Beware the looming payroll tax hike
Until or unless Congress actually does something, 2013 will be the year of tax increases. Big tax increases.
The fiscal cliff is a bit of a misnomer, but when it comes to taxes, the metaphor is apt. If all of the tax cuts, credits, and deductions set to expire at year end do in fact expire, incomes will fall off a tax cliff. Median earners will have 4 percent less in take-home pay in 2013 than they otherwise would; households making a million dollars or more would have 11.4 percent less.
You can see what a fully armed and operational tax cliff would mean for different earners in the chart below from the nonpartisan Tax Policy Center.
But not all tax cuts, credits, and deductions are created equal. Some hit much harder than others, and some hit different earners much harder than other earners. The chart below, again from the indispensable Tax Policy Center, breaks down which tax provisions are worth what to different earners. It's pretty crazy that nobody in Washington is fighting to keep the payroll tax cut.
There's a lot going on here, but there are three big takeaways.
1) The middle-class Bush tax cuts, the payroll tax cut, and the stimulus tax credits are the most important tax issues for most households. These three policies are among the two-costliest for everybody making $200,000 or less -- and almost $500,000 or less. The middle-class Bush tax cuts are worth more to the HENRY (high-earner-not-rich-yet) crowd than anything else, since those cuts apply to the bottom $250,000 of income. The Alternative Minimum Tax (AMT) patch is worth a bit more, but not much more, than the payroll tax to those earners.
2) Higher top-end rates, higher capital gains taxes, and limited deductions only hit the rich -- and mostly the very, very rich. Here's a startling fact: The top 0.1 percent of households earn half of all capital gains. That's why higher taxes on savings only make a big difference at the very top of the income ladder, even if the Obamacare surtax on capital gains didn't kick in only for households making $250.000 or more. But it's not just capital gains taxes that mostly matter to the über-wealthy. The same is true of the high-end Bush tax cuts. Remember, these are marginal rates -- they only apply to income above their thresholds. So the more income you have above these thresholds, the more these cuts are worth to you. That's exactly what we see in the chart above, with the high-end Bush tax cuts and uncapped deductions worth twice as much to households making more than a million dollars than to households making between $200,000 and $500,000.
3) The AMT is a big, big deal. The Alternative Minimum Tax is just that -- a minimum tax to prevent rich households from paying little to nothing in taxes. The problem is its threshold wasn't indexed to inflation when it was created back in 1969, so more and more households are subject to it -- unless Congress patches it over. That's become a regular right of passage for Congress, and if it doesn't do so again, then 28 million more households will pay it in 2013, according to Eric Toder of the Tax Policy Center. AMT collection would more than triple from $34 billion this year to $120 billion the next, with those 28 million new AMT payers accounting for $64 billion of the new $86 billion of revenue.
The good news, if there is any, is President Obama and House Republicans agree on extending the middle-class Bush tax cuts, the stimulus tax credits, and patching the AMT. The bad news is neither side wants to extend the payroll tax cut, or replace it with something similar. In other words, even in a best-case scenario, 2013 will be a year of tax increases for all, just not as big as they would otherwise be.
That's probably about the most we can ask for from this Congress.