July 20 (Bloomberg) -- President Barack Obama describes them as “millionaires and billionaires” who can afford to pay higher taxes. Republicans call them “job creators” who need to keep their money so they can hire more workers.
As the Democratic president and his Republican opponents debate whether to extend the George W. Bush-era tax cuts for the top 2 percent of U.S. taxpayers -- individuals earning more than $200,000 a year and married couples making more than $250,000 -- their poll-tested phrases obscure the truth about who would be affected.
They are two-earner professional couples living on the East and West Coasts, doctors, lawyers, engineers and Wall Street executives. Few are billionaires or earn more than $1 million a year, and most are not employers.
“The 2 percent, they’re people who are successful in their professions, but they’re not the absolute rock stars,” said Leonard Burman, an economist at Syracuse University in New York. “There’s a big difference between the 99th percentile and the 99.9th.”
Fewer than 1 percent of the U.S. population have annual income of more than $1 million. In the top two tax brackets, slightly more than one-third -- 35.5 percent -- were employers receiving business income, according to 2007 figures from the Treasury Department.
The U.S. Senate plans to vote next week on an Obama-backed plan to extend expiring income tax cuts for everyone except these top 2 percent of earners. The Republican-led House will vote the following week to extend the cuts for all income levels.
Obama, including himself in this group of high earners, says they are a fortunate few who can pay more to help reduce the U.S. budget deficit.
“What we’re saying is for those folks, we can afford to pay a little bit more in taxes by going back to the rates that were paid under Bill Clinton,” Obama said in Ohio July 16.
Republicans maintain that the 2 percenters include business owners who would lose the incentive to add jobs if they had to pay higher marginal tax rates.
“Those who will be punished in the president’s proposal are A, small business owners, and B, those who are most likely to contribute to economic growth,” Representative Kevin Brady, a Texas Republican and member of the House Ways and Means Committee, said in an interview on C-SPAN’s “Newsmakers” July 15. “We might be able to find one economist who thinks it’s good for the economy trying to raise those taxes, but we would wear out a car trying to find a second.”
Under Obama’s plan, the current 33 percent and 35 percent top individual brackets would be replaced with brackets at 36 percent and 39.6 percent. No one with a gross annual income of less than $200,000 and no married couple making less than $250,000, in 2009 dollars, would pay more in 2013 than they’re paying today.
Obama’s proposal would set the taxable income thresholds at $247,450 for married couples and $203,950 for individuals. In many cases, taxpayers with adjusted gross incomes far exceeding those thresholds or the $200,000 and $250,000 ceilings would be able to use deductions and other tax breaks to avoid the higher rates. Separately, as part of the 2010 health care law, a 3.8 percent tax on top taxpayers’ “unearned income,” including capital gains and dividends, takes effect in 2013.
The administration’s proposal would raise income taxes for 1.3 percent of households by an average of $35,757 in 2013, according to the Tax Policy Center, a nonpartisan research group in Washington. More than 95 percent of households in the top 1 percent of income -- those making more than $596,998 a year -- would pay more.
In terms of revenue for the Treasury, the Democrats would raise about $68 billion more from a one-year extension than Republicans would, according to the nonpartisan Joint Committee on Taxation. Over 10 years, the parties are about $966 billion apart.
The debate over the top two tax rates is part of a broader fight in Congress over how to avert the $607 billion fiscal cliff of automatic spending cuts and tax increases scheduled to take effect in 2013. Democrats say higher taxes for top earners must be part of any alternative. Republicans say the current rates should remain for all, shifting the burden of deficit reduction to the spending side of the budget.
Jon Bakija, an economist at Williams College in Massachusetts, has used tax-return data from 2005 to compile occupational breakdowns for the top 0.1 percent, the top 1 percent and the top 5 percent of taxpayers.
“As you go up higher in the income scale, you get a larger share of executives and finance people,” he said.
Engineers, architects and information-technology workers make up 9.6 percent of the top 5 percent of taxpayers and 4.2 percent of the top 1 percent of taxpayers, Bakija said. The top 5 percent includes managers, financial professionals, lawyers and medical professionals, though all in lower concentrations than in the top 1 percent.
U.S. households in the top 5 percent are more likely to have two spouses working than those in the top 1 percent. Of that top 5 percent, 23 percent have spouses who don’t work outside the home, compared with 31.6 percent of the highest 1 percent and 39.3 percent of the top 0.1 percent.
“What you have is a growth in two-earner couples at one end of the income scale,” said Scott Hodge, president of the Tax Foundation in Washington, which favors a simpler tax code with fewer targeted breaks. “You have this huge cohort of people reaching their peak earnings potential.”
Geographically, the taxpayers in the 2 percent group are concentrated in high-income states along the coasts. In Connecticut, 3.6 percent of households would pay higher taxes under Obama’s plan, more than triple the 1.1 percent in Ohio and the 1 percent in Idaho, according to Citizens for Tax Justice, a Washington group that favors raising taxes for top earners.
After Connecticut, the greatest concentrations of households that would be subject to higher rates are in New Jersey, Massachusetts and New York, at 3.2 percent, 2.8 percent and 2.6 percent, respectively. The District of Columbia tops all of them at 4 percent. Mississippi and West Virginia occupy the bottom of the list, with fewer than 1 percent of households in their states facing the proposed tax increase.
Much of the debate in Washington over income tax cuts centers on whether the higher taxes would affect small businesses. Companies structured as S corporations, partnerships or sole proprietorships don’t have to pay the corporate tax of up to 35 percent. Instead, business owners report profits on their individual tax returns, and those are known as pass-through or flow-through businesses.
Each side has its own favorite statistics on the subject, which are accurate and incomplete.
Obama and congressional Democrats like to mention that 97 percent of small businesses wouldn’t be affected by tax increases, because they’re not in the top two tax brackets.
That’s true and misleading, Republicans counter. They note that 53 percent of business income reported on individual income tax returns is earned by taxpayers who would be affected by Obama’s proposal.
Republican presidential candidate Mitt Romney at campaign events emphasizes the theme that Obama’s plan would hurt business owners.
“Dreams are being crushed when taxes go up, and up, and up on job creators, and business creators, when regulations become overwhelming and burdensome, when the people in governments sometimes treat you like you’re the enemy instead of the friend,” he said on July 10 in Grand Junction, Colorado.
Not all of the businesses that pay taxes through their owners’ individual returns are small. The partners in global law and accounting firms, oil pipeline companies and hedge funds all have their business profits flow through to their personal tax returns. Even the small businesses don’t necessarily have employees.
A 2011 Treasury Department analysis attempted to separate large pass-through businesses from smaller ones and to differentiate businesses with workers from those with none.
The study found that, depending on the definition of small business, between 29 percent and 32 percent of small business income is subject to the top two tax rates. Of the taxpayers subject to the top two tax rates, 25 percent are small businesses and employers.
Beyond the debate over who would be affected, lawmakers also disagree as to how households and businesses would respond to higher marginal tax rates. Democrats point to economic growth during the 1990s with higher tax rates, while Republicans say a reduction in after-tax rates of return would lead to slower growth.
The economic evidence is mixed, Bakija said.
“There would be some reduction of incomes of top earners if we raise their tax rates, but it’s probably going to be modest,” he said. “Anybody who claims to have really convincing evidence that this is going to hurt job creation, there just isn’t such convincing evidence.”
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