Given that election season is in full swing, I've been having a lot of conversations with friends and family about the candidates and their policies. For most, the biggest issue in the election revolves around taxes and the economy. Personally, I think this is where the candidates have the biggest difference in policies as well.
What I've found interesting in my many discussions with friends and family is that what appeals to them isn't necessarily what is best for them. Here's what I mean…
Aspirations vs. Reality
Aspiration: a hope or ambition of achieving something.
Reality: the world or state of things as they actually exist.
During my many conversations, a lot of my friends were enticed by paying less taxes. And that makes a lot of sense. I'm enticed by paying less taxes, and I think most people are. However, how much you pay in taxes depends completely on your reality, not your aspirations.
I aspire to be wealthy, and would benefit from tax cuts once I achieve that level of income/wealth. However, until I reach that point in life, I want a current tax policy that will benefit me.
My friends are all middle income earners, and so is most of my family. Some people think they earn a lot, but even pushing $200,000 doesn't put you in the ballpark for rich to these presidential candidates. While we all aspire to be there someday, we are not today.
The debate around taxes has been a hot button of the entire campaign, with both candidates putting out very different viewpoints. Here are some key highlights of each candidate (based on available information from their websites and third-parties).
- Allow the Bush Tax Cuts to expire for top earners, raising the top 2 tax brackets to 36% and 39.6%, and raising the taxes on capital gains and dividends back to 20%
- Keep the Bush Tax Cuts for middle income earners
- Extend the Payroll Tax Cut
- Index to Inflation the AMT (Alternative Minimum Tax) to avoid penalizing middle income earners
- Tax carried interest as ordinary income
- Restore the estate and gift taxes to 2009 levels
- Continue tax relief for small businesses
- Keep permanent the Bush Tax Cuts for all income levels
- Repeal the AMT
- Cut individual income tax rates by 20%, bringing the highest tax rate down to 28%
- End or reduce certain specified tax credits and deductions: AOTC (Higher education tax credit), Child Tax Credit, Earned Income Tax Credit
- Eliminate or reduce certain un-specified tax credits and deductions
- Eliminate taxes on long term capital gains, interest, and dividends on middle and low income families
- Repeal the Federal Estate Tax
As you can see, both candidates present almost opposite views on the tax situation.
Let's do some math for the sake of argument. Take, for example, the following scenario:
Total Income: $125,000 (Includes wages, and dividends and capital gains of $5,000)
Tax Credits and Deductions: $19,000 (Includes student loan interest, mortgage interest, and several others)
Taxable Income: $98,600
Under the current tax code, this family would have a tax liability of roughly $16,700, or effectively 13.4%.
This is how the same family would be impacted by their proposals:
Under Obama, the only real change to the current tax policy is that the dividends and capital gains taxes would rise to 20% from the current 15%. There may be some other expirations changing, but most of the deductions remain in place, and so taxable income would stay about the same as well.
As a result, given the same scenario, I estimate the taxes to increase to $18,800, or effectively 15.0%.
Romney's plan is a bit tougher to figure out, but I'm going to assume that most of the tax credits and deductions that would have been allowed before would be eliminated. I'm assuming that the exemptions would stay.
As a result, taxable income in this situation would increase to $117,600. However, at the same time, the marginal tax rates would fall 20%.
However, because there is more taxable income in the higher marginal rates, your total taxes would increase to $21,180, or effectively 16.9%.
For a breakdown of the marginal rates under each individual's plans, check out: 2012 Tax Parameters.
Figuring Out Your Situation
The hardest part is figuring out your own situation so you can make an accurate choice. There are actually a lot of resources out there to help you decide:
- Barack Obama Tax Calculator
- Mitt Romney Tax Plan
The Bottom Line
The bottom line is that in 2011 there were roughly 3.8 million households who earned over $200,000.
Under Obama's policies, there is no doubt that earners in this income bracket will pay more taxes. Even if nothing else is changed, Obamacare does raise taxes on this group.
The opposite is true for Romney – there is no doubt that earners in this income bracket will pay less in taxes if his plans are executed.
The grey area is the middle class – those earning $30,000 to $150,000 – whose policies will have the biggest benefit or biggest bite? I'd like to think that I'm in the top tax brackets and would benefit from Romney, but I'm not, and I think his tax cut and eliminate deductions and credits will be more detrimental to my tax bill that the status quo.
What are your thoughts on taxes and aspirations?