Copyright © 2000 Robert L. Sommers, all rights reserved.

November, 2000 Hot Topics

The Current Tax Burden in Perspective -
Analyzing the Gore and Bush Tax Proposals

Reality check

Despite what the presidential candidates say, there is no $4 trillion surplus for them to spend. There is only a very shaky projection that, if the economy maintains its torrid pace and if Congress does not increase expenditures, then over the next ten years, there could be a budget surplus of $4 trillion.

Even so, Bush and Gore are debating how to spend the projected surplus. Both would shore-up social security and Medicare, but as projected uses of the balance of the surplus, the candidates vehemently disagree. Bush wants to return most of it to the taxpayers, while Gore wants to pay down the national debt and provide tax breaks for targeted groups of taxpayers such as poverty-level families with three or more dependents and middle-income families (defined as those with adjusted gross incomes of between $100,000 and $110,000) for education and child care. Thus, Bush’s emphasis is on across the board tax breaks with the government deficit reduction taking a back seat, while Gore is focused on paying down the national debt and providing smaller tax breaks to certain taxpayers.

The Current Tax Burden

Cutting tax rates does not benefit all taxpayers equally. The lowest 60% of taxpayers, determined by pre-tax income, pay just 7% of income taxes, the remaining 93% is paid by the top 40% of taxpayers. Of that amount, the top 20% pays 77% and within the top 20%, the top 1% pays about 30% of income taxes. Thus, the bulk of the Bush tax breaks goes to the richest Americans because they are the ones paying the most taxes.

The Rich Already Received a Capital Gains Cut

Let’s look at Bush's proposal that current income taxes are 6.5 percentage points too high. Under this plan, for every $100,000 of taxable income over $150,000, one would save $6,500 in federal taxes. However, the capital gains rate has been cut from 28% to 20% so for every $100,000 in long-term capital gains, the taxpayer saves $8,000. Thus, the cut in capital gains that proportionally favors which outweighs the current disparity in the income tax espoused by Bush.

Bush believes in Ronald Reagan's supply-side economics: Cut the taxes on the richest Americans and they will invest in the economy to create jobs which benefits everyone. The Bush official website states, "As President Reagan demonstrated, the best way to encourage economic growth is to cut marginal tax rates across all tax brackets."

During the 1980's tax rates were cut which benefited the wealthiest Americans. As a result, less revenue flowed to the government. But Congress failed to cut spending so there was a mismatch between revenues and expenditures and the national debt soared. When President Clinton came to office, he raised taxes on those who benefited from the tax cut. Congress also curtailed spending and the economy began growing. The combination of raising taxes, lowering spending and a booming economy has produced a budget surplus (revenues are exceeding expenditures). The political issue for the 2000 election is how to spend the projected budget surplus. The sub-issues are whether taxes too high and should be cut, or whether the deficit should be paid down.

Although the promise of a large tax cut could be popular politically, economists, including Allan Greenspan, chairman of the Federal Reserve ("Fed"), believe this is the wrong time to stimulate an overheated economy with tax cuts. He is worried that tax cuts will produce inflation and the Fed would be forced to counter with interest rate increases. Higher interest payments for homes, automobiles and other consumer and business debt could more than offset the decrease in taxes.

Additionally, although tax cuts are supposed to translate into increased investment and jobs, there is nothing that specifically ties economic benefits to the United States. There is no guarantee that tax cuts for the rich will produce a greater investment in the U.S. In fact, it is possible that some tax cuts would be invested in foreign countries to build factories that compete with American workers.

With the booming economy of the past 8 years, the U.S. is running a surplus projected to be $4 trillion dollars over the next 10 years. George Bush wants to a tax cut to all Americans with the surplus. Al Gore wants to provide a much smaller and targeted tax cut to "middle-class" Americans and use the surplus to pay off the national debt.

Smoke and Mirrors

The Bush proposal is misleading on several counts. First, his tax cuts benefit the richest Americans. Even so, they are largely illusionary. Bush wants to cut tax rates to a maximum of 33% on incomes over $150,000, down from 39.6%. Theoretically, this will amount to a $6,500 savings for each $100,000 of taxable income over $288,350.

However, we have two systems of taxing income, the regular tax rates that Bush talks about cutting and the Alternative Minimum Tax ("AMT") that the Bush proposal fails to address. The AMT is calculated on a flat 26% of the first $175,000 of AMT income (a complex calculation)and 28% on AMT income in excess of $175,000. Americans enjoying a tax cut that falls below the AMT will wind up paying the AMT amount, rendering the Bush tax cut proposal meaningless for them.

