Payroll Taxes
Still worried about the fragility of the recovery, in September 2011 President Obama asked Congress to double down on the payroll tax holiday, requesting not only that the two-percentage-point employee payroll tax holiday be extended through the end of 2012 but also that the employer portion of the payroll tax also be cut by two percentage points. In addition, he asked that emergency unemployment benefits be extended through the end of 2012. After much negotiation, in February 2012, Congress passed the Middle Class Tax Relief and Job Creation Act of 2012, which extended the cut in the payroll tax for employees through the end of 2012 but did not expand the tax cut to include employers.
If the payroll tax holiday expires at the end of 2012, payroll taxes would rise by $127 billion in 2013.
Other Tax Provisions and Depreciation Benefits
A host of small tax credits and exemptions are either due to expire at the end of 2012 or expired at the end of 2011 but have lagged effects on tax revenues. Most of them are small; the largest tax feature is partial expensing of capital spending, an investment stimulus granted through more generous depreciation provisions. If these tax features are allowed to expire at the end of 2012, taxes (mostly on business) would rise by $87 billion in 2013.
Estate Taxes
Federal estate taxation changes so much, it is hard to keep track. The estate tax disappeared in 2010 only to reappear in 2011. If current law is not changed, in 2013, it will revert to its form from 2000. The maximum tax rate would go up from its current 35% to 55%, while the exemption amount would fall from $5 million to $1 million. The result would be an estimated increase in tax liabilities of about $30 billion for 2013, nearly all of which would be paid in 2014.
ACA Taxes
In 2010, Congress passed and President Obama signed into law the Patient Protection and Affordable Care Act, or ACA for short, which has been nicknamed "ObamaCare." This long and complex law was designed to extend medical insurance to the uninsured, overhaul medical sector regulations and control medical costs. To fund the program, a series of tax increases is scheduled, starting in 2013.
Currently, the Hospital Insurance (Medicare) payroll tax is a flat 2.9% on all employee wage and salary income. For Medicare, unlike Social Security, there is no cap on taxable payroll income. The tax is shared equally by employers and employees, who each pay 1.45% of payroll. The self-employed pay a full 2.9% on their earnings, but they are allowed to deduct half of that from their income taxes. Starting in January 2013, taxpayers making an adjusted gross income (AGI) of more than $200,000 for an individual or $250,000 for a couple will have to kick in an additional 0.9% on wage and salary income above those thresholds, taking the top Medicare payroll tax rate to 3.8%. The extra tax is imposed directly on employees, so the top tax rate on employees would rise from 1.45% to 2.35%; employers will not have to pay more nor will they deduct additional withholdings from employee paychecks. The self-employed will experience comparable increases on their earnings over the income thresholds; the new levy is not deductible from their income taxes.
In addition, the new 3.8% Medicare tax will be imposed on investment income exceeding those income thresholds. For example, a couple earning $220,000 in salary income and $50,000 in dividends would pay extra taxes amounting to 3.8% on the $20,000 of investment income over the income threshold of $250,000.
The IRS has not completely clarified what constitutes investment income for these taxes, but we think the following is likely. The new tax would apply to dividends, taxable interest, rents, royalties, net capital gains, the taxable portion of annuity payments, income from the sale of a principal home above certain thresholds, any net gain from the sale of a second home, and private-equity managers' profits on leveraged buyouts ("carried interest"). The tax would not apply to payouts from a regular or Roth IRA or 401(k) plan, pension benefits, Social Security income, annuities that are part of a retirement plan, life-insurance proceeds, municipal-bond interest, veterans' benefits, or small business income.
An estimated 4.1 million households, or 2.4% of Americans, would pay one or both of the new ACA taxes.3 In effect, a new income tax system will come into being, working in parallel with the old income tax.
Moreover, the thresholds for the higher tax rates are not indexed for inflation, so over time, an increasing share of households will be subject to these higher tax rates, a feature it shares with the AMT.