On January 1, 2013, taxes went up by $4.2 trillion, as Clinton-era policies snapped back into place. On January 2, however, Congress cut taxes by $3.6 trillion, permanently cementing into law the vast majority of the temporary tax cuts first enacted in 2001 and 2003. So, where does this leave American tax policy? Answer: still in need of reform.
Last week, the Congressional Budget Office (CBO) released a report that shows that the Federal Government will collect more than twice the amount of taxes it did last year by the year 2023 – proving the government has all the revenue it needs.
|2012 (actual)||2023 (projected)|
|$2.4 trillion||$5.0 trillion|
At the same time, the tax code remains riddled with complexity, and real tax rates are higher than they have been in more than a quarter century – when Congress last reformed the tax code.
According to an analysis (see below) from Ways and Means Chairman Dave Camp (R-MI), tax rates are now as high as 44 percent on wages and salaries and as much as 44.6 percent on small businesses. When capital gains and dividends are taxed twice (once at the corporate level and then again at the individual level) the level of taxation now reaches 55.0 percent (it is a top rate of 30.8 percent if only taxed on the individual level).
These excessively high tax rates are the result of President Obama and Congressional Democrats’ insistence on maintaining certain Clinton-era tax rates plus ObamaCare taxes.
|Taxes on…||Top Real Tax Rate|
|Workers’ Wages and Salaries||44.0 percent|
|Small Business Income||44.6 percent|
|Rent, Royalties, and Interest||44.6 percent|
| Capital Gains and Dividends
Chairman Camp stated, “Clearly, with revenues doubling over the next decade, the problem isn’t too few taxes; the problem is too much wasteful Washington spending. In order to get our economy back on track, we have to address these excessive and punitive tax rates as well as the code’s complexity. No matter how much money a taxpayer or business makes, it is simply wrong for Washington to take nearly half of that in federal taxes – especially on top of all other state, local and excise taxes that people pay.”
Tax reform that significantly lowers rates needed now more than ever
While legislation enacted on January 2nd negated virtually all of the enormous tax increase that had taken effect the day before, the top statutory tax rates on many types of income did – at the insistence of President Obama and Congressional Democrats – revert back to their Clinton-era levels as of January 1st. Those higher headline rates tell only part of the story, however.
As detailed below, when accounting for additional, hidden rates imposed through the reinstatement of the Pease limitation on itemized deductions,1 the newly implemented 3.8-percent ObamaCare surtax on net investment income,2 Medicare payroll tax rates that have also increased under ObamaCare, and the alternative minimum tax (AMT), many of the top real rates borne by individual taxpayers are even higher than the advertised statutory rates. The same goes for the 95 percent of U.S. businesses that are organized as partnerships, S corporations, or sole proprietorships – “pass through” business entities commonly used by small businesses that file their taxes on their owners’ Form 1040s and pay taxes at the individual tax rates.
At the same time, larger U.S. businesses continue to struggle under the highest statutory corporate tax rate in the industrialized world, which not only puts those employers at a severe competitive disadvantage, but also results in the government taking more than half of the total value of corporate earnings received by investors each year.
Now more than ever, hardworking individuals, families, and employers of all sizes deserve comprehensive tax reform that lowers tax rates, simplifies the tax system, and creates the jobs and economic growth that America needs. The Ways and Means Committee held 20 hearings on comprehensive tax reform in the 112th Congress, and the Committee remains committed to advancing those tax reform efforts this year. The very high real rates outlined below show a key reason why, while also providing a useful reminder of how complicated the tax code has become with respect to its disparate treatment of various types of income.
|Type of Income|| Headline Rate
Income Tax Rate)
(HI) Payroll Tax
| Wages, salaries,
|39.6 percent||1.2 percent|| 3.8 percent3
|| 44.0 percent4
(ACTIVE BUSINESS INCOME EARNED BY PASS-THROUGH ENTITIES)
Type of Income
| Headline Rate
(Top Statutory Income Tax Rate)
Rate from Pease
| ObamaCare Surtax on
Net Investment Income
| Small business income
(active business income earned by
|39.6 percent||1.2 percent||
INTEREST, ROYALTIES, RENT AND SHORT-TERM CAPITAL GAINS
|Type of Income||Headline Rate
Income Tax Rate)
Rate from Pease
Surtax on Net
|39.6 percent||1.2 percent||3.8 percent||44.6 percent|
QUALIFIED DIVIDENDS AND LONG-TERM CAPITAL GAINS
|Type of Income|| Headline Rate
(Top Statutory Income Tax Rate)
|ObamaCare Surtax on Net Investment Income|| Effect of Other
dividends and long-term
| 20 percent
|| 3.8 percent
|| 7.0 percent
(for certain AMT filers)7
| 1.2 percent
(from Pease limitation for other taxpayers)8
DISTRIBUTED TO INVESTORS AS DIVIDENDS
OR REALIZED BY INVESTORS AS CAPITAL GAIN
|Type of Income||Top Statutory
|Real Rate On
|Real Integrated Rate|
| Corporate income
dividends or realized
by investors as
|35 percent||30.8 percent|| 55.0 percent9
Of course, even these real rates show only the top Federal tax rates with respect to income and payroll taxes. American taxpayers are subject to an even higher total tax take when factoring in income and payroll taxes imposed at the state and local levels, as well as excise taxes imposed by all levels of government. So while the total, all-in tax rate will vary for any particular individual depending on the type of income earned and where he or she lives, the bottom line for taxpayers across the nation is the same: America needs comprehensive tax reform that lowers rates, simplifies the tax system, and creates more jobs and economic growth. In 2013, the Ways and Means Committee aims to advance fundamental tax reform that does just that.
