Taxable Talk

There are many reasons to vote for a candidate for President. Even though taxes are important they may not be, for you, the most important issue. I strongly advise everyone to review both candidates' records, their views, and their character, and make your decision. And do vote—we're blessed in the United States to be able to exercise the privilege.

That said, there are major differences between the two candidates on taxes. (Though I have opinions on other issues I'm only an expert on taxes. I'll leave the other issues for you to research.) Both candidates promise tax cuts. Senator Obama is generally against extending the Bush tax cuts while Senator McCain want to extend them. Senator Obama has about a trillion dollars worth of new programs; he hopes to fund these by "closing loopholes" and likely by cutting military spending. Senator McCain proposes fewer new programs but his revenue collections would be lower.

Actually, all of this misses an important issue—perhaps the most important issue of all. Under the Constitution, all tax legislation must start in the House of Representatives. Under the rules of the House, said legislation will start in the House Ways and Means Committee. The chair of that committee, Congressman Charles Rangel (D-NY) will end up dictating, to a large degree, what gets in the bill. And here we can look at history to see what this will be like.

In 2007 Congressman Rangel proposed a major tax overhaul. His plan was purportedly revenue neutral. We're likely to see legislation similar to this. In some ways this looks like Obama's proposals; in other ways it doesn't. The major changes (many of which are positive) impact businesses.

So what's likely to happen if Obama wins? First, the Bush Tax Cuts will die in 2011. There's no way they can pass Congress, and even if that happened Obama would veto them. That means everyone will have a tax increase in two years.

Second, we're likely to see even more income redistribution. Wealthier taxpayers will be more heavily taxed. Under Rangel's 2007 proposal marginal tax rates would have exceeded 50% for the wealthiest taxpayers. Expect that to occur, and this will definitely hurt small businesses and the economy at large. Taxes are just another cost, and if taxes increase, either prices will increase or expenses will be cut. Generally, this will lead to lower employment.

Third, assuming Republicans have more than 40 seats in the Senate the proposals will require GOP support to pass. This will blunt somewhat their impact.

Fourth, given that the Democratic leadership in Congress is far to the liberal side you can throw Obama's $250,000 figure into the trash can. Today, Governor Richardson stated that the real number is $120,000. In my previous post I said it was $125,000. No matter, it's not $250,000.

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No matter who is elected I do expect a permanent estate tax exclusion to be agreed upon. I expect it to be $3 million, with the estate tax being 50% above that figure. Both Obama and McCain want to see permanency here, so this is the one area where I actually expect bipartisanship to rule.

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If McCain is elected the extreme redistribution plans are dead. There's no way McCain would sign such legislation.

McCain would be able to veto legislation with earmarks, and the Democrats would not have enough votes to override the vetoes. Thus, that's one plank of McCain's program that would go through (and it's a big positive).

The rest of McCain's proposals would likely never pass unless the American people rose up and forced the issue. They did this in Ronald Reagan's first term, and he was able to get a major tax proposal through Congress. I think that today's legislators are far more dogmatic in their stances and I don't see that happening.

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If Obama wins I'll have more business. Joe Kristan wrote an excellent post on what happens when the top tax rate is increased. It's extraordinarily harmful to small business, and I don't like that.

I wish one candidate would have proposed a huge simplification of our Tax Code. Ideally, I'd like to see a flat tax. Yes, it would drastically decrease my business but there are many other things I could do. Regrettably, neither candidate is proposing anything like that.

Instead, we have a choice between change that would harm the economy and likely gridlock. At least with gridlock we're probably not going to get a worse Tax Code.

This is the second of a three-part series on the Presidential candidates. Today I take a look at what Senator John McCain proposes in his tax plan.

Here are the basics of what Senator McCain proposes (most of the following is taken from John McCain's web site):
1. Keep Tax Rates Low. Senator McCain proposes keeping the current tax rates.
2. Phase out the Alternative Minimum Tax (AMT).
3. Lower the corporate tax rate from 35% to 25%.
4. Allow businesses to fully expense first year equipment and technology expenses.
5. Add a credit for businesses equal to 10% of wages that are spent on Research & Development.
6. Ban taxes on the Internet.
7. Ban new taxes on cellular phones.

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John McCain also proposes to eliminate wasteful spending. Senator McCain wants to balance the budget by 2013 (conveniently right after his term in office would end).

Senator McCain's health care plan involves eliminating the deductions for health care (mainly a business/corporate deduction) and replacing these with tax credits. For most Americans this would equate to a slight savings (based on after tax dollars).

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Senator McCain wants, "a one year spending pause. Freeze non-defense, non-veterans discretionary spending for a year and use those savings for deficit reduction."

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Senator McCain has stated on various occasions he'd like to see the inheritance tax exclusion at $5 million. He has also publicly stated that he's for extending the Bush tax cuts.

