8 Potential Tax Changes Obama Plans to Implement in Second Term

barack obama tax changesPresident Obama plans to make a few major changes to the tax code in his second term as President of the United States. The basis of Obama’s plan is to keep fighting to keep taxes for middle-class families low, simplify the tax code, and to have millionaires and billionaires pay their “fair share” in order to reduce our deficits. (comparison to Romney’s tax plan)

Obama currently believes the tax code favors the wealthy and is unfair to the middle class. Obama said, “Do we want to keep giving tax breaks to the wealthiest Americans like me, or Warren Buffet, or Bill Gates – people who don’t need them and never asked for them? Or do we want to keep investing in things that will grow our economy and keep us secure? Because we can’t afford to do both.”

Below are 8 of the major tax changes Barack Obama has set to change or plans to make to the current tax system.

Change 1: Individual Income Tax Rates

Obama plans to keep the income tax rates the same for the 10% and 28% bracket, but plans on increasing the tax rate on the top two income tax brackets. Below is a table that compares current income tax rates to Obama’s planned income tax rates.

Obama Rate Current Rate Single Income Married Income
10% 10% $0-$8,700 $0-$17,400
15% 15% $8,701-$35,350 $17,401-$70,700
25% 25% $35,351-$85,650 $70,701-$142,700
28% 28% $85,651-$178,650 $142,701-$217,450
36% 33% $178,651-$388,350 $217,451-$388,350
39.6% 35% $388,351+ $388,351+

In year 2000, the top two brackets were taxed at 36% and 39.6%. Obama’s plan is to revert back to these tax rates by letting the tax cuts on these brackets expire, while at the same time making the current rates permanent for the lower income levels.

Change 2: Long Term Capital Gains Rates

obama capital gainsCurrently, the tax rate on capital gains is 15% for individuals in the 25% to 35% tax brackets and 0% for those in the 10% and 15% tax brackets. Under Obama, these rates are set to go to 10% for the 15% and under tax bracket, 20% for individuals in the 25% to 36% brackets, and 23.8% for individuals making over $200K (married couples filing jointly making over $250K).

The additional 3.8% that is being added onto individuals with higher incomes comes from the health care reform legislation (Obamacare) that became law in March, 2010 and goes into effect in 2013. This additional tax is to help Obamacare be deficit neutral once implemented. In essence, the individuals that do not need help paying for health care will fund it for the people who do need help.

Change 3: Dividend Income

obama dividend incomeCurrently, dividend income is taxed at 15% for the 25% to 35% tax brackets and 0% for the 10% & 15% tax brackets. Obama plans on keeping the dividend income rates the same for individuals making under $200K a year ($250K a year if filing as married). For those making above $200K ($250K married) their dividend tax rates will be their individual income tax rates (36% & 39.6%).

The decision to tax higher income individuals at their individual tax rates is a step to make the wealthy “pay their fair share.”  The decision to do this comes under much scrutiny because dividends are already taxed at the corporate tax rate and then they are taxed again at the individual level. For example, if we assume that $100 of earnings at the corporate level is taxed at 28% (assuming Obama cuts the corporate tax rate from 35% to 28% as stated below), the remaining $72 is paid out as a dividend, then taxed at an additional 39.6% ($28.51) tax will be imposed at the individual level. This results in an effective tax rate of 56.51% (60.74% if corporate rate not reduced) on corporate income. This change can deter wealthy investors from investing in corporations that pay dividends or it can change the way corporations handle profits they would otherwise pay as dividends.

Change 4: Interest Income

obama interest incomeCurrently interest income is taxed at the individual income tax rates that are mentioned above. Obama plans to continue taxing interest income at the individual income tax rates. This means that tax rates on interest income will go to 36% for the 33% bracket, 39.6% for the 35% bracket, and anyone below these brackets will have their interest income taxed at the current income tax rates mentioned above.

Change 5: Gift Tax & Estate Tax

Currently the gift tax and estate tax is 35% with a unified lifetime credit of $5.12 million. Currently, gifts can be given up to $13K a year (26K if married) that do not need to be added to the unified lifetime credit. The reason for this is so people do not give away their wealth before death to avoid taxation on their estate. When someone is dies and their estate transfers, the amount above 5.12 million plus anything that has been added to the unified tax credit through gifts is then taxed at 35%.

obama gift tax and estate taxObama plans to increase the estate tax rate to 45% and prior taxable gifts exceeding $3.5 million. This will mean that a higher tax rate will apply to many more people. This increase will help the government take in more money each year to help with the budget deficit. An increase in the estate tax is also step towards preventing greater disparities of wealth in the United States since it is harder to pass wealth from generation to generation.

This stance on increasing the estate tax comes under much criticism for the following reasons:

  • It creates a disincentive for further investment and work for individuals that know their estate will face this tax.
  • The moral claim that the deceased have the right to dispose of their wealth as they see fit, not the government.
  • The estate that is being taxed has already been taxed. In some circumstances this could mean a 70%+ effective tax rate on that income.
  • The estate tax has been found to impose a big compliance burden on the U.S. economy, roughly equal to the amount of revenue raised.
  • With other countries having tax rates near zero, it encourages individuals to relocate to minimize taxation. This moves the wealth and future tax revenues abroad, which decreases the future tax base of the U.S.

Change 6: Tax Deductions

obama tax deductionsObama has stated the he plans to reduce the deductions that are available to the wealthy (200K+ single, $250K+ married). He mentioned that he would possibly set a dollar cap to the amount of deductions that these individuals can take. He has not mentioned any figures or which deductions could be impacted.

Obama’s tax system is set to reduce the use of the medical expense deduction. Currently, total medical expenses in excess of 7.5% of a person’s adjusted AGI can be deducted. In 2013 this is set to go up to 10% of a person’s AGI, which means fewer people will qualify for this deduction. Even if they qualify,  they will deduct a lower amount in 2013 than if they took the deduction in 2012.

Change 7: Corporate Taxes

obama corporate taxesObama plans to cut back the corporate tax from 35% to 28%. This is a step to help corporations be more competitive abroad since the U.S. currently has one of the highest corporate tax rates in the country.

Obama plans to keep the current “worldwide” tax system which requires to pay taxes on all profits, even those earned overseas. Obama also plans to end various corporate tax breaks that he feels unfairly benefit certain companies.

Change 8: Buffet Tax

obama buffett taxObama wants to make sure that anyone making more than a million dollars a year will pay at least a minimum tax rate of 30%. Some figures estimate that this could take in from $37 billion a year to $50 billion a year in additional tax revenues.

There has been much opposition to this rule because it could negatively impact job creation and investment. In many cases wealthy individuals make a much of their income as capital gains. The original reason for having a lower capital gains rate is that it spurs new investment in the economy and allows capital to move more quickly.

Potential Impact on U.S. Government Revenue

obama government revenueObama claims that his tax plan will pay down the deficit by $4 trillion over the next 10 years. His tax plan will increase tax revenues and decrease the annual deficit by raising taxes significantly on upper income individuals. Even with the implementation of Obamacare, which is a large expense to taxpayers, revenue will be neutral by increasing taxes on investment income for high-income taxpayers and imposing fees or excise taxes on certain manufacturers and insurers.

Obama is fighting hard for the middle class and believes that his plan will help keep more money in their pockets by “asking” that everyone pays their fair share.

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