Upper Class Tax Cuts Would Leave Middle Class Bleeding

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Published June 14, 2011

| Daily Finance

On the surface, the national deficit doesn't seem all that complicated: In May, America's debt slammed against its officially set limit of $14.3 trillion, and almost everyone agrees that the federal government needs to come up with a lot more money. But when it comes to the question of how to raise that money, things get a lot more complicated -- and political.

Generally speaking, Republicans want to cut taxes and slash expenses, while Democrats want to raise taxes on the upper income brackets and preserve social programs. The Republican approach certainly has its attractions: Nobody likes paying the tax man, and there's something remarkably grown-up and responsible-sounding about phrases like "protecting future enerations" and "tightening our belts." 

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But under scrutiny, it starts to look like these lofty goals may conceal another agenda, as the proposed cuts in taxes and spending are likely to benefit the wealthy, while placing an out-sized burden on the country's poor and middle class.

Historically Low Taxes

The current top tax rate is 35%, a level that infuriates some Republicans -- notably U.S. Rep. Paul Ryan (R-Wisc.). In his controversial budget proposal, Ryan suggested dropping the top rate to 25%, effectively slashing income taxes on the wealthy by 10%. 

This, of course, would lead to a massive cut in revenue, but Ryan has proposed methods for replacing the money -- namely, a repeal of President Obama's health care plan and drastic cuts in Medicaid and Medicare. While some Republicans have criticized Ryan's plan -- and its out-sized impact on the non-wealthy -- his push for a 10% cut on taxes for the rich is a boilerplate platform plank in Republican budget proposals.

Even apart from the question of whether or not the wealthiest fraction of the country need a 10% tax cut, the loss of health care benefits are likely to brutalize many in the middle class. Perhaps this is why Ryan's proposed cuts to Medicare wouldn't affect people who are currently 55 or older -- a group that would be likely to wage a fierce lobbying battle against any cuts to their benefits. Even so, a recent poll showed that 72% of respondents preferred increased taxes on the rich over cuts to Medicare.

For that matter, it's not clear that repealing the Obama's health care plan would actually save money. According to a recent analysis by the Congressional Budget Office, it is impossible to predict the economic effect of Obamacare: While Republicans insist that the program will be fiscally devastating, some economists argue that it could actually increase federal revenues.

Health care cuts aside, Republican griping about income taxes seems odd, if only because today's top tax rate is close to an all-time low. In fact, since 1917, the highest bracket has only been lower two times: from 1925-1931, it hovered between 24% and 25%, and from 1988-1992 it fell to between 28% and 31%. But for the majority of the 20th century, the top rate was 50% or higher. In fact, during World War II, it hit a high of 94%.

Capital Gains and Dividend Taxes

In addition to a surprisingly low top tax rate, America's wealthiest citizens can take advantage of a variety of loopholes, deductions and incentives that further slash their payments into the public coffers. In fact, according to the IRS, the 400 richest people in America paid -- on average -- only 18.11% of their income in taxes in 2008. By comparison, people who make $34,500 pay a comparatively hefty 25% of their income in taxes before deductions.

One way that the ultra-wealthy can cut their tax burden is by taking advantage of incredibly low capital gains and dividend taxes, which enable them to pay a mere 15% of their profits from stock holdings. A look at the finances of Ralph Lauren, CEO of Polo Ralph Lauren (RL), offer a good example of how this works: Listed as the sixth-highest paid CEO by Forbes, Lauren made $43 million in base pay in 2010. Before deductions, this would be taxed at 35%, the same rate paid by someone who brought home a comparatively paltry $374,000. In other words, Lauren probably paid the same tax rate as his dermatologist.

But base pay is only a fraction of Lauren's income. He also owns about $3.42 billion worth of stock in his company. In 2003, President Bush lowered the top capital gains rate to 15%, meaning that, if Lauren were to sell shares that he had held for at least a year, he would pay taxes on his profits at the same rate as someone who makes $8,400 per year. In 2010, he did just that, selling $850 million in shares -- and paying just 15% on the proceeds.

Lauren's company also pays dividends on its stock: In 2011, they are expected to reach 80� per share. For the famed designer's 25.9 million shares, this could come to as much as $20,720,000, which would also be taxed at 15%. The same, incidentally, goes for every other investor -- from Warren Buffett to Bill Gates -- who has held a share of stock for more than 60 days.

The Rich Get Richer and the Middle Class ...

The Bush-era tax cuts are now set to expire in 2013, but -- as the December 2010 budget battle showed -- they could be extended indefinitely. In the meantime, many of the country's richest citizens are paying a smaller tax rate than its poorest, and programs that are designed to keep the middle class from slipping into poverty are coming under withering attack from the right.

With federal finances stretched to the breaking point, belt-tightening sounds like a great idea. The trouble is, Republican proposals basically demand that only the bottom 98.2% of Americans need to cinch their bellies, while letting the top 1.8% -- those who make more than $250,000 -- take a bigger bite from an ever-shrinking pie. Critics of capital gains and dividend taxes argue that these levies force the country's richest citizens to pay taxes twice on the same profits -- once when they earn the money that they invest, and once again when they sell their stock or receive dividends from it.

Then again, with millions struggling to make ends meet, it's hard to find tears for America's wealthiest stockholders.

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