Democrats are inching closer to achieving their long-term goal of reforming the federal tax system so that the wealthy pay a higher rate than they do now – or what President Joe Biden refers to as their “fair share.”
The President has pledged to raise taxes only on those who earn more than $400,000 a year and on corporations, and Democrats in Congress have come up with a complicated proposal that does just that – though some Americans who earn less may still be indirectly affected by some of the changes.
Many economists assume, for example, an increase in the corporate tax rate will result in lower wages for workers. And other elements, like a higher tax on cigarettes, would disproportionately affect low- and middle-income households.
House Democrats put forth details of their plan earlier this month, though the proposal remains under negotiation in Congress.
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“Overall, it’s fair to say the proposal did a very good job keeping out those who earn under $400,000,” said Howard Gleckman, a senior fellow in the Urban-Brookings Tax Policy Center.
The tax increases are meant to pay for a massive Democrat-backed spending plan aimed at revamping the nation’s safety net by, among other things, providing paid family leave, making community college tuition free and creating universal pre-K.
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Democratic leaders are planning to push through the package using reconciliation so it would not need any Republican support if the party stays unified. (Congress is also attempting to pass a bipartisan infrastructure bill, which would be paid for without raising taxes but add to the deficit.)
Here’s what we know so far about the tax plan, according to details released by Democrats on the House Ways and Means Committee.
90% of households could have more money in their pockets
Roughly 90% of households won’t see a tax increase during the first year the plan is in effect.
In fact, they will see their after-tax incomes go up, according to an analysis by the right-leaning Tax Foundation. That doesn’t mean each of those households will receive a tax cut, but the average change is expected to be positive.
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Those Americans could end up with more money in their pockets largely due to the expanded child tax credit and other tax credits included in the proposal, like those for green energy.
The Democrats want to make keep the temporary changes Congress made to the child tax credit as a pandemic-related benefit. The enhanced payments send households $3,600 for each child under 6 and $3,000 for each one under age 18 for 2021 – up from $2,000 per child under age 17.
But it’s worth noting the House Democrats’ proposal would only extend the bigger payments through 2025. Plus, West Virginia Sen. Joe Manchin, a key moderate Democrat, is pushing for a smaller credit.
The enhanced child tax credit is fully refundable, making it even more significant for low-income parents. Those making less than $19,500 a year would actually see a 14.5% increase in after-tax income, according to the Tax Foundation.
Currently, heads of households earning up to $112,500 and joint filers making up to $150,000 are eligible for the full enhanced credit.
Smokers could take a hit
The more than 30 million Americans who smoke could get hit with higher prices.
Biden didn’t call for this tax increase, but the proposal from the House Ways and Means Committee would raise the excise taxes on cigars, cigarettes, smokeless tobacco and other nicotine products and then tie the rate to inflation going forward. It would also impose a new tax on vaping products. Excise taxes are imposed on companies, but they typically result in higher prices for consumers.
In this case, low- and middle-income individuals would be disproportionately affected. About 21% of households earning less than $35,000 a year smoke, compared to just 7% of those earning more than $100,000 a year, according to the Centers for Disease Control and Prevention.
If the increase goes into effect, an average pack-a-day-smoker who makes $35,000 a year will end up paying more than 5% of their income on federal and state tobacco taxes, up from 4% today, according to an analysis from the Tax Foundation.
The provision could raise $96 billion in tax revenue for the federal government over 10 years, according to the Joint Committee on Taxation, a nonpartisan congressional group that produces official revenue estimates of all tax legislation.
How taxes would go up for the wealthy
On average, the top 10% of tax filers, or those earning more than $115,800, could see their after-tax income shrink if the plan takes effect, according to the Tax Foundation.
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It would be a small decrease for those earning less than $400,000, amounting to about 0.2%. While those households won’t face a higher income tax rate and won’t be paying Uncle Sam more, their wages could take a hit due to the higher corporate tax rate – which the Democrats’ plan calls for raising to 26.5% from 21% on corporate income greater than $5 million a year.
There is a more significant increase in taxes for those individuals earning more than $400,000 a year and joint filers making more than $450,000. The House plan would reverse a key part of the Republicans’ 2017 tax cuts by returning the top marginal income tax rate to 39.6%, up from 37%. The legislation goes even further and adds a new 3% surcharge on a taxpayer’s modified adjusted gross income over $5 million.
The plan also calls for raising the top capital gains tax, which is generally imposed on the profit made from selling a stock or property, to 25% from 20%, reduce the estate tax exemption, as well as limit the maximum value on the deduction for pass-through businesses.
As result, the top 1% of tax filers, roughly, would see a 5% reduction in after-tax income, the Tax Foundation analysis found.