Don't Mess With Taxes

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House Republicans are scrambling to revise the tax component of their One Big Beautiful Bill (OBBB) so that all of its members will approve it.

Their biggest hurdles are acceptable compromises on how the bill deals with Medicaid, state and local taxes, and the Biden administration’s energy tax credits. They also need to find a way to satisfy Republican deficit hawks who are worried about the bill’s cost.

The fiscal concern is a major hurdle in tweaking the bill so that all in the GOP’s slim majority will agree to send the bill to the Senate. Various estimates say the OBBB will add roughly $3.3 trillion to $4.6 trillion to the federal debt over the next decade.

Republicans appear committed to making cuts rather than raising revenue to help limit the deficit damage. Specifically, the party has abandoned a move that even the White House had supported, raising taxes on the wealthy.

Going back to pre-2017 top rate: The easiest option would be to let the current and temporary top 37 percent ordinary tax rate expire at the end of 2025.

It then would revert to the 39.6 percent rate in place before being reduced by the Tax Cuts and Jobs Act (TCJA) of 2017, enacted in Donald J. Trump’s first term.

As mentioned, the Trump administration was amenable to a version of this, suggesting that the 39.6 rate return for single taxpayers making more than $2.5 million and married jointly filing couples with adjusted gross income exceeding $5 million.

The White House proposal would have made the OBBB slightly more equitable, but would have missed out on most of the income of the very wealthy, according to the Institute on Taxation and Economic Policy (ITEP), a Washington, D.C.-based left-leaning tax policy think tank.

Ultra-wealthy would still escape top rate: Using 2022 tax year data, the latest complete information available from the Internal Revenue Service, an ITEP analysis found that 85 percent of the income of these wealthy taxpayers would not have been taxed at the proposed higher rate.

Of the $1.05 trillion in income reported by these taxpayers, only $162 billion — or 15 percent of their total income — would have been subject to the 39.6 percent rate.

The reason for the limited tax reach is that many other special breaks in the tax code, some from Trump’s 2017 tax law and many others that existed prior to it, would ensure that most income of very well-off people would never be subject to the 39.6 percent tax rate, noted ITEP.

Capital gains tax rate break: The main tax benefit here is one Warren Buffett told us about back in 2012 when the Oracle of Omaha compared his effective tax rate with that of his secretary. Her rate was higher.

That’s not unusual. Most of us, like Buffett’s assistant, pay tax on ordinary income based on seven tax brackets with rates ranging from 10 percent to the already cited 37 percent.

Most wealthy individuals, however, get a large chunk of their income from long-term capital gains. These profits on assets held for more than a year are taxed at generally lower levels, ranging from 0 percent to 15 percent for most taxpayers to 20 percent for the wealthiest investors.

ITEP’s analysis found that the vast majority of the income received by the $10-million-or-more group of taxpayers — $713 billion or 68 percent of their total income — was in the capital gains category.

Their long-term capital gains and qualified dividends have been taxed at the 20 percent rate, 17 percentage points lower than the top ordinary income rate, since 1997 when Bill Clinton signed the change into law, and tweaked further as part of George W. Bush tax cuts in 2021 and 2023.

For some of these ten-million-dollar taxpayers, another $176 billion or 17 percent of their total income, would be taxed at a lower effective rate due to the 20 percent qualified business income deduction enacted as part of the TCJA.

ITEP’s analysis also found that the 68 percent of income of these taxpayers’ income not subject to the 39.6 percent rate includes income taxed at ordinary rates in brackets below the top bracket. That includes income that is not taxable because of various deductions, like the itemized deduction for charitable giving.

Overall, says ITEP in its Just Taxes blog, had the proposed 39.6 percent tax rate been in place for those with incomes exceeding $10 million incomes in 2022, the total additional tax collected would have been less than $8 billion.

And I suspect that with the high-dollar tax advisors they could afford, it might have been even less.

You also might find these items of interest:

• Are you still in the shrinking U.S. middle class?
• Higher state taxes don't drive away wealthy residents
• Most Americans favor raising taxes on higher-earners and big businesses

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