Politicos push taxpayers toward 50% cliff

If Congress stays as cocked up as it been in the recent past, high earners in states like Wisconsin and Minnesota could achieve the dubious distinction of paying more than half of their incomes to state and federal government in 2013.

Without Congressional action and a presidential signature, many tax breaks for individuals and businesses expire at the end of 2012, and the combination of all those expirations could jack combined rates above the 50% mark.

Further, rates would rise for all taxpayers, not just the “one percenters.”

You’d think the negative effects on a struggling economy might scare the bejeesus out of congressmen seeking reelection this fall, but the level of dysfunction in our polarized capitol suggests the expirations could happen. It could be complete gridlock prior to the November elections and then paralysis in the lame duck session prior to new members taking office in January.

Here’s how a high earner could get to the magic 50% bracket:

• A married couple with income of $250,000 (they could own an LLC or an S Corp. where the business income flows through to them) would see their federal rate go from 33% or 35% to 39.6% on Jan. 1. For comparison, President Obama paid 20.5% to the IRS last year and Mitt Romney paid 14%. Some 40% of the population paid zip.

• Add on another 3.8% for a couple with mostly passive income (interest, dividends), a new tax come 2013 to pay for Obamacare.

• Add on the maximum 7.75% rate in state taxes in Wisconsin or 7.95% in Minnesota, meaning a net of about five add-on points after deduction from federal taxation.

• Add on 1.45% for the Medicare tax for each earner.

• Assuming the current two-point tax break goes away Jan. 1, add on 7.65% for the employee share of Social Security for income up to $110,000, or up to $220,000 if both spouses make more than that base amount or more. (You could argue that the employer share of 7.65% is also really a tax on the employee.)

Without the employer share of the Social Security tax, the stack-up in state and federal income-based taxes can accumulate to as much as 55%.

The same couple also pays a 5.6% sales tax in Southeastern Wisconsin. So if they spend half of their income on consumables, that adds another 2.8 points in state taxes.

And, at the local level, let’s assume they pay $5000 in property taxes, another two points before state and federal deductions, or at least one point on a net basis.

Add it all up, and our “rich” couple could be paying nearly 60% in taxes at all three levels.

Of course, such a couple will avail themselves of whatever legal loopholes are available, such as the deduction of mortgage interest and charitable deductions. But, in truth, unless you are super rich, there aren’t all that many loopholes available.

Romney and Warren Buffet avail themselves of the low 15% rate on dividends and capital gains to keep their percentages low, which is why Buffet’s proposal for a flat tax of 30% on the super-rich makes sense in terms of equity, if not in terms of investment stimulus.

There are cliffs out there for corporate and estate taxation, as well. (More on that in later blog.) Suffice to say that the level of uncertainty about where the nation’s tax policies are going could be at an all-time high. That takes some of the perceived upside out of a lot of investments.

Every economist and business person would agree that such uncertainty curtails investment — just what we don’t need as a nation amidst a painfully slow recovery.

Every financial advisor is sending out red alerts to their clients, urging them to take defensive action on what could happen in 2013. Said one, “We’re all playing a wait and see game until the elections.” President Obama would like to see the Bush tax cuts reversed for high earners, meaning a reversion to the 39.6% rate, while Romney would keep them in place, at a minimum.

The obvious defensive answer for our rich couple is to maximize income at 2012’s lower rates and push deductions into 2013. Another is to move income from passive to active, where possible, to avoid the new 3.8% Obamacare tax.

And, if they own a business, they are surely considering switching to a C corporation to avoid the 39.6% hit.

So, confusion, uncertainty and tax-driven decision making are the order of the day, at the expense of investment-driven decisions.

In the face of such turmoil, you would think Congress could get to some bipartisan compromise. Don’t bet on it.

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