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Obama 30 Percent Millionaire Tax Poses Risk With Limited Payoff

Barack Obama
President Obama during the State of the Union address at the Capitol on Jan. 24, 2012. Photographer: Joshua Roberts/Bloomberg

Jan. 26 (Bloomberg) -- President Barack Obama’s proposal to require high earners to pay at least 30 percent of their income in taxes is only one of several potential ways to boost the tax rate paid by the wealthiest Americans, tax experts say.

Other options for raising taxes for the highest earners, who Obama has said don’t pay their fair share of taxes, include increasing the rate on investment income, revising the alternative minimum tax or further reducing the number of deductions that can be claimed by those earning more than $1 million a year.

Each path poses political risks and might fall short of the revenue needed to reduce the U.S. budget deficit. Also, top earners might develop fresh tactics for driving down their annual tax bills.

“It will always be a challenge to have a rule that nobody can get around,” said David Kautter, managing director of the Kogod Tax Center at American University in Washington. “I refer to it as closing off the escape routes.”

In his State of the Union address to Congress this week, Obama proposed a more defined version of the so-called Buffett Rule named for investor Warren Buffett, who has called for U.S. millionaires like him to pay more taxes. Obama said those with income topping $1 million should have a tax rate of at least 30 percent. The Obama administration hasn’t provided details, including how and whether the tax would be phased in or how business income reported on individual returns might be excluded.

Chances Slim

Though the proposal’s chances for advancing in Congress before the November election are slim, Democratic leaders pledged yesterday to spend the year pressuring Republicans to consider such a plan. Democrats are also pushing to allow the 2001 and 2003 tax cuts to expire on Dec. 31 for high earners.

“The issue is going to be at the forefront of the debate all year,” Senate Majority Leader Harry Reid, a Nevada Democrat, told reporters.

An alternative that lawmakers could consider is changing the tax treatment of investment income. While ordinary income, such as wages, is taxed at a rate as high as 35 percent, capital gains and dividends are taxed at a rate of 15 percent.

“The reason that a high-income person would pay low taxes is the historically low rate on capital gains and dividends,” said Chuck Marr, director of federal tax policy at the Washington-based Center on Budget and Policy Priorities, which advocates for low-income people.

Investment Income

Republican presidential candidate Mitt Romney demonstrated the benefits of the preferential tax rates for investment income when he released his 2010 tax return on Jan. 24, which showed he paid 13.9 percent on $21.6 million in income. More than half of the former Massachusetts governor’s earnings were considered capital gains and dividends.

Also, the discussion of Romney’s returns reignited the political debate over the treatment of carried interest, or the profit stake that private-equity managers receive from successful investments and which is taxed at the capital gains rate of 15 percent. Romney’s 2010 income included $7.4 million in carried interest, according to his campaign.

Raising rates on investment income, and changing the tax treatment of carried interest, has proven to be difficult in Congress. One of the biggest decisions lawmakers face this year is whether to let the capital gains rate rise to 20 percent next year. Dividends would be taxed as ordinary income unless Congress acts.

High Earners

Taxes on capital gains could rise to as much as 25 percent for high earners next year once a new tax included in the 2010 health-care law and a provision that limits itemized deductions take effect, according to Donald Marron, director of the Tax Policy Center, a nonpartisan research group in Washington.

Those increases still wouldn’t be enough to send the tax rate of high earners across Obama’s 30 percent threshold, Kautter said.

“There’s no way to get there unless you increase the rate on the lower-tax income,” he said.

Another alternative for raising taxes for high earners, according to Kautter, would be to prevent the deductibility of charitable giving for this group. While the Obama administration has proposed eliminating deductions for housing, health care, retirement and child care for the highest earners, it has spared charitable giving.

“What gets you down to a lower tax number is all the deductions,” Kautter said.

Another path could include revisions to the alternative minimum tax, or AMT, which is designed to prevent people from avoiding taxes legally. The parallel tax system doesn’t eliminate the preference for investment income, which is something Congress could change if lawmakers determined that was necessary, said Neal Weber, a tax partner in the Washington office of Cherry Bekaert & Holland LLP.

“In today’s tax law, capital gains are taxed at 15 percent for both regular tax purposes and for AMT tax purposes,” he said. “Perhaps under a new AMT tax regime, you would not use a 15 percent rate. You would use a different rate.”

To contact the reporter on this story: Steven Sloan in Washington at ssloan7@bloomberg.net

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

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