrats.

Obama’s plan also would make it tougher for companies to defer U.S. taxes on overseas earnings. The administration released a framework for lowering the corporate tax rate and removing corporate breaks.

Democrats also want to extend a tuition tax credit and other tax breaks from the 2009 economic-stimulus law that are scheduled to expire at the end of the year.

Lacking Details

Treasury Secretary Timothy F. Geithner said in February the administration wouldn’t propose a comprehensive tax rewrite because Republicans in Congress wouldn’t cooperate.

Mostly, Democrats have been highlighting the fact that the Republican plan doesn’t say how it would finance its lower tax rates.

“We’re filling in the other half,” Levin said.

During his first term, Obama was able to include higher taxes on the unearned income of top taxpayers in the 2010 health-care law. He also pushed through tax cuts targeted to middle- and lower-income workers, including the 2 percentage point payroll tax cut expiring at the end of this year.

Democrats have been successful so far in making arguments about the tax burden that resonate with the public, said Phil English, a former Republican member of Congress from Pennsylvania.

’Extremely Disciplined’

“The Democrats have been extremely disciplined in framing tax questions in purely political terms without the need for precision,” said English, now a lobbyist at Arent Fox LLP in Washington. “So what you have is a debate that is a caricature of the reality but is very poorly challenged.”

Senator Ron Wyden, an Oregon Democrat, said he still sees an opportunity for bipartisanship that would let Democrats take on what they see as special interests and let Republicans advocate lower rates.

“The American people want to hear not just what you’re against, but what you’re for,” said Wyden, a member of the Senate Finance Committee. His plan would keep the top income tax rate at 35 percent. It also would eliminate many tax breaks while keeping preferences for mortgage interest and charitable contributions.

Levin said that talk about overhauling the tax code obscures the loopholes that Democrats prefer to focus on. In his view, those include private-equity managers’ ability to pay a lower tax rate on their carried-interest profits than ordinary wage-earners pay. Also, oil and gas companies shouldn’t get a domestic manufacturing tax break on their income from extraction, he said.

“We’re not defenders of the status quo,” Levin said.

To contact the reporter on this story: Richard Rubin in Washington at rrubin12@bloomberg.net

To contact the editor responsible for this story: Jodi Schneider at jschneider50@bloomberg.net


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