By Sam Brunson
In anticipation of tonight’s debate, I’m going to describe what both candidates propose to do with tax rates, provide a little commentary, and suggest a couple questions that the moderator might ask to clarify what the candidates plan on doing.
The candidates’ proposals for individual tax rates illustrate one of their biggest divergences. As best I can tell, in fact, their plans for tax rates are as different as it is possible to be. And what are those plans?
Currently, there are 7 ordinary tax rates for individual taxpayers: 10%, 15%, 25%, 33%, 35%, and 39.6%. The tax brackets are indexed for inflation, and differ depending on a taxpayer’s marital status, but in 2016, married couples filing jointly will pay income tax of 10% on their first $18,550 of income. They will pay 15% on their income between $18,551 and $75,300, then 25% up to $151,900, then 33% up to $413,350, 35% up to $466,950, and 39.6% on that portion that exceeds $466,950.[fn1]
In addition, long-term capital gains are subject to preferential rates of 0%, 15%, or 20%, depending on the taxpayer’s income. In addition, taxpayers with income in excess of $250,000 (or $200,000 for unmarried taxpayers) pay an additional 3.8% net investment income tax on passive income, including capital gains.
Clinton’s plan doesn’t appear to change the current brackets at all. Rather, she appears[fn2] to propose three main changes to tax rates:
The Buffett Rule
In 2011, Warren Buffett famously wrote that he paid a lower effective tax rate—17.4% of his taxable income—than anybody else in his office. Based on this anecdote, President Obama proposed that millionaires pay an effective tax rate of at least 30%.[fn3]
Clinton has reiterated her support for this so-called Buffett Rule.
And she’s doubled down on it—not only does she propose a minimum 30% effective tax rate on those earning more than $1 million a year, but she also proposes a 4% “Fair Share Surcharge” on taxpayers earning more than $5 million a year.
Clinton also proposes taxing carried interest—most commonly earned by private investment fund managers—at ordinary rates.
- The details are sparse, but it looks like the 4% surcharge is imposed on all of the income of a taxpayer who earns more than $5 million. Otherwise, it’s just an additional 42.6% tax bracket on incomes above $5 million. If that’s the case, it has a huge cliff effect; ignoring potential deductions, a taxpayer earning $5 million would pay income taxes of $1,906,906.30. One more dollar of income would increase her tax bill by $200,000, a marginal rate of about 20 million percent on that additional dollar of income. Is that right?
- A marginal rate that high is bound to create incentives for taxpayers to evade taxes. How do you anticipate ultra-high-income taxpayers changing their behavior in response to the Fair Share Surcharge? And what will your administration do to prevent that tax evasion?
- The Buffett Rule is basically an alternative Alternative Minimum Tax. The AMT has been riddled with problems (including bracket creep and tremendous complexity). How will the Buffett Rule avoid those problems?
Trump proposes reducing the number of tax brackets by more than half: under his proposal, the current 7 brackets would give way to 3. For married taxpayers filing jointly, the first $75,000 would be taxed at 12%, then from $75,001 to $225,000 at 25%, and above $225,000 at 33%. (Unmarried taxpayers’ brackets would be halved, meaning their first $37,500 would be taxed at 12%, etc.)
Long-Term Capital Gains
Trump would keep the 0%-15%-20% structure, matching each rate to one of his three tax brackets. He would eliminate the 3.8% net investment income tax, though.
Like Clinton, Trump would tax carried interest at ordinary rates.
- Though Trump’s new plan would cost less than his old plan, it would still leave the US with a multi-trillion-dollar deficit, even with the rosiest of predictions. But that’s not really an issue with tax rates, so I’m not going to propose any questions about it.
- The Tax Reform Act of 1986 did something similar to what Trump intends: it consolidated about 15 tax rates into 2 as of 1988.[fn4] By 1991, though, the two rates had grown to 3, and by 1993, there were 5 rates. Do you have any reason to believe that your 3 rates have staying power?
- How do you respond to the criticism that your proposal represents a huge tax cut for the highest-income taxpayers (at least a 6.6 percentage point decrease) and, possibly, a tax increase for low-income taxpayers? (The increase at the low end may be offset somewhat by the proposed increase in the standard deduction, but even if low-income taxpayers don’t pay more, the cuts are significantly concentrated at the top.
[fn1] Note that the brackets ensure that there’s no cliff effect: earning an additional dollar should not cause a taxpayer to increase her tax liability by more than $1.
[fn2] I’m hedging a little bit with both candidates, because what they’ve proposed is less specific changes than outlines of what they want, so I’m not 100% sure of all of the details.
[fn3] Note that this 30% wouldn’t necessarily just be income tax, but rather, include all taxes paid by a millionaire.
[fn4] (or 4, if you count an effective bubble rate)