Washington Matters


Little Tax Promises and Average Joes


The tax promises the candidates rolled out this week got mercifully little attention in last night's third and final debate on Long Island. In fact, when it was over, New York Times columnist David Brooks on PBS pretty much ridiculed the ideas -- things like suspending mandatory retirement plan distributions, allowing penalty-free early withdrawals from IRAs, cutting the capital gains tax, making unemployment insurance tax-free -- as "little promises."

Promising tax cuts is more American than apple pie, though so-very-much less satisfying. Even with record deficits and a $10 trillion national debt (the financing of which eats up 10% of our national budget), John McCain and Barack Obama continue to trot out new tax cuts as salvation. Before taking a quick look at some of the latest ideas, a little perspective ...


I remember covering Ronald Reagan's first big tax cut in 1981. It was the biggest tax cut ever. Oh, yeah, I also covered the biggest tax hike ever...the one the Gipper signed into law the following year. Who can forget George H.W. Bush's 1988 "read my lips, no new taxes" pledge . . . and the subsequent 1990 tax hike he signed into law after lawmakers locked themselves in a hanger at Andrews Air Force Base to come up with a plan? Middle-class tax cuts were the centerpiece of Bill Clinton's 1992 "it's the economy, stupid" campaign. Yet, a fascinating piece in the Times published shortly after his inauguration explained how his advisers were already plotting tax hikes...and figuring they could get away with it because it was unlikely that voters ever believed the promises in the first place. "Voters never believed in the middle-class tax cut," one adviser was quoted as saying. "They always believed their taxes would go up whether Bill Clinton became president or George Bush was president."
 
Oh, what cynics taxpayers are!
 
Quick thoughts on some of the latest proposals:

  • Suspending mandatory withdrawals from retirement plans. Current law requires retirees age 70 1/2 and older to draw down their IRAs and 401(k)s based on their life expectancies. Both candidates would temporarily waive that requirement so seniors aren't forced to sell in this down market. Sounds helpful (although retirees who have their money in CDs and money market funds haven't suffered market losses in their retirement accounts), but it would mostly benefit retirees who don't really need the cash from their accounts to pay their bills. For many (probably most) retirees, though, the problem isn't a desire to take out less money than the minimum required by law. They have to take out at least that much just to stay afloat.
  • Cut the tax on retirement withdrawals. At the same time the candidates want to let retirees keep their money in their tax shelters, another of McCain's proposals seems to acknowledge the fact that most retirees need the cash:  He'd set a flat 10% tax rate on the first $50,000 of retirement plan withdrawals by retirees age 60 and older. That would surely help a lot of folks (although low-income seniors pay 10% or less on their withdrawals now), but none so much as high-bracket taxpayers who don't really need the money. They could save a bundle by pulling  $100,000 out of their accounts over the next two years at 10%...money that otherwise would be taxed as high as 35% (or 39.6% if Obama's tax hike for folks making more than $250,000 makes it into law).
  • Penalty free early withdrawals. Obama proposes letting folks under age 59 1/2 raid their retirement accounts for up to $10,000 penalty-free. (There's generally a 10% penalty for early withdrawals.) Apparently, in this case, the need for cash trumps the worry about selling in a down market. And, get this: although the withdrawal would dodge the penalty, it would still be taxed.
  • Cut the capital gains tax in half. McCain wants to cut the maximum capital gains tax in half, from 15% to 7.5%. Although Obama foolishly complains that no one has capital gains any more (apparently forgetting that investing in stocks, mutual funds and real estate was going on before the latest market meltdown), there are surely hundreds of billions of dollars in unrealized capital gains in Americans' portfolios. But, don't forget that for millions of taxpayers (those with taxable incomes below $32,550 on single returns and $65,100 on join returns) the tax rate on capital gains is...drum roll, please...0%. (Another fun fact: the median family income in the U.S. is about $50,000.) It would be yet another break that generally provides help to those who don't especially need it.
  • Making unemployment compensation tax-free. I bet most Americans didn't know these payments were taxed. Thankfully they weren't back during my one stint on the rolls -- in 1977 -- but Jimmy Carter imposed a tax on some benefits in 1979 and Ronald Reagan's Tax Reform Act of 1986 made benefits fully taxable. The latest numbers  from the IRS show that 7.4 million unemployed taxpayers reported a total of $26.5 billion in taxable benefits in 2006.What do you think: Should jobless pay be tax-free, just like combat pay? I wonder if cash-strapped cities and states would move to cut the payments if Uncle Sam quit taking a piece.
  • Tax credit for creating new jobs. Obama has proposed giving businesses a $3,000 tax credit for every new job they create. What a great idea as unemployment spikes, right? Maybe, but don't get your hopes up. Martin Sullivan, an economist and former Treasury official, writes in Tax Notes that a very similar credit created in 1977 was such a bust it disappeared after two years. One problem: enormous complexity in figuring out which businesses deserve the credit. What's a new job?  How, for example, do you measure new jobs in a contracting industry like automaking or banking? How do you deal with companies that merge with other firms or spin off a division?

One final point about the real star of last night's debate: Joe the Plumber. I don't know the fellow, but I do want to remind you that it doesn't sound like he's really an average Joe. The tax hike that McCain said Obama would punish Joe with is the one Obama says would only apply to taxpayers making more than $250,000.
 
I wish Joe well, but I think he'd be doing stupendously if he can buy a business and turn a quarter million dollar profit in the first year. Remember, that's taxable profit...after he's paid his employees and for all this equipment and other expenses. I looked up the latest numbers from the IRS. In 2006, just 1.45% of taxpayers reported more than $200,000 in taxable income.
 
Bottom line? I suggest voters make their decision on who should be the next president on issues other than taxes.




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