But Obama’s plan is a blueprint of sorts for what’s going to happen when federal coffers finally run dry and there’s no choice but to raise taxes—including some that will inevitably hit the middle class.
Budget softies argue there’s no need to worry about a federal money crunch now, since Washington’s annual deficit is falling, the economy’s picking up, and the Treasury can still borrow at remarkably low rates. All true. But barring an economic miracle, the coming crunch is a matter of simple math. The soaring cost of entitlement programs is already crowding out other types of spending, and the mass retirement of the baby boomers is going to drain Social Security and Medicare for good, if nothing changes.
The Medicare trust fund is expected to run out of money first, around 2030. That date sounds sufficiently far in the future that we can stick our fingers in our ears and pretend it will never happen. But there are all sorts of things that could accelerate the budget reckoning, and probably will—rising interest rates, another recession, unexpected costs for a war or some other urgent matter. Or, mere disgust with soaring income inequality and stagnant living standards could trigger new pressure to redistribute wealth from the top (and possibly the middle) downward. In a slowly-improving economy with a rising share of have-nots, it would be foolish to assume Washington can spend beyond its means indefinitely.
Obama and other policymakers — including some Republicans — have provided a useful preview of which taxes are likely to go up first. They’ve targeted those likely to generate the least amount of opposition. Here’s where the pain is likely to hit:
Capital gains and dividends. It seems inevitable that taxes will rise on investment income, since capital gains and dividends accrue to the wealthy more than anybody else and those tax rates are relatively low, historically speaking. Obama likes to point out that the top tax rate on investment income today — 23.5% -- is lower than the top rate under tax-averse President Reagan, which was 28%. It may not go back there under Obama, but it could under his successor.
Some business leaders already seem resigned to higher taxes on investment income. “If capital gains taxes go up, fine,” Jamie Dimon, CEO of J.P. Morgan Chase, recently told the International Business Times. Dimon emphasized he’d only support such a move if it was part of a broader package that included other incentives meant to boost economic growth. What, exactly, will stimulate growth is a matter of some disagreement.
Estate taxes. By calling these “death taxes,” Republicans have won a PR battle over whether they seem fair or not. But estate taxes affect a tiny portion of the population, since they don't kick in until the value of an estate hits $5.4 million. And the maximum estate tax rate has dropped from 77% in 1976 to 40% today. Obama’s latest plan calls for higher taxes on certain estates, which are easy to characterize as trust funds for rich kids. When the crunch comes, that will probably carry the day, and most people will realize that death taxes are a problem for other people, not them.
529 college-savings plans. It’s a surprise Obama wants to scale back the tax savings offered by these plans, which help a lot of middle-class families save for their kids’ education. Obama’s rationale: the tax break benefits wealthy families with money to save more than it does working-class families with little extra income. That’s true, but a lot of families that use 529s don’t consider themselves wealthy at all, and many depend on two working parents. In the future, look for tax-raisers to split the difference by making no change for lower earners but setting income thresholds at which 529 benefits phase out and then disappear.
Gasoline. Even some Republicans, such as Tenn. Sen. Bob Corker, want to raise the federal gas tax for the first time since 1993, because the infrastructure account it’s supposed to fund has been coming up short for years. Congress uses money from other sources to make up the difference. But as money gets tighter, motorists will once again have to fully fund the roads they use.
Paychecks. There are two simple, though unpopular, ways to provide more funding for Social Security and Medicare: Either raise the amount of payroll taxes (FICA) taken out of everybody’s paycheck, or raise the income threshold at which the Social Security portion of that withholding ends. (There’s no income threshold for the Medicare portion.) The most likely tax hike is an increase in the threshold for Social Security tax, which would place the burden on higher earners rather than lower ones.
Right now, everybody pays 6.2% of their income to help fund Social Security, up to the first $118,500 of earnings. On earnings above that threshold, there's no Social Security tax. The threshold rises every year by the average rate of wage growth, which was 1.2% in 2014. But Congress could raise the threshold to any income level -- $150,000, $500,000, $1 million — or eliminate it completely. Higher earners would squeal but if the country really needed the money, it wouldn’t matter.
There are many other tax hikes policymakers will consider — or, put another way, existing tax breaks they may scale back. Big ones include the exclusion of employer-provided health insurance (which is a form of compensation) from income tax, tax deferral on 401(k) plans, and tax deductions for mortgage interest and state and local income taxes. Those are all huge benefits to the middle class, however, and they’re far more politically explosive than tax hikes that start with the rich and filter down to some income level well above the median.
Tax increases, whenever they come, won’t happen alone -- they’ll also be paired with cuts in government spending. Mainstream tax-reform plans call for a ratio of about $2 in spending cuts for every $1 in new taxes. That assures mostly everybody will feel some pain when austerity hits, including middle and lower earners along with the poor, who tend to benefit more from spending programs. Although we don’t know the exact details, everybody ought to plan for the eventuality of tax hikes and spending cuts. Since it’s not happening today, however, most of us won’t.