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Unlike Senator Obama's plans (which are somewhat detailed on his web site) Senator McCain's plans are not as detailed. Perhaps that's because he's proposing far fewer new programs (and, thus, a much lower need of new revenues) and is actually proposing things like cutting all earmarks.

Yet without the meat it's difficult for anyone to do anything but give a broad critique. No one likes to be pinned down and as I mentioned Senator Obama is as guilty as Senator McCain. Still, I think it's a worthwhile exercise to see where Senator McCain's policies on taxes would likely lead.

First, while I'd love to see corporate tax rates fall (since corporate taxes are always passed on to consumers, cuts in corporate tax rates always benefit consumers) I don't see that happening. Most Americans are unaware of the economic impacts of corporate taxes, and most politicians like to criticize corporations.

Second, attempting to balance the federal budget is a worthwhile goal. Yet without major cuts in multiple programs it just can't happen. Add in a probable recession (which will likely lead to more government spending) and you have an impossible goal. Senator McCain's head is in the sand on this issue.

The one proposal of Senator McCain's that I hope whoever is elected implements is the vetoing of all bills with earmarks. A million here and a million there and you soon have a leak in the system, so to speak. Will Senator McCain follow through on this if he's elected if Senator Smith puts in a $10 million earmark on the defense appropriations bill? I'm actually optimistic on this issue.

But I think all legislators need to look at fiscal discipline. That's a goal of Senator McCain's but I don't see it as a goal of many in Congress.

Yet Senator McCain proposes billions in tax cuts (according to the non-partisan Committee for a Responsible Federal Budget, it's about $450 billion). Eliminating the AMT is a good goal, but where is the federal government going to replace that revenue? Sure, if enough federal programs are cut the revenue wouldn't be needed but how often have you seen a federal department or program eliminated?

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I don't see many (any?) of Senator McCain's proposals getting through an ideological Democratic Congress. That isn't so bad—we'd have the current (flawed) system. Senator McCain also hasn't identified any programs that he would eliminate (save earmarks). Cutting earmarks would save maybe a billion dollars, but that's nowhere near enough money to fund his programs. Just saying that you are going to conduct a review of all programs (which will cost money, of course) and that there will magically be some that can be eliminated borders on wishful thinking.

Still, Senator McCain has some good ideas. The devil is in the details, and those are lacking today.

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In part three I'll examine the two candidates side-by-side. I'll also note the impact that Congress will certainly have on each candidate's goals.

This is the first of a three part series looking at what taxes might be under our new President. This series starts by looking at what might happen under a President Obama. Next week I'll examine John McCain's plans. In the final part I'll compare and contrast the two plans.

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Let's start with what the Obama campaign says they'll do. This is taken from the Barack Obama website:

• Cut taxes for 95 percent of workers and their families with a tax cut of $500 for workers or $1,000 for working couples.
• Provide generous tax cuts for low- and middle-income seniors, homeowners, the uninsured, and families sending a child to college or looking to save and accumulate wealth.
• Eliminate capital gains taxes for small businesses, cut corporate taxes for firms that invest and create jobs in the United States, and provide tax credits to reduce the cost of healthcare and to reward investments in innovation.
• Dramatically simplify taxes by consolidating existing tax credits, eliminating the need for millions of senior citizens to file tax forms, and enabling as many as 40 million middle-class Americans to do their own taxes in less than five minutes without an accountant.

These seem like great goals, and a wonderful plan. Let's check this out to see if it's borne out by facts.

Here are the nuts and bolts of the plan:
1. A $500 (single)/$1000 (MFJ) refundable tax credit for those who work.
2. A $4,000 refundable tax credit for college education.
3. A 10% refundable tax credit to offset mortgage interest payments. It's unclear from the fact sheet whether this credit would be available to those who itemize or is limited to those who do not itemize.
4. No income tax for senior citizens who make less than $50,000.
5. An automatic pension account will be created.
6. The Savers Credit will be expanded so that it will match 50% of the first $1000 for families earning under $75,000.
7. Health care tax credits will be increased.
8. Expand the Earned Income Tax Credit to more working parents.
9. The child care credit would be refundable and allow low-income families to receive up to 50% of $6,000 of child care expenses.
10. Add a $7,000 tax credit for purchase of "advanced technology vehicles."
11. Simplify the system; some taxpayers would receive pre-printed forms with numbers already filled-in.
12. Eliminate capital gains taxes on investments in small and start-up firms.
13. Increase corporate tax on companies that "retain their earnings overseas." Use that money to lower corporate tax rates for companies that expand operations within the U.S.
14. Add a refundable corporate tax credit for small businesses that offer healthcare.
15. Make the Research and Development tax credit permanent.
16. Increase the top tax bracket to 39.6% on families making $250,000 or more.
17. Estate tax begins at $7 million per couple ($3.5 million/person).

