While headlines yesterday crowed and complained of the small rise in the budget and the focus on taxing the wealthy - which admittedly given the peak polarization in political parties is unlikely to actually move into legislation anytime soon - JPMorgan's Michael Cembalest finds perhaps the most controversial part of the proposal hidden deep in the report. While the JPM CIO notes the CBO baseline and alternative scenarios, it is the difference between the $293bn benefit (CBO estimate from last year) and the Administration's new estimate of $584bn that caught his eye as buried on Page 73 of the Green Book were three new taxes on existing tax-efficient 'benefits'. Tax the mass-affluent (>$250k) seems indeed the new motto of this presidency.
JPMorgan - Eye On The Market:
The President’s Budget: An Unhappy Valentine’s Day card for high income taxpayers
The President’s budget was released yesterday. Due to the political impasse between the parties, it seems unlikely to result in tax legislation this year. But as a reflection of the priorities of the Administration, and as a reflection of its stance in any future budget negotiations, it is an interesting document. The proposal aims to raise revenue from upper income taxpayers by any means necessary. [Note: upper income begins at around $200k in adjusted gross income]. The proposal would, according to Administration projections, stabilize the Federal debt close to today’s elevated levels. Revenue increases play a large role, specifically the following three proposals. The second one surprised us the most.
- reset tax rates on ordinary income, dividends and capital gains for upper income taxpayers back to 2001 levels
- for upper income taxpayers, include a portion of municipal bond income, pre-tax employee contributions to defined contributed plans, and pre-tax employee and employer health insurance payments as taxable income
- limit non-charitable itemized deductions such as state/local taxes and mortgage interest for upper income taxpayers
The following chart outlines some basic budget scenarios. The CBO baseline assumes that 3 tough decisions are taken: Bush tax cuts all sunset back to 2001 levels, the AMT is no longer indexed to inflation, and Medicare reimbursements to doctors are cut. The CBO also provided an Alternative Case, assuming no action is taken at all to reduce deficits. Our Realistic case is an estimate of what would happen if Congress sticks to what it agreed in the Budget Control Act and nothing more. Lastly, the purple diamond is the President’s proposal, as estimated by the Office of Management and Budget.
The President’s budget proposal would get around halfway to closing the yawning gap between CBO Alternative Case and the CBO Baseline. There are elements of the Buffett rule here, but the budget does not contain a minimum tax rate on adjusted gross income on those with AGI over $1 million. Instead, many of the clauses apply specifically to those with AGI over $250k (the numbers shown in parentheses are OMB estimates of revenue raised over ten years).
- Ordinary income rates back to 2001 levels ($442 bn)
- Dividends taxed at ordinary income rates ($206 bn)
- Long term capital gains taxed at 20% ($36 bn)
- Restoration of limits on itemized deductions and exemptions ($165 bn)
In addition, the proposal raises another $584 bn by, among other things, limiting the tax value of itemized deductions (such as state and local income taxes and mortgage interest) to 28%. While this in theory applies to all taxpayers, in practice it will only affect taxpayers with statutory tax rates above 28%, which means people with AGI over $217k.
The most controversial part of the proposal (at least in our view) was buried on page 73 of the Green Book, which is the Treasury’s “General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals”. We were wondering why the Administration estimated the benefit of the above proposal at $584 bn, when the CBO estimated it at $293 bn just last year.
The answer: this proposal includes a new category of taxable income, which would include your municipal bond income, your contributions to 401k plans and other similar vehicles, and your entire health insurance premium (regardless of who pays it). The approach appears to apply a tax rate to these items equal to the difference between your top statutory tax rate and 28%. For example, a taxpayer subject to a top statutory rate of 35% would pay a 7% tax on this income.