1 The Pease limitation – which reduces up to 80 percent of the total amount of otherwise allowable itemized deductions by $0.03 for each dollar of income over $250,000 ($300,000 for joint returns) – effectively imposes an additional, hidden marginal tax rate increase of approximately 1.2 percent. A related provision – the personal exemption phase-out (PEP), which reduces or eliminates personal exemptions claimed by taxpayers above that same income threshold – largely affects taxpayers in the 33-percent bracket and is generally already phased out before taxpayers enter the 39.6-percent bracket. Although taxpayers with a very large number of dependents could, because of PEP, actually face marginal rates higher than 39.6 percent, PEP is excluded from the calculations of real rates in this document for simplicity.
2 This new tax is imposed on investment income (e.g., dividends, capital gains, interest, royalties, and rent) and applies to taxpayers earning more than $200,000 ($250,000 for joint returns).
3 The maximum total Medicare (HI) payroll tax rate (employee share and employer share combined) is 3.8 percent. Economists generally agree that employees bear the economic burden of both the entire employee share – i.e., 1.45 percent plus, for taxpayers earning more than $200,000 ($250,000 for joint returns), an additional 0.9-percent newly implemented as part of ObamaCare – and the employer share of 1.45 percent.
4 This real rate is slightly less than the sum total of the percentages in the other columns in this row because, to be consistent from an economic standpoint, taking the employer share of the HI tax (1.45 percent) into account as part of the taxes effectively paid by the employee also requires adding that employer share into the employee’s income. The appropriate economic calculation is as follows: (.396/1.0145 [headline rate] + .012/1.0145 [Pease limitation] + .038/1.0145 [HI tax] = .440)
5 Active business income (i.e., business profits not provided as compensation) earned by owners of pass-through entities (e.g., S corporation shareholders and limited partners) is generally exempt from the additional rate resulting from the Medicare (HI) payroll tax. In contrast, a general partner is subject to the HI tax on his or her entire distributive share from a partnership or limited liability company, resulting in a top real rate of 44.0 percent, as described in the previous table showing the tax treatment of compensation.
6 S corporation shareholders and limited partners who do not materially participate in the operations of the business (generally less than 500 hours of work per year) are considered “passive” investors for purposes of the tax on net investment income, and thus subject to the 3.8% rate even if their entire distributive share of income is derived from active business operations. Those owners who do materially participate are not subject to this tax, and thus face a maximum rate of 40.8 percent on their distributive shares.
7This additional AMT effect, which assumes that the taxpayer has ordinary income in addition to the taxpayer’s capital gain, results from the 25 percent phase-out of the AMT exemption and the 28 percent AMT rate (0.25 multiplied by 0.28 = 0.07).
8Taxpayers not subject to the AMT effect noted immediately above can instead be subject to the additional, hidden rate of 1.2 percent from the Pease limitation, leaving them with a top real rate of 25.0 percent on dividends and long-term capital gains.
9Corporate income is subject to a double layer of tax – it is taxed once when earned by the corporation (subject to a top rate of 35 percent), and then taxed again at the individual level when distributed as a dividend to, or realized as capital gain by, the investor (subject to a top real rate of 30.8 percent, as noted in the previous table). A corporate profit of $100, for example, is first taxed at the 35 percent corporate rate, leaving $65. If the shareholder receives that remaining $65 as a dividend – or ultimately realizes it as capital gain – the corporate income is then taxed again at a top individual rate of 30.8 percent, leaving only $44.98. Thus, the top integrated tax rate on such corporate income is 55.0 percent, meaning that the Federal government takes more than half.