Increased Tax Rates and Reduced Tax Breaks

Current tax cuts are scheduled to expire in 2012, meaning that rates on income, capital gains, and dividends will increase in 2013. Additionally, the nation’s top earners will have additional levies on unearned income as a way to help pay for health-care reform.

President Barack Obama proposed allowing income-tax rates to rise to as much as 39.6% from 35% for couples and individuals earning over $250,000 and $200,000, respectively. The government will then tax dividends and capital gains at a top rate of 20%, increased from 15%. As part of the health-care bill, top wage earners will also have an additional 0.9% point increase in the Medicare payroll tax on wages and a 3.8% tax on unearned income in 2013.

These tax increases are due to the pressure on the federal government to reduce the deficit and nation debt. Mark Robyn, and economist for the Tax Foundation, believes that the government will likely increase taxes and reduce spending as a means to reduce the deficit. The bipartisan deficit commission proposed overhauling tax rates, creating a top rate of 28%,decreased from 35%.

Some financial advisors worry that reducing tax breaks and increasing tax rates will discourage individuals from investing. According to a 2007 report, 81% of stocks were owned by the top 10% of wealthy holders. Were tax gains’ preferential tax treatment taken away, then this top 10% may become wary about investing.

Charitable contributions, incentives for retirement savings, mortgage interests, state and local taxes, and employer-provided health care will all likely provide individuals with the biggest federal tax breaks. Some financial advisors believe that incentives to encourage retirement are “short sighted,” however, and may create uncertainty for the future wealth strategies of individuals. This uncertainty may persuade wealthy individuals to take advantage of the current gift tax, as the $5 million gift tax exemption will likely revert back to $1 million in 2013.

Though many of the tax increases seem to most affect the wealthy, according to Senator Max Baucus, chairman of the Senate of Finance Committee and a Montana Democrat, the tax increases are need to reduce the deficit: “Over the last decade this country has failed to live within our budget. It is time to craft deficit reduction legislation that will stabilize debt held by the public by 2014 or 2015.”

Deficit May Clip 12-Year Tax Streak For Wealthy,” Bloomberg News May 31, 2011.

 Special thanks to Joel Dobris (Professor of Law, UC Davis School of Law) for bringing this article to my attention.