Note: The same can be said for Bush's call for the elimination of the estate tax. This will not occur for 10 years; there will not be any meaningful estate tax relief for a generation.

Because the Bush proposal pays off the National Debt over 16 years, while Gore will pay it off in 12, the interest on the debt will cost an additional $300 billion for those additional 4 years. Given the size of the Bush tax cuts and the additional interest payments on the National Debt, there is doubt that enough money exists in the Bush proposal to pay down the debt.

In conclusion, the Bush tax cuts do favor the rich; but if there is not a corresponding reduction in the AMT, those tax cuts will be illusionary. Taxpayers will wind up paying about the same federal income tax as they do under the current system or the Bush plan.

Recommendation

Bush should cut tax rates less drastically and revamp the AMT to that is applies in fewer situations. An AMT exemption should be raised to $50,000 for individuals and $100,000 for married couples and tax rate should be a flat 20%.

The Bush Proposal – Lowering Marginal Tax Brackets

Single Taxpayer

Thus, under the Bush proposal, a single person (standard deduction with one exemption) with a taxable income of $50,000 would receive a 10.5% tax reduction worth $911. If the taxpayer made $500,000, he would receive a 14% reduction worth $24,355. The conclusion: Despite the claims to the contrary, Bush’s income tax reductions favor the wealthiest taxpayers, both in actual dollar amounts and in the percentage of tax reduction.

Married Filing Jointly

Under the Bush proposal, joint filers (standard deduction with two exemptions) with taxable income of $75,000 and $750,000 would receive the following tax benefits: an 11% reduction worth $1,326 and a 15% cut worth $40,136, respectively.

Alternative Minimum Tax

Now, factor in the Alternative Minimum Tax: Suppose the single person making $500,000 a year in wages and the married couple earning $750,000 a year in wages also had $200,000 worth of incentive stock options (a preference under the AMT). Note: For simplicity, there are no other income sources and no itemized deductions. TurboTax’s Tax Estimator software was used to determine these numbers. The result: There is no advantage to the single filer and the couple’s $40,136 tax break is reduced to $4,900. Thus, what the Bush tax cut offers, the AMT overrides.

The Gore Approach

The Gore proposal specifically targets certain economically disadvantaged groups and provides selective tax breaks for those taxpayers. For instance, Gore wants to provide poverty-level families with three or more children a $500 tax break. He also has tax breaks for education and life-long learning.

Al Gore wants the government to retain the surplus and apply it according to government-mandated priorities. It is the opposite approach from George Bush.

Central to the Gore proposal is paying down the national debt because the interest expense on the debt is the third largest government expenditure. Tax cuts proposed by Gore are analogous to government incentives to induce certain socially-desirable behavior. While this has been a standard goal of tax breaks, the Gore proposals are confusing and aimed at those with AGI's of $100,000 or less. Those who meet the Gore requirements should receive a much bigger break under his proposals, provided they are willing to comply with the government programs. However, those who are paying the bulk of the taxes today will not receive any direct tax benefits.

While paying down the National Debt is laudable since it benefits all Americans by keeping the economy strong and lowering interest rates, Gore’s efforts to micro-manage the economy with targeted tax breaks is complicated and problematic.

Providing breaks for higher education for those earning about $100,000 and no more, punishes those who through their hard work, have increased their standard of living to beyond that amount. Families struggling to make ends meet consider themselves middle class, regardless of whether their income is $50,000 or $300,000.

As a practical matter, in many parts of the Bay Area, it takes an annual income of $200,000 to $300,000 for a family of four to pay the costs of housing, private education for children, day-care, health-care costs, real estate taxes, sales taxes and California income taxes, let alone obligations to care for their parents, and save for retirement. Using 100,000 as a government-dictated cutoff will strike those who are struggling to meet expenses as unfair and discriminatory against hard work.

Recommendation

Gore should simplify his tax breaks by providing tax rate reductions in the 15% and 28% tax brackets, rather than attempting to manage behavior with a series of confusing tax breaks. He should moderate his tax package to include those who are paying taxes, as well as those on the lower end of the economic spectrum.

Gore has many tax incentives for individuals and businesses. The following are the major tax breaks for individuals

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All contents copyright © 1995-2003 Robert L. Sommers, attorney-at-law. All rights reserved. This internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.