I have not been able to find any accurate press reports on the tax changes for 2013, and indeed I am quite confident that no such reports exist. Nevertheless, I will try to piece together various fragments of information, and provide guesstimates of the impact of the deal. My initial reaction is that the Dems won big, and the GOP was completely rolled (as expected.) However I should add that this assumes the GOP actually favors what they claim to favor. It seems equally likely that the GOP likes high tax rates, tax complexity, the marriage penalty, and big government spending programs, and merely claims to have libertarian leanings on economic issues. So when I say “GOP” I am referring to their alleged beliefs, not necessarily their actual beliefs. (Have you ever noticed that many ultra-conservative southern states have steeply progressive state income taxes, whereas Massachusetts has a 5.3% flat tax, and liberal Washington State has no income tax at all. Watch what they do, not what they say.)
Almost all of the press reports on the tax increases are wildly inaccurate. Taxes rates will rise much more than advertised, and not just on those making over $400,000. Here are some problems with the agreement:
1. The tax code becomes far more complex.
2. The marriage penalty becomes even worse.
3. There is no reduction in the maximum unemployment benefits, despite the recent fall in the unemployment rate. Every day that goes by a larger and larger share of the unemployed become structural, as our labor market becomes more “European.” I have heard several stories from different people I trust, who describe people they know who are enjoying a long vacation at Uncle Sam’s expense, and bragging about it. That’s not to say most unemployed are doing this, it’s just a minority. Maybe 1% of the workforce. But it is becoming an increasing problem as more and more people figure out how to game the system. Ivy league professors overlook this problem because they don’t socialize with the sort of modest income person doing a crappy job who is tempted by this option, and they can’t imagine anyone they know taking this route voluntarily.
4. There are virtually no spending cuts.
5. MTRs rise for almost all Americans, and by much more than advertised.
6. There is no “lower rates for less loopholes” deal, as had been discussed in the early stages of the negotiations.
Let’s take my case, someone making less than $150,000 a year. From the headline you might assume that I won’t have to pay more taxes next year. Yet the phase-out of the 2% payroll tax cut will raise my taxes by over $2000. Still, it might appear that my MTR will stay at 28%, as I make more than the maximum income threshold taxed for Social Security. In fact because I am married I’m not in the 28 % bracket; I’m in the 33% bracket. If I got divorced and kept living with my spouse I’d be in the lower tax bracket. One of my colleagues (with a wealthy wife) did this, and saved a huge amount on taxes. (We should tax everyone as an individual, as Sweden does.)
OK, but at least my combined married income only puts me in the 33% bracket, and those valiant Republicans were able to stop our evil President from pushing up our MTR on labor income (my main source of income.) Nope, my MTR will rise sharply. But first note than my current MTR on wage income is 35.9%, not 33%, because the 2.9% Medicare tax goes up to infinity.
But at least the GOP was able to stop Obama from adding another 3% points on top of that already high MTR, right? Yes, they stopped the 3% increase, and signed off on a 5% increase.
Here’s where I am going to have to make some guesses. The deal re-instates the phase-out of personal exemptions and itemized deductions from married couples making over $260,000. This link suggests the itemized deduction phase-out adds about 1.1% to MTRs for married couples making more than $260,000 (but not for couples “living in sin” and making more than $260,000.) I could not find info on the PEP phase-out, as it depends on the size of one’s family. We have three people in our family, and I assume that’s about average for married couples. The personal exemption will be $3800/person next year, so the tax savings are about $1250. These savings are phased out between $260,000 and $380,000, which implies an extra 1% MTR per exemption. But taxes are not my area, and this may be completely wrong.
In addition, the Medicare payroll tax on wage income rises from 2.9% to 3.8% next year, for those making over $250,000. So add the 1.1% itemized deduction phase-out, the three 1% MTRs for each exemption phase-out, and the 0.9% payroll tax rise, and I will see my MTR on wage income rise from 35.9% to 40.9%. Of course that doesn’t include state income taxes. Iowa Democrat Tom Harkin was so outraged that college professors like me will only see their MTRs rise from 35.9% to 40.9% that he voted against the agreement. He wanted even more.
And maybe people like me should pay more, after all, although my six figure income is quite modest in Newton Massachusetts, it’s way above the national average, and more than I “need.” My outrage is not directed at the amount of taxes I pay, but rather at three other morally indefensible aspects of our tax code, each of which gets substantially worse:
1. The marriage penalty
2. The complexity of the tax code, including the fact that the IRS itself is unable to answer questions when I call for advice. If they don’t understand their own code, how can the average person?
3. The taxation of investment income, which double taxes all income that is saved and then spent in the future, rather than spent today.
And the tax rate on investment income rises by even more than 5%. As far as I can tell the increase will be about 7.9% on people in my income bracket, and 8.8% on the very rich.
The GOP did get one minor victory; the dividend tax increase on the rich was scaled back from an absurd 28.4% to “only” 8.8%. It will rise from 15% to 23.8% on the rich. Recall that dividend income is triple-taxed.
Everywhere else they lost badly. As I predicted last year, the GOP made a huge mistake in refusing to do a deal with Obama back in 2011, and the entire country will now pay the price of their stupidity. Even worse, I doubt they even understand the full dimensions of their failure, or why it happened.
PS. I’m sick of explaining why the taxation of investment income is unfair, inefficient, and double-taxes wage income that is saved. If you don’t understand, take a course in public finance, or read Miles Kimball’s blog.
Update: Or my earlier post.