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Hard Facts About the President's New Tax Cut Proposalby
Bill Bischoff Jan 13, 2003 Even before President Bush officially unveiled his new tax plan,
the usual suspects were already reciting their tiresome “Tax
Cuts for the Rich” mantra. Give me a break! If you are against
Bush Tax Cut II, fine. All I ask is that your stance be based on
facts, rather than emotional class-warfare baloney. In this column,
I’ll examine the president’s tax cut wish list item-by-item,
fact-by-fact. After deciding what you think, please weigh in by
contacting your elected representatives in Washington. Your voice
could help shape the outcome of the upcoming political slugfest
over how best to stimulate our nation’s sagging economy.
First Things First
Before you can even begin to assess whether you favor or oppose
any specific tax reduction proposal, you first must accept one essential
fact: You can only cut income taxes for people who actually pay
income taxes. The simple truth is, lots of people don’t. As
things currently stand, a married couple with two young children
must earn more than $32,150 to owe the IRS. A single parent with
one young child must earn over $19,100.
In fact, many low-income individuals are actually entitled to receive
free government money in the form of “tax refunds.” Why? Because they can still collect child credits and earned income
credits even after their federal income tax bills have been completely
zeroed out. So they don’t just owe nothing. The government
owes them (negative income tax, if you will). The point is,
you simply cannot cut income taxes for individuals who owe nothing
or less than nothing. Sorry about that. This isn’t a matter
of fairness. It’s a matter of mathematics!
Even so, the Bush plan would deliver additional cash assistance
to many low-income parents by immediately increasing the child tax
credit from $600 to $1,000 (more on that later). So qualifying individuals
could actually receive substantially more free money from the government
than they do now. The bigger child credit would also excuse many
more parents with higher, but still modest, incomes from paying
any federal income tax whatsoever. For instance, a married couple
with two young children would have to earn more than $38,150 to
owe the IRS (up from $32,150 under current rules). A single parent
with a young child would have to earn at least $22,100 (up from
$19,100). Naturally, the anti-tax-cut partisans will never admit
this, because it contradicts their stance of “Tax Cuts for
the Rich.”
On the flip side, it is possible to cut income taxes for
people who actually pay them. However, any across-the-board
reduction will, by definition, cut taxes most for those who pay
the most. This is simply a mathematical fact! Therefore, broad-based
tax relief cannot truthfully be labeled as “Tax Cuts for the
Rich.” Instead, the technically accurate description is “Soak
the Rich Less, and Give a Break to Everybody Else Who Pays Taxes
Too.” Of course, the latter phrase just doesn’t have
that energizing class-warfare spin so beloved by the anti-tax-cut
crowd.
OK. So much for the basics. Next, let’s check out all the
Bush Tax Cut II changes one by one. You may like some of them, all
of them, or none of them. Let the facts be your guide.
Eliminate Double Taxation Of Corporate Dividends
Corporate dividends are generally subject to double taxation. First,
the company pays corporate income tax on its earnings. Then when
the company pays out what’s left as dividends, the shareholders
get taxed again. So the same earnings get taxed twice: once at the
corporate level and again at the shareholder level. The new Bush
tax plan would make qualifying dividends free of any federal income
tax, meaning no more double taxation. This change would especially
benefit the many senior citizens who earn a good chunk of their
income from dividend-paying stocks held in taxable accounts. Of
course, high-income investors would benefit as well.
Media stories often describe Bush’s tax-free dividend proposal
as “controversial.” Please! It’s anything but.
The great majority of reputable tax experts and economists have
long believed the double taxation of dividends is an absolutely
horrible idea that should be repealed ASAP. Here’s why. First,
it encourages companies to finance with debt rather than equity,
because interest is deductible while dividends are taxed twice.
Second, it motivates companies to funnel excess cash into ill-advised
“growth” ventures rather than returning it to shareholders.
Bottom line: taxing dividends twice actually encourages corporate
executives to screw shareholders by taking on too much debt and
throwing away cash on goofy high-risk ventures. Finally, the double
taxation of dividends is bad tax policy because it’s just
fundamentally unfair. Other types of income aren’t hit with
the double tax whammy.
Another very good thing about the Bush tax-free dividend proposal:
only dividends paid out of a corporation’s previously taxed
income would qualify. So if a company wants to please the stock
market by issuing tax-free dividends, it must first admit it earned
taxable income and pay the IRS accordingly. This should discourage
companies from using disreputable tax-avoidance schemes to shortchange
the U.S. Treasury (yet another distasteful corporate shenanigan
that’s been occurring over the last few years).
There is, however, a shortcoming here. Any person who owns dividend-paying
stocks in a tax-deferred retirement account (traditional IRA, 401(k),
and the like) should be entitled to increase the tax basis of his
or her account by the amount of any tax-free dividends. Otherwise,
the account owner will be taxed on the dividends when they are eventually
taken out as cash withdrawals. The Bush proposal doesn’t currently
include any such basis increase mechanism, which effectively discriminates
against retirement accounts. That’s unfair.
Accelerate Rate Cuts and Marriage Penalty Relief
The president’s plan would accelerate previously enacted income
tax rate cuts and marriage penalty relief. The lower rates would
kick in January 1st of this year, instead of being reduced in two
later stages (in 2004 and 2006). So this year’s rates would
be 10%, 15%, 25%, 28%, 33%, and 35% (versus 10%, 15%, 27%, 30%,
35%, and 38.6% under current law). The 10% bracket would also be
widened a bit, by $1,000 for singles and $2,000 for joint filers,
so more income would be taxed at the lowest rate.
To prevent people from having to pay more to the IRS just because
they happen to be married, Bush Tax Cut II would also immediately
widen the 15% bracket for joint filers and grant them a larger standard
deduction. Under current law, these changes would be phased in between
2005 and 2009. (We should live so long!)
Who would benefit? Anyone who pays federal income tax, with extra
savings going to married couples. It’s true that upper-income
taxpayers who now pay the maximum 38.6% rate would get more dollars
back than others, as they would receive an immediate 3.6% reduction
off their top rate, which is more than lower-bracket taxpayers would
get. Still, the federal Tax Code will remain progressive after these
tax changes are in place (those earning more will pay a higher percentage
of their income in taxes).
Accelerate Bigger Child Tax Credit
The tax credit for dependent under-age-17 children is currently
set at $600 per child. Bush Tax Cut II would immediately jack the
credit up to an even $1,000. The government would then issue rebate
checks to qualifying taxpayers to provide the economy with a quick
shot in the arm. Under current law, the child credit won’t
reach the $1,000 level until way out in 2009.
Who would benefit? Lower to middle-income folks with dependent kids
under 17 years old. I’m pretty sure most couples with three
young children wouldn’t mind receiving a nice $1,200 tax rebate
check later this year. On the other hand, the “rich” would get absolutely nothing out of this deal. Why? Because the
child credit is totally phased out for high-income folks. True.
Three Other Changes You Probably Have Not Heard About
The Bush proposal also includes three other less-publicized tax
breaks.
The Last Word
Is the president’s new plan really “Tax Cuts for the
Rich?” I don’t think any objective observer can come
to that conclusion. In fact, the Bush proposal is simply “Tax
Cuts for Taxpayers,” as I’ve just explained (and as
the scenarios presented below clearly prove). Now, if you just cannot
stomach across-the-board tax relief in any form, please be
honest enough to admit you are against Bush Tax Cut II for that
reason and that reason alone. Spare me the class-warfare rhetoric.
Bill Bischoff is a CPA and a tax columnist for Smartmoney.com |
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