Tax day 101: How is the tax code changing under Obama?

Obama has showered new tax perks on the poor and middle class while pledging to maintain many of the Bush tax cuts. But his tax code largess stops at wealthy households.

Charles Dharapak/AP
President Barack Obama speaks about tax reform in the Grand Foyer of the White House in Washington, on May 4.

Barack Obama campaigned for president as a tax cutter – and in his first year in office, that's what he has been for the vast majority of Americans.

From the "making work pay" tax credit to incentives for first-time home buyers and for people who invest in energy efficiency at home, Mr. Obama has showered new tax perks on the poor and middle class while pledging to maintain many of the Bush tax cuts.

But where President Bush reduced tax rates for people in all income brackets, Obama set a cutoff line for his tax-code largess: Households earning more than $250,000 need not apply.

Tax hikes on those high-income Americans are a central plank in Obama's planned budget for 2011, which would allow the top-tier tax rates to revert to Clinton-era levels (a top income-tax rate of 39.6 percent). New taxes on those same high earners figure prominently in Obama's recent health-care reform legislation. The goal is to raise revenue to provide health insurance for more Americans.

It may be just the beginning of a broader shift in tax policy under Obama. The question now is: What next, as he faces pressure to reduce federal deficits? Will he raise more taxes, in ways that extend beyond the rich?

Both before and after the 2008 election, Obama and his team voiced commitments not to raise taxes on the vast majority of Americans. Yet the president recently set up a fiscal commission, with a mandate to consider all the tax and spending-reduction options.

Some Republicans say Obama's health-care reforms already impose new burdens that spread beyond the wealthy.

Progressive vs. flat tax

What Obama has done so far reflects party-line ideological divides: The president and fellow Democrats favor a more progressive tax system, in which wealthier Americans pay substantially higher rates than the middle class. Although his team includes fiscally centrist advisers schooled under Clinton Treasury Secretary Robert Rubin, Obama has also shown a penchant for using the tax code for various social goals, from helping to finance college education to expanding the earned-income tax credit.

Republicans lean toward a "flatter" tax-rate structure – often advocating an outright "flat tax."

But with federal deficits running high, simple economic pressures are also bearing down. The Obama administration has opted to spend a lot on short-term stimulus to bring the economy out of recession. But the risk is that fast-rising federal debt will dampen economic growth in the years ahead.

Obama's budget plan currently envisions the interest on the public debt soaring from a roughly $188 billion expense in 2010 to $840 billion in 2020. Unless deficits are tamed, that runaway-debt scenario would continue until something – such as a Greece-style debt crisis – stopped it.

What Obama might do next

The budget gap is poised to remain so wide, many tax experts say, that both spending cuts and tax hikes will be needed. More taxes on just the "rich" are unlikely to do the trick.

"We are going to be desperately seeking revenue," predicts Rosanne Altshuler of the Tax Policy Center in Washington, which does nonpartisan research on tax policy.

In a recent analysis, she and colleague Roberton Williams tested several ways to reach Obama's goal of bringing the budget deficit down to 3 percent of gross domestic product by 2015. To do it just by raising income taxes on those earning more than $250,000, the tax rates on those top earners would have to rise to 77 percent of income.

"The rates would be so high as to make collecting the taxes impossible," Ms. Altshuler says.

However, a dramatic break with campaign pledges could be politically damaging to Obama or any politician.

More like Europe?

One possibility is that, if Obama calls for ramped-up federal revenue after congressional elections this year, his plan won't involve big hikes in middle-class income taxes. One option under review is a new value-added tax (VAT), similar to a national sales tax.

Many European nations have such a tax. Both fans and foes of the VAT say it's not surprising that as the US edges more toward Europe in its health-care entitlements, it will ponder tax-code parallels as well.

"My own guess is that the United States will likely raise taxes substantially, and taxes as a percent of GDP will reach levels never seen in U.S. history (although common in Europe)," Harvard University's Gregory Mankiw, who served as Mr. Bush's top economist, wrote in a recent online posting.

Health-care controversy

As for health care, Obama's legislation includes a range of taxes that are intended to keep the reforms from adding to federal deficits: higher capital-gains and Medicare taxes on the rich, a tax on high-end insurance coverage offered by employers, and levies on the health-care industry, including drug and medical-device manufacturers.

The health-care law also includes penalties on businesses (except very small ones) that don't offer health plans for their employees, as well as on individuals who don't have health insurance.

Critics say some of the health reform provisions amount to backdoor taxes on middle-class Americans. The White House argues that, overall, the reform package will reduce health-care costs for millions of families without adding directly to their tax burden.

Also in Tax Day 101:

Part 1: Top mistakes to avoid on your tax return

Part 2: Who pays no income taxes on April 15?

Part 3: How to file a tax extension form to the IRS

Part 4: How is the tax code changing under Obama?

Part 5: Are some states driving people out with high state taxes?

Part 6: How some millionaires can owe no taxes

Part 7: The tax code needs a fix – but exactly how?

Part 8: 42 excuses you can't use to avoid filing IRS forms

Part 9: OK, now it's time to plan for next April 15

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