Tax Cut or Tax Hike? Understanding Obama's Plans

May 13, 2009 — -- Nearly a month has passed since Americans scrambled to file their income tax returns, but now a new type of tax frenzy is on: the rush to understand President Obama's tax proposals for 2011.

Experts say that the president is adhering to his promise not to raise taxes for American couples earning less than $250,000, but making good on that pledge has not come without complications.

"The mechanics of this are kind of daunting," said Tom Ochsenschlager, the vice president of taxation for the American Institute of Certified Public Accountants.

The administration has proposed raising the country's highest tax rate from 35 percent to 39.6 percent and its second-highest rate from 33 percent to 36 percent.

But, because the second-highest tax income bracket includes some couples earning less than $250,000, the Obama administration is expanding eligibility for the third-highest tax income bracket – the 28 percent bracket – so that those couples would fall into that bracket instead, experts said.

The proposal is "more generous" than expected, said Clint Stretch, a tax principal at Deloitte Tax LLP.

"Now they've subjected less income to the higher rate than what would have happened if (the Obama administration) had just struck 33 percent and written in 36 percent," he said.

In formulating the tax plan, policymakers took "a very conservative approach," a senior administration official said earlier this week during a briefing in Washington.

"We felt that this had been a very strong commitment by the president and take the most conservative number possible," the official said, referring to Obama's pledge not to raise taxes on couples earning under $250,000.

But not everyone is impressed with the administration's commitment.

Bob Williams, of the Tax Policy Center, a D.C.-based tax analysis group, said that the expansion of the 28 percent tax bracket will actually result in lower total taxes for some of those in second-highest tax bracket. While the portion of their income would be subject to the 36 percent tax rate, more of their money would also fall under the new, wider 28 percent bracket.

As a result, Williams said, when applied to 2009 tax guidelines, couples with taxable incomes as high as $268,716 and singles with taxable incomes up to $222,480 would actually see a reduction in their taxes overall.

"We've complained that the president's promise to protect more than 95 percent of households from a tax increase would make it hard to collect enough revenue to balance the budget," Williams wrote in a blog post on the Tax Policy Center's Web site. "What we didn't realize was that he planned to give tax cuts to people who live above his generously defined middle class."

Taxable vs. Gross Income

There's also some criticism over the administration's assertion that the higher tax rates would apply to "taxable income" – that is, the income that results when the standard deduction and personal exceptions are subtracted from adjusted gross income. For a couple earning $250,000 in adjusted gross income, that taxable income would be roughly $235,000, administration officials said.

Douglas Holtz-Eakin, former director of the Congressional Budget Office and senior policy advisor to the McCain campaign, said that, on the campaign trail, Obama didn't make it clear that the $250,000 was not in reference to taxable income.

"The reality is, in the campaign, they were not particularly specific about this comment," Holtz-Eakin said.

The majority of Americans won't fall into either of the two highest tax brackets but, experts say, they could see changes to their tax bills thanks to a host of other measures included in Obama's plan.

The administration's proposal includes expanding or extending several existing tax credits:

• The "Making Work Pay Credit," which could save 95 percent of American families an average of about $800 a year.

• The "American Opportunity Tax Credit," which could save families up to $2,500 per year for up to four years.

• The "Saver's Credit for Americans," which will match 50 percent of the first $1,000 of retirement savings for a typical family.

The administration's plan also includes almost $100 billion in tax cuts for businesses as well as proposals aimed to close loopholes, including $36 billion in tax breaks for oil companies and $86 billion from the "check the box" provision that allows multi-national US companies shift income to overseas tax havens.

The proposals take on "a series of unjustifiable loopholes and unjustifiable tax breaks that we simply cannot afford when trying to both pay for critical priorities and maintain fiscal responsibly going forward," a senior administration official said.

Whether the Obama administration's tax plans become law is, of course, up to Congress, where they face an uncertain future.

"Congress isn't happy about a number of things that are being proposed," Bob Williams said. "…The real question is how much of this is real?