How would all of these be paid for? Obama wants to reform international tax loopholes, close domestic tax loopholes, eliminate tax breaks for oil and gas companies, and close other loopholes.

But there's more on other areas of the website that impact taxes. Obama wants to "...ask those making over $250,000 to pay in the range of 2 to 4 percent more in total (combined employer and employee)." Originally, Obama wanted to completely uncap the social security tax above $250,000. What's not said here is would this kick in based on individuals at $125,000 or families at $250,000?

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Let's assume that Obama is elected President. Let's also assume that Congress continues to be controlled by Democrats. What would the tax impact be for you and I?

1. The wealthy already pay most of the taxes in the U.S. Under a President Obama they'd pay even more. In high tax states such as California the marginal tax rate would end up at 58.8% for those making above $125,000 if employed and 68.7% for those who are self-employed. That's if Obama gets his way. Given the leanings among the Democrats in Congress, that's likely the best we could hope for under Obama.

2. Obama's tax plan would result in the redistribution of income away from entrepreneurs. Though Obama wants his plan to help entrepreneurs (through elimination of capital gains on investments in small companies), his income tax plan says the opposite. Additionally, there's nothing in Obama's plan about the AMT. Assuming the AMT lives on, those capital gains tax cuts would be imaginary; entrepreneurs wouldn't pay capital gains taxes but they'd pay the same amount as AMT.

3. Obama has proposed a wealth of new programs. Those new programs would have to be funded with money from somewhere. Obama mentions health care, but that's not the only program he proposes. Obama's reliance on "closing loopholes" is misplaced (see #4 below).

4. Obama's primary funding for his tax plan comes from closing various loopholes. Good luck. The IRS has been trying to close various loopholes for years, and increase enforcement activities. Congress writes the Tax Code to benefit lobbyists and others--in the bailout legislation that just passed numerous loopholes were added. As far as international loopholes the IRS has been successful in closing some. The reality is that only incremental progress will occur no matter who is President. There is no way that Obama will be able to fund his programs and tax cuts solely from closing loopholes.

5. A much more realistic scenario is that under a President Obama only a couple of his programs would be implemented but the tax increases and redistribution plan would occur. This would likely lead have a major negative economic impact (see #6 below).

6. Many large companies are organized as S-Corporations and are taxed on individuals tax returns rather than at the corporate level. (As a reminder, corporate taxes are always passed on to individuals.) When taxes increase to S-Corporation owners they will likely cut their hiring.

7. It is possible that Congress would go much further with social security taxes than the Obama campaign currently wants. There is sentiment among Democrats in Congress to tax high-income self-employed individuals fully at 15.3% (that is, uncapped social security). If this were to occur many high-income individuals would stop working when their income reached a certain level as the tax would be confiscatory. This occurred in the 1940s and 1950s when marginal tax rates reached 90%. This would have a negative impact on the economy in the United States.

8. The current economic climate is uncertain. Increasing taxes when the economy is not doing well would cause major economic problems. Obama has mentioned this in an interview with Bill O'Reilly.

9. Obama has publicly said he's for the elimination of the Bush Tax Cuts. All of them. The elimination of a tax cut is a tax increase--forget the semantics.

10. The goal of Obama's that makes the most sense--simplification of the tax system--is impossible under President Obama. His programs would tremendously increase the complexity of the Tax Code.

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Obama likes to talk in broad terms and doesn't like to be forced to mention specifics. That's true of his stance on taxes. I'll be very specific: If Obama is elected President you will pay more. This may be in taxes, or in the increased cost of goods and services as tax increases on some are passed on. There is no free lunch.

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Next weekend I'll report on what taxes might be like under a President McCain. It should be clear that I'm not a fan of Obama's tax plans. For very different reasons I have concerns over McCain's tax plans.

The bailout bill passed Congress today and was signed into law by President Bush this afternoon. I'm of mixed opinion on the bailout portion of the bill. But I'm thrilled about one part of the bill—this year's AMT (Alternative Minimum Tax) patch was included in the bailout legislation.

Every year Congress goes through the effort to raise the AMT exemption so that millions more individuals don't get impacted by AMT. Last year Congress waited until December to pass an AMT patch and it impacted the filing season.

Also included in the bill were "extenders." The extenders extended popular deductions that would have been eliminated.

Here is a list of some of the major tax items in the bill:

- AMT exemption increased to $46,200 for single and $69,950 for married filing jointly;
- Sales tax deduction extended through 2009;
- The Tuition and Fees deduction extended through 2009;
- Educator expense deduction of up to $250 extended through 2009;
- The real estate taxes deduction (for those taking the standard deduction) of $500 single/$1000 married filing jointly was extended through 2009; and
- Major tax benefits for those who live and/or work in major disaster areas.

There's probably a lot more in the legislation (it runs 300 pages) but let me add a caveat: California will not be in compliance with any of these changes for 2008.