Obama’s Tax Reckoning

Apr 15, 2009

by Walter Alarkon and Ian Swanson

The Obama administration will be hard-pressed to avoid raising taxes on the middle class, according to economists crunching federal budget numbers in the lead-up to tax return day—today, April 15.

President Obama’s proposed changes to the tax code, combined with exploding entitlement costs, will lead to ever-growing debt, according to independent estimates. The big question for Obama and his economic team will be whether he can meet the rising costs with increased tax revenue only from small slices of the electorate.

In coming years, almost all households will receive hundreds of dollars in tax cuts under proposals highlighted in Obama’s first budget, but the top 0.1 percent of the population would see an average increased tax burden of $371,675, according to calculations by the nonpartisan Tax Policy Center. Much of that revenue would pay for the tax cuts going to others.

Many economists, including some who voted for Obama, do not believe that he can indefinitely avoid imposing tax increases much further down the income scale—on the middle class.

“You just simply can’t tax the rich enough to make this all up,” said Martin A. Sullivan, a former economic aide in the Reagan administration who said he backed Obama last fall.

“Especially just for getting the budget to a sustainable level, there needs to be a broad-based tax increase,” said Sullivan, now a contributing editor at Tax Analysts publications. “If you want to do healthcare on top of that, almost certainly, it just makes [a middle-class tax increase] all the more certain.”

Obama geared his tax proposals toward working-class people to fulfill a campaign promise and to narrow the gap between most people’s after-tax income and that of the wealthiest. The gap widened during President Bush’s tenure.

Obama’s Making Work Pay tax cut, signed into law in February as part of the economic stimulus package, would reduce income taxes for middle-class families by up to $800 and for individuals by up to $400 annually. Obama has also called for a deficit-neutral healthcare reserve fund to enact reforms that will increase lower- and middle-class access to health insurance.

But even economists sympathetic to tackling income inequality say it will be difficult to avoid other tax hikes.

“There’s no way we’re going to be able to pay for government 10, 20 years from now without coming up with a new revenue source,” said Leonard Burman, director of the Tax Policy Center, during a forum on Obama’s tax proposals earlier this month.

Burman said a value-added tax is “inevitable.” Burman, deputy assistant Treasury secretary during the Clinton administration, said Obama should consider using revenue from the broad-based VAT to fund his healthcare plan. That would give middle-class and lower-income people incentive to keep taxes and health costs low, he said.

The administration disputes the notion that its proposals will require middle-class tax hikes. “The president’s budget put forward the frames for energy independence and healthcare reform and cutting the deficit in half, and did so while also providing the largest and broadest middle-class tax cut in history,” said Tom Gavin, a spokesman at the Office of Management and Budget. “The critical needs of this country can be balanced with the middle-class tax cut.”

The White House has said that an overhaul of the healthcare system is essential to shoring up the country’s finances and increasing equality, and that it would help the economy. White House budget director Peter Orszag has said federal healthcare costs would increase from about 5 percent of the gross domestic product (GDP) to 20 percent if they keep rising at their present rate.

Obama is seeking to pay for his plans by increasing taxes on the wealthy, who already pay a large share of all taxes but also earn more than half of all income earned by Americans. The wealthiest 20 percent paid 69.3 percent of all federal taxes in 2006, according to the Congressional Budget Office, and made 55.7 percent of pre-tax income. Obama’s budget would allow the income tax cuts championed by President Bush for those making more than $200,000 to expire but would permanently extend tax cuts for taxpayers making less.

Obama would raise corporate tax revenue by hitting multinational companies with new rules on tax havens and by making it harder for companies to defer taxes on overseas income.

The president’s overall tax proposals, including perpetuating most of Bush’s tax cuts rather than allowing them to expire, will lead to $3 trillion in lost tax revenue over the next decade, according to an estimate by the Joint Committee on Taxes, which provides independent projections to congressional tax writers.

More revenue will be needed to service the growing national debt. Because annual deficits are expected to remain above $500 billion for the next decade, Sullivan expects debt payments to more than double, from about 1.2 percent of GDP to more than 3 percent.

Clint Stretch, managing principal for tax policy for Deloitte Tax, doubts the administration will be able to generate enough revenue with its current policies. Obama’s proposals would raise corporate taxes by about 10 percent, Stretch estimates, but his proposals would cut revenue overall from individuals.

Many of Obama’s proposals have drawn opposition in Congress, and tax groups are gearing up for a huge fight in 2010.

“These numbers are so beyond the pale, it’s hard to gauge their impact,” said Martin Regalia, chief economist for the U.S. Chamber of Commerce. Regalia thinks Congress will only go forward with tax hikes if the economy has improved by 2010.

He also argues that Obama is less likely to benefit from the huge jump in business productivity that Regalia said enabled the Clinton administration to impose tax hikes that did not slow investment. He also noted that Obama faces larger deficits and a weaker economy than Clinton.

Obama’s budget proposed that his signature Making Work Pay tax credit be made permanent, but it was not included in either the House or Senate budget blueprints, partly because doing so would have increased the size of the deficit on paper.

A task force on taxes is set to report to Obama economic adviser and former Federal Reserve Chairman Paul Volcker on Dec. 4, just as Obama is preparing a budget for fiscal 2011. Stretch said the timing suggests Obama would like the task force’s recommendations to inform the budget proposal.

Still, major business tax reform could be put off. Stretch said it would be a tight squeeze to include Volcker’s recommendations in budgetary work, and if the economy is still struggling at the end of 2009 or beginning of 2010, there could be resistance to changing business taxes.

“I could see a scenario where they’re not ready,” Stretch said. “They’ve got to have it wound up very early.”

Reprinted from The Hill

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