Where We Stand on Taxes

In my previous post, I examined various tax rates and found that under Obama, tax rates haven’t increased from what they were under George W Bush. How about for the next 4 years? Before we compare the proposals of Obama and Romney, let’s look at what is about to happen in 2013. According to current law, the Bush tax cuts are set to expire at the end of 2012. In broad terms this means:

  • Income taxes will go up for everyone.
  • Many deductions, such as personal exemptions and itemized deductions for high-income earners, and child and dependent care credit will be significantly trimmed.
  • Taxes on capital gains will go up and dividends on investments will be taxed at regular tax rates rather than at capital gains rates.
  • Many taxpayers will end up paying the alternative minimum tax (AMT). Normally, any taxpayer (individual or corporation) must pay the greater of their regular tax or a flat tax rate (the AMT). The current law has incorporated several exemptions built into the AMT, but these are set to expire in 2013.
  • The estate tax will go up significantly. Estate tax (sometimes also called the inheritance tax or death tax) is the tax imposed on the transfer of “a taxable estate” of a deceased person. Currently, the exemption for this tax is $3.5 million and the highest tax rate is 45%. Beginning 2013, the exemption will be dropped to $1 million and the highest tax rate will be increased to 55%.

What will this do to the economy? According to the analysis from the Congressional Budgeting Office (CBO), these changes will have the following effects: The deficit projected in the 2013 budget will fall sharply (by almost $500 billion) because of the increase in tax revenues. This trend will continue in later years, leading to much lower deficits and debt. Also, inflation will remain very low. This is the upside. On the downside, this sudden fiscal tightening on so many fronts will almost certainly cause another recession. Right now, the CBO projects that real GDP will decline by 0.5% between the end of 2012 and the end of 2013. This will result in an increase in unemployment to about 9%.

Thus, the government has tough choices. It could allow the tax cuts to expire and make significant headway towards addressing the debt problem. However, this would also cause another recession and sustained unemployment. Could we risk this given our fragile recovery? Are there ways to address both problems? And between Obama and Romney, who has the better plan? This is what we should compare.

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