Presidential Campaign Issues: Taxes

     

Federal Tax Revenues and Expenditures

One of the big differences between the candidates in the last Presidential debate came on the issue of taxes. Republican Donald Trump argued that an across the board decrease in tax rates was necessary in order to get the economy growing again. He also stressed the need to significantly lower the corporate tax rate in order to grow American business and make it more competitive with other countries.

Democrat Hillary Clinton promised to increase taxes on the rich by which she means anyone making over $250000 per year. She argued that this tax increase would enable her to implement all the programs in the Democrat platform without adding to the Federal deficit which is now close to $20 Trillion.

Neither candidate pointed out that there is a difference between raising tax rates and raising taxes. An increase in tax rates on the rich or anyone else does not always lead to increased government revenues. Historically, almost the opposite has occurred. Over 50 years ago, President Kennedy lowered tax rates and Federal revenues grew dramatically. President Reagan did the same thing with a similar result after he took office.

Even the much-maligned Bush tax cuts did not reduce Federal revenues. In 2002 the Federal government collected 1 Trillion dollars in income taxes and 1.88 Trillion in total revenues. By 2007 after five years of Bush “tax cuts”, Federal income tax collections went up by 50% to over 1.5 Trillion dollars, and total government receipts exceeded 2.5 Trillion. In 2007 the total federal deficit was a mere 160 Billion dollars, the same it had been in 2002. Only with the recession did income tax revenues go down to 2002 levels although total government receipts stayed higher.

Today, total Federal government revenues are the highest they have ever been. Unfortunately, during the Obama administration massive government spending has far outstripped the increased revenues produced by the Bush cuts. Even if a newly elected president Clinton were to tax those making over $250000 at a rate of 100%, it would not come close to dealing with the massive debt roll accumulated during the Obama administration.

Ironically for conservatives, it would appear that reductions in tax rates lead to increased government revenues and only enable more government spending. At the same time, it would appear that raising tax rates would actually lead to less revenue for Washington? Why should this be so?

In the last election campaign Mitt Romney tried to make the same point that Donald Trump is making today. He argued that lower tax rates would actually grow the economy and produce greater revenues for the Federal government. Most people, including those who should know like politicians and newspaper editors, could not understand the concept.

But there is another factor. Increasing tax rates only increases tax avoidance strategies both legal and illegal. Increasing tax rates on the rich or anyone else will only encourage more tax avoidance since the potential reward gets greater. If someone’s income is taxed at a 50% rate rather than 25%, the potential reward for deferring, sheltering, or otherwise hiding income has doubled.

Although he has not released his tax returns, Donald Trump has admitted that he uses “depreciation” on his real estate holdings to keep his taxes down, a perfectly legal strategy that neither President Obama nor Hillary Clinton has ever challenged.

No one has ever asked candidate Clinton or her husband why they felt a need to set up the tax exempt Clinton Foundation for their charitable work in the first place. Many financial planners advise high-end clients to set up foundations for tax purposes. We all know of the Gates foundation and the Buffett foundation. Theoretically, since these foundations pay no taxes, more of their money can be used for the charities they wish to support.

 Even assuming that the Clintons had the best of motives, they must have realized that they could achieve greater results with their money than the Federal government could. Why give the government a third or more of your speaking fees when all the fees could go to the Foundation. Of course, they also could be able to maintain control over the tax exempt funds as opposed to leaving it to government bureaucrats to decide. The funds could go to pet causes. Recent email leaks have indicated a dark side in the Foundation. It appears that daughter Chelsea had to initiate an investigation of the Foundation to see if there were any conflict-of-interest issues jeopardizing its tax-exempt status.

There are other legitimate ways for people to shelter income from taxation. For example, taxable withdrawals from IRAs and other retirement plans can be deferred until age 70, and after that only minimum withdrawals need be taken over one’s lifetime. Raising tax rates only discourages taking money out of IRAs. Lowering tax rates would actually increase taxable withdrawals.

Trump is also right about lowering the Corporate tax rate. Corporations actually don’t pay taxes. The taxes are figured into the price of what their customers pay in the same way that the real estate taxes paid by landlords come out of the rent paid by tenants. Higher corporate taxes are inevitably passed on to the consumer.

Also, corporate accountants are paid to find ways to create strategies that will minimize their corporate tax liability. A higher tax rate will inevitably lead to more and more drastic measures. When states raise corporate tax rates, corporations move to more tax friendly states as General Electric did this year in Connecticut. We all know that the high federal Corporate tax rate has led many domestic companies to relocate overseas.

Inevitably, increases in tax rates never produce the expected tax revenues. Just look at the state of Connecticut. Two years after his election Democrat Governor, Dannell Malloy, and an overwhelmingly Democrat legislature pushed through the largest tax increase in State history. The expected revenues failed to materialize, and the Governor had to raise taxes again to balance his budget.

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Romney's Tax Plan

     

I would like to put my two cents worth into the almost interminable comment on last Wednesday’s Presidential debate. In the first place, even though I have never been a supporter of President Obama, I do not think that he gave as bad an account of himself as both sides have suggested. To me he appeared to have grown and matured in office into something much more than the inexperienced but charismatic community organizer of four years ago.

On the whole, despite disagreeing with most of what he said, I thought the President did a good job but he was simply overwhelmed by the knowledge, experience, competence, and conviction of Gov. Romney. Romney showed that not only did he belong on the same stage as the President of the United States, but that he also belonged in the Oval Office.

