Reader e-mail re: “Bracketology“:
I am a CPA who spent the the better part of the last 7 years working in public accounting. It is not only the increase in the rate that scares those who are making the $250K plus, but the FICA taxes Obama wants to throw on it too. So really it would be a jump not to 39%, but more like 53% when you factor that in. Most of my savvier colleagues in public practice, as soon as it became apparent that Obama was going to get elected, immediately started advising clients to accelerate as much income into 2008 as possible and push as much expenses into 2009. Pay any large dvidends or distributions out of your company in 2008 before either the dividend tax rate goes up or those distributions from your S-corporation are subject to FICA. On top of that, some of the earners will probably ease up, figuring it isn’t worth giving up 60% of your income (when your factor state taxes) to the government. Some who own small businesses will just not hire or invest in new equipment.
Chait obviously doesn’t know a lot of CPAs or a lot of small businessmen.
I have a few thoughts concerning your Corner post titled Bracketology. My wife and I are both Pediatricians. We own our own practice together. We have one PA and 7 other employees. We each gross about $200 K a year. We have 3 young children at home, 2 of which are not in school. We also employ an in home Nanny. My wife has been torn for years about not being at home for these children, which are our biggest investment in the future. We operate parallel S corperations as PC’s, with a 50/50 ownership of the LLC that is our business. We file taxes jointly. After crunching some numbers concerning the President’s tax hike proposals, I have come to the following conclusions. If the President’s plan is inacted, we will do the following:
1. My wife will become a stay at home mother.
2. At least 3 of my 7 employees will be released.
3. The practice will downsize to a smaller office space, i.e. less rent.
4. The number of patients cared for on a daily basis will drop by 40%.
5. My wife will come out of the forced ER call schedule for good.
6. I will gross $249,999.00 a year, exactly.
7. The net income of our personal home will decrease by less than $10 K a year from where it would have been if we changed nothing.
Mr. Chait’s problem is that he doesn’t think like a businessman. The goal isn’t to maximize profits. The goal is to maximize return on investment and minimize risk. Tax increases diminish returns, so the businessman assesses the diminished return in light of risk. What must be invested and at what risk to earn the diminished return? If it’s relatively easier and less costly to earn that $250,000th buck, then it might be a good investment. If not, I’ll look for ways to reduce the risk, and cost, or I’ll invest the capital someplace else. For example, I might run the numbers on paying a high dollar tax accountant to find me a “loophole,” or I might look offshore.
The idea that there are idiots earning in excess of $250,000 is, well, idiotic, and the idea that a sane businessman will blithely pursue diminishing ROIs is even stupider.
With all due respect, Chait is either disingenuous or an idiot himself. The tax code works precisely that way. While it’s true that increases in marginal rates only impact the 250,000th dollar and above, that is NOT true for when the income level is used as a trigger for phase-outs. For example, if the child tax credit disappears after a certain level of income, by earning one dollar less, you can save a nice tax credit. Same for AMT triggers, deduction phase-outs, earned income credits, joint filing credits, etc.
Since Obama has not specified exactly how he intends to implement this magical “not one dime increase for those earning less than $250K”, we cannot be sure, but it is likely that in addition to whatever marginal rate increase is passed, there will also be all manner of phase-outs that kick in that reduce credits or deductions, effectively increasing the marginal rate even for income below that level. Of course, nobody believes that garbage about “not one dime” anyway, so it won’t really help to reduce below $250K, since anybody paying taxes at all (however few of us are left) is gonna get socked with an increase too.
It is the marginal increase that will cause people to pull back, as your friends suggest. If you have the choice of A) spending more time with the family or B) funding irresponsible and out-of-control government at an increased rate for what is basically overtime, a lot of people will choose A.
This is why Obama’s GDP and deficit numbers are a joke: he is creating disincentives for the most productive portion of the population. So really, for entrepreneurs, small businesses and per-hour professionals, this is an increased tax on overtime – but only for people who make six figures; I wonder how the unions would react to an overtime tax.
I think you miss the point Mr. Chait, and his ilk, are making.
