The Rosett Report

Dear Barack Obama: Your Real Marginal Tax Rate for Joe's Dreams = 93%

Barack Obama’s plans to “spread the wealth around” rely on the idea that under his policies, there would still be plenty of wealth to spread. But is this the audacity of bad math? Obama’s promise is that only those who have achieved Joe the Plumber’s dream of making more than $250,00 per year would pay higher taxes, and almost all lower-income Americans would get a bundle of “tax benefits.” Should we believe him? Or is Obama’s tax “Change” a trainwreck-in-the-making?

Below is a letter addressed to a future President Obama. It spells out how Obama’s promises of “Change” would have to drive up the marginal tax rates on Joe’s dreams to 92% — and in the end, the regular Joes would still get soaked. (Full disclosure: this letter came by way of some emails that family and friends have been swapping around; the author is my brother, Joshua Rosett, who has a Princeton Ph.D. in economics and teaches financial accounting at California’s Claremont McKenna College. Discount as you like for family ties, but he’s not a politician making promises, he’s Josh the Economist, trying to figure out what’s about to happen to his income — and I think this is a letter worth sharing):

Dear President Obama,

 

During the campaign you repeatedly said that if I make $250,000 or less, my taxes will not go up by even “one cent.” When McCain called you on this, you mocked him.

 

Therefore, my plan is to stay under $250,000 per year from now on, and to use the 2008 tax code to file my taxes. That will ensure that I do not pay one cent more. Of course, I have the capability to make more and contribute more to our national productivity, but I do not think it will make sense for me to do so. Here is why.

 

First off, let’s assume that you will not raise spending so that we can focus just on taxes.

 

On the campaign trail, you’ve also repeatedly promised $1000 “tax reduction” to 95% of workers and their families ($500 for individuals). It also says this right on your website, here. (“Cut taxes for 95 percent of workers and their families with a tax cut of $500 for workers or $1,000 for working couples.”) Since there are over 110 million households in the lower 95%, this adds up to transfers from the top 1.5% of households (that is how many make over $250,000) to the bottom 95% of maybe $80 billion per year.

 

Evidently the roughly 3.5% of households that make less than $250,000 per year but are above the 95th percentile will get no tax reduction but also not pay once cent more in taxes. That applies to all households in approximately from roughly $150,000 to $250,000.

 

That leaves you with 1.7 million households making $250,000 per year or more. Based on figures for 2005, in total these households make about $562 billion per year. That’s a lot of money! And you only have to take about a seventh of it to pay for your transfer. However, your website also promises to raise their top marginal rate to no more than about 39% (your website says “But no family will pay higher tax rates than they would have paid in the 1990s.” Since the current top marginal rate is 35%, that is an increase of 4%. Assuming that rate only applies to income above $250,000 (otherwise the taxes on those below $250,000 would see their taxes go up at least a cent), that leaves $562 billion – 1.7 million x $250,000 = $137 billion that could be taxed at a rate higher than 35%. 4% of $137 billion is just under $5.5 billion, which is a bit short of the $80 billion needed.

 

So your tax policy alone will result in about a $75 billion shortfall per year compared to our current tax system, which is already running a very large deficit.

 

So what marginal top tax rate would allow you to pay for this transfer? Assuming that those earning over $250,000 are happy to continue working as hard as they do even if you greatly increase the taxes on their earnings over $250,000, the top rate would have to be approximately 58% higher than the 35% rate to pay for the $80 billion transfer to the lower 95% of the distribution. That is, the top rate necessary to pay just for the first item promised under the tax heading on your website would require a top marginal rate of about 93%.

 

OK. So you are only off by about a factor of about 15 on how much you will raise the top rate to pay for the “spreading the wealth around” part of your economic plans. No big deal.

 

There is just one problem with this. If you tax every dollar of earnings above $250,000 at 93%, no one will bother working to make more than $250,000. Suppose you are able to earn $125 per hour (just about enough to make $250,000 per year). If you get to keep 7% of that, after tax earnings on each dollar above $250,000 would fall to $8.75 per hour. Do you think people in that tax bracket will do a lot of extra hours at $8.75 per hour?

 

But of course you promise a lot of additional tax cuts on your website: “Provide generous tax cuts for low- and middle-income seniors, homeowners, the uninsured, and families sending a child to college or looking to save and accumulate wealth.”  Hard to say how much more you will have to raise the top rate to pay for this, since you don’t define “generous”. So let’s call it 7% on top of what we figured above. That would provide an additional $9.5 billion per year to pay for all of the other generous tax cuts you propose. However, it also brings the top rate to 100%. It’s not too wild a guess to say that no one earning $250,000 per year will do additional work if they get to keep none of the additional money they earn.

 

Then you also promise a lot of additional spending. Estimates are a trillion dollars over the next four years. So let’s be conservative and call it $200 billion per year. How much more do we need to raise the top rate to pay for this? Well, if we stick to just the household income above $250,000 per year, the top marginal rate necessary to bring in $289.5 billion ($80 billion for the transfer + $9.5 billion of other generous cuts + $200 billion in new spending) is 246%. However, you can’t raise the rate beyond 100% (at least, I don’t think you can), so perhaps you can start taxing income below $250,000 per year to pay for this additional spending. So you will quickly discover that you will have to raise taxes on maybe just a few more people. Maybe even everyone who actually currently pays income tax.

 

Hence I plan to hold you to your word, make no more than $249,999 per year, and pay using the 2008 tax schedule to ensure that I will not pay one cent more than before.

 

Good luck balancing your budget.

 

Best wishes,

 

Joshua Rosett

Professor of Economics and Accounting

Claremont, CA

 

 

[Ed. Note: As initially posted, the calculations above pointed to a 92%,  marginal rate on Joe’s ambitions. Adding in some additional relevant information, that turned out to be optimistic — as explained in the revised text above, Joe’s marginal rate would actually come to 93%.]