On one occasion the President said that it’s just arithmetic or math. Nevertheless, few ever bother to do the math when trillions of dollars are involved. For example, the President as well as most commentators did not appear to grasp what Romney was getting at when he suggested that cutting tax rates was not the same thing as cutting taxes. Let’s look at Romney’s claim that cutting tax rates would not reduce Federal revenues but actually might increase federal revenues.

Federal tax rates use a graduated scale. There are currently six different tax rates: 10%, 15%, 25%, 28%, 33%, and 35%. Here’s how it works. Everyone pays 10% of the first $8700 of taxable income. Income from $8700 to $35350 is taxed at the 15% rate. The tax rate on income from $35350 to $85650 is then taxed at the 28% rate, and so on until the 35% rate is applied to income over $388000.

So, let’s use as an example, an unmarried taxpayer with a taxable income of $85650. Remember, taxable is adjusted gross income minus personal deductions. On the approximately $50000 of taxable income over $35350, this taxpayer would currently pay the 25% rate or $12500. Romney proposes reducing tax rates by 20%, which would bring our taxpayer’s rate down to 20% thereby reducing his tax to $10000. Romney’s plan would save our taxpayer $2500. Multiply that by millions of taxpayers and it adds up.

However, Romney proposes to offset that reduction by eliminating or scaling back some tax deductions or tax credits. Suppose the above taxpayer had a $20000 tax deduction for mortgage interest and real estate taxes. If he was only able to deduct half that amount, he would owe an additional $2500, thereby neutralizing his savings from the reduction in his tax rate.

If the taxpayer’s bill remains the same, and the government collects the same amount of tax, why even bother? In the first place, there is a question of fairness. A tax deduction is worth much more to a taxpayer in the 35% bracket than to one in the 15% bracket. Even Democrats don’t object to this inequity that favors the wealthy.

More importantly, lowering tax rates does stimulate the economy. Gov. Romney tried to explain it last Wednesday and I hope that his running mate will continue in the next debate. History is on their side.

Over 50 years ago, President Kennedy lowered tax rates and Federal revenues grew dramatically. President Reagan did the same thing with the same result when he took office. Finally, even the much-maligned Bush tax cuts did not reduce Federal revenues. In 2002 the government collected 1 Trillion dollars in income taxes and 1.88 Trillion in total revenues. By 2007 Federal income tax collections went up by 50% to over 1.5 Trillion dollars, and total government receipts exceeded 2.5 Trillion. In 2007 the total federal deficit was 160 Billion dollars, the same it had been in 2002. Only with the recession did income tax revenues go down to 2002 levels although total government receipts stayed higher.

Two final notes on the first debate:

First, commentators were shocked that President Obama did not bring up Gov. Romney's 47% comment. I can only guess that the President's advisors must have felt that Governor Romney was prepared to knock that one out of the park. Any major leaguer will knock a 95 mph fastball out of the park if he knows it's coming.

Second, I though that veteran newscaster Jim Lehrer did a fine job of moderating. He allowed the focus to stay on the candidates and kept himself in the background. It was the best debate I have ever watched, and Lehrer had a lot to do with it. ###

Tax the Rich?

                                             

Recently, I had an argument with a friend who claimed that the “rich” in America paid no taxes.  By the “rich” he meant the top 1%, a group that has been demonized by President Obama (although he is a member) as well as by the “Occupy” protestors. I recalled seeing somewhere that the top 1% actually paid almost 40% of all Federal income taxes but my friend could not believe it.

A quick check on the web showed that I was correct. Here are the figures. In 2009 the top 1%, those with Adjusted Gross Income (AGI) in excess of $343927, paid 36.73% of all Federal Income taxes that year. That was not an aberration for the 2008 figures were about the same. This calculation does not take into consideration the amount the 1% paid in other taxes, like state and local income taxes, sales taxes, or real estate taxes.

The top 5%, those with AGIs over $154643, paid almost 60% of all Federal income tax. The top 25% (AGI over $66193) account for 87% of all income tax. Finally, the bottom 50% (AGI below $32396) pay practically nothing (2.25%) of the Federal tax bill. This last group must include most of the Occupy protestors.

Typically, when people like President Obama say, “tax the rich”, they rarely provide any kind of realistic figure of how much revenue will actually be gained by their proposals. When studies show that the increased revenues will come nowhere near closing the ever-growing federal deficit, it becomes clear that “tax the rich” is a political ploy and not meaningful fiscal policy.

Instead of increasing taxes on the rich, government should focus on increasing incomes for everyone. Why does only 10% of the population make more than $112124 per year? Why does 50% of the population make less than $32396 per year? Government should exist to promote and protect wealth accumulation, and not to destroy it.

Even if advocates of higher taxation have their way and increase taxes on income, they will not be able to reduce the deficit. The Federal government will be forced to look for other sources of revenue. Eventually, in addition to taxing income, politicians will discover the tax gold mine of an asset tax.

In my career as a financial advisor I had many clients who had modest incomes and paid very little in Federal income tax, but who could be considered millionaires. I recall one elderly couple with a house worth about $600000 and investment assets of about $400000 from which they took an income of about $10000 per year to supplement their social security income. They lived modestly since their house was free of mortgage debt and paid no Income tax. However, like many senior citizens they did pay a substantial real estate tax on their suburban home.

A real estate tax is an asset tax. It is calculated on the basis not of your ability to pay but on the value of your home. It is the major source for local government funding in most states. It always increases and will eventually drive most seniors from their homes. It will not surprise me to see the Federal government propose some kind of asset tax in the near future. It wouldn't take much to see the government add a tax on mutual fund assets and have the fund companies collect it along with their management fees. An asset tax is a form of confiscation.

Anyone who is in favor of higher taxation should view the attached video from an Indiana newscast to see where his or her taxes actually go. ###