Mr. Chait et al view productive people as a natural resource, one that will be there no matter what happens (i.e. taxation). You see, all people have the same motivation Mr. Chait has, which is altruistic humanitarianism, even if they don’t realize it. Don’t listen to all those people who try to tell you self interest is what motivates us. That is an idea whose only proponents are “a few ‘wealthy idiots.’”
Taxation is just something that any rational, enlightened person will submit to. Furthermore, any sane, well balanced person will not change his or her work habits just because hard work will be taxed. On the contrary, all intelligent and right-minded people recognize that paying higher taxes is not only patriotic, but a holy obligation few of us are privileged to incur. Working hard is a duty and a way of life. Mere taxation will not stop the workers from uniting and taking control of the means of production! Er, I mean, the free American people will rise to this challenge and do what is patently and obviously the right thing to do at this perilous time.
A local talk show here in Houston has had a lot of small business owners call in to discuss this exact point.
A lot of them are working on there business plans to adjust what reported income they state to ensure below whatever threshold is set ($250k changed in the run up to the election several times) they don’t get caught up in it. Obviously this means shrinking the business.
Another popular thing mention was that prior to the election, many small business owners told their employees the ramifications of this tax policy Obama proposed. Many businesses would shrink their business in order to continue to operate versus struggle with higher taxes. A lot of small business owners whether they make $250k or $400k in the business usually have about the same take home pay. Most of the rest of the money goes into paying employees and operations. Getting rid of some employees and workload capacity will help the business in the long run and keep the owner in the same position.
Just like with minimum wage increases, the guys that get hurt are on the bottom and not the “evil” business owner.
I’m sure you don’t need any more email on the subject, but let me agree. Sure you don’t LOSE money by making more than $250,000 ( or $203,000 or wherever the break for the top marginal tax rate will be), but what is the incentive? When you make 249,900, and you pay an effective tax rate (fed, state, local, and sales tax) of 50% or more (at the 33% fed tax marginal rate), what do you think the effective tax rate is when the marginal rate is 40 or 50%?
I also agree with the article that this won’t be an option for someone making millions a year, but how many people make $250,000 – $350,000? This is certainly an option for them.
If I can decide my own hours (lawyers, doctors, dentists, second-income-earners, etc) why would I work 50 hours a week instead of 40 if I’m going to be keeping 35-45 cents of every dollar for the overtime work? I’d rather spend that time with my family or friends, and make do with less income. I suspect everyone else would, too.
Not good for productivity. Not good for GDP. Not good for recovery.
Chait is right in that the ramification for that extra dollar of income is limited to its marginal effect on that extra dollar. So while it may be true that under Obama the marginal effect is only 2, 4, or 6% (depending on what actually passes from his budget), I think the greater effect is the psychological line that Obama has so clearly drawn in the sand. If the tax rates are adjusted so that someone making 250,000 is taxed at 39.6%, if this person is self-employed, they are looking at a total tax rate of up to 61.4% on each dollar over $250,000. [61.4% = Federal Income Tax (39.6), State Rate (up to 10.3% in California), and self-employment tax rate (roughly 11.5% when you take into account your deduction for ½ of the self-employment tax)].
I am a tax accountant, don’t consider myself to be an idiot, and I am right in Obama’s income target range. I will be joining those looking to limit hours worked so as not to enter that 60% territory. Part of the motivation will be the self satisfaction of not contributing to the socialist cause.
Reagan used to tell the story about how when he was a movie actor he’d make 2 pictures a year, which would take maybe 8-9 months, then lay on the beach for the rest of the year. The reason was by the end of the second picture he was in the 90% tax bracket, and it wasn’t worth all that effort to get another 10 cents on the dollar.
It didn’t hurt him, he said, as he made plenty of money anyway. But what it meant is that the cameramen, set designers, sound people, etc had to go out and look for part time work the rest of the year.
This experience was a primary factor in leading him to advocate lower marginal rates for top income earners. It helped average income earners too.
As I am sure you will be informed, ‘bracketology’ (at least during March) can only refer to the NCAA basketball playoffs.
Trust me, I’m well aware.