In many ways, the November election is shaping up to be a fight between different visions of America's economy. To prepare for the battle, the Republican party has lined up two of its biggest economic warriors: Mitt Romney, a former Wall Street money man, and Paul Ryan, the party's most famous number-cruncher. Together, the pair hopes to offer a sustainable, prosperous vision of the future, a "Path to Prosperity," to borrow the title of Congressman Ryan's famous budget proposal.
While it is unclear how much of Ryan's proposal will ultimately be enacted if he and Romney win, there's no question that his suggestions for lower taxes and drastically scaled-back services has informed much of current Republican economic thought. What has been less discussed, however, is how his suggestion would affect the average middle class family -- and whether or not they would be better off in a Romney-Ryan America.
A Pretty Decent Tax Cut
Let's start with where we are right now. The average American household has 2.6 people and lives on just under $50,000 per year. Under the current tax code, it pays 10% of its income up to $17,400 and 15% of everything above that. After the standard deduction of $11,900, this comes to $4,845 in base taxes, not including exemptions and tax credits.
Ryan's plan streamlines the tax code, condensing the current six tax brackets into just two: 10% and 25%. The plan doesn't specify where the cutoff line between the two brackets would lie, but it seems reasonable to expect that it would stay somewhere near where the 25% bracket currently hits in, at $70,700 for a married couple filing jointly.
If that was the case, and if the standard deduction stayed the same, the average household would see an immediate drop in its base tax rate. A couple filing jointly would pay $3,810 -- a savings of $1,035 when compared to their base tax rate under the current code. While not the stunning $265,000 that the average millionaire household would save under the Ryan plan, it is nonetheless a nice chunk of change.
Ryan's tax cuts for the wealthy would leave a big hole in the budget, but he argues that the shortfall could be filled by cutting some of the tax code's credits, exemptions and loopholes. In a recent interview with Fox News' Britt Hume, Ryan claimed that this would primarily affect rich taxpayers: "What we're saying is get rid of special interest loopholes and deductions that are uniquely enjoyed by the wealthy so we can lower tax rates for everybody."
In other words, Ryan claims that his plan would reduce tax breaks for the wealthy in order to cut taxes for the poor and middle class.
Quiz: The Economy and the Tax Gap in the United States
What Paul Ryan's Budget Plan Would Mean for an Average Family
Answer: C. Thanks in large part to the exceedingly generous 15% capital gains and dividend taxes, most of the super-rich pay a lower tax rate than middle-class filers making $69,001 per year.
C. $5.12 million
D. $10 million
Answer: C. In 2001, the estate tax exemption topped out at $675,000, and the top rate was 55%. Today, the exemption is $5.12 million, and the top rate is 35%. Side note: $5.12 million represents the average yearly earnings of over 103 households – none of whom would get a 100% exemption on their taxes.
Unfortunately, though, eliminating tax shelters and other upper-class tax benefits would barely make a dent in the massive revenue cuts Ryan is proposing. To fill that gap, the Bipartisan Policy Center recently pointed out, the tax code would need to eliminate nearly every exemption -- including those enjoyed by poor and middle class workers. These include dependent exemptions, child tax credit, education credits, mortgage deduction credits, and other exemptions that bring down the average family's total tax burden.
These exemptions aren't minor. After getting all their deductions, the average family currently pays an effective federal income tax rate of roughly 3.3%, or $1,650. (Though of course, that's not the full tax rate: the effective total federal tax rate for an average middle-income family is 14.3%)
With all exemptions and credits removed, that turns the $3,810 tax bill that Ryan's plan proposed as a net savings for you into a $2,160 tax hike.
Admittedly, this is an extreme scenario. However, Ryan has said his tax code revision would be revenue neutral -- and based on his explanation of how to get us there, the only way the math adds up is if all our tax breaks get the ax.
Cuts in Services
But even if a Ryan plan could be devised that preserved all the exemptions, deductions and credits the middle class enjoys today, his plan would still have a major impact on middle class finances. It calls for roughly $4 trillion in budget cuts over 10 years. Because big ticket items such as spending on Social Security, defense and interest on the national debt are protected, most of these cuts would come out of the one-third or so of the budget that's labelled "discretionary" programs.
The Ryan budget talks about these cuts in very vague terms, but a veritable army of economists have devoted themselves to determining how they would actually play out. The general consensus is that most of the savings would come out of basic federal services. Washington Post reporter Brad Plumer has broken this down to a few simple numbers: Among other things, he argues that under a Ryan budget plan, transportation spending would be cut by 25%, assistance to the poor by 16%, and education and social services by 33%.
These cuts would hit middle class families hard. In vague terms, they would translate into dozens of costly problems, including driving delays as road repairs are put off, food poisoning outbreaks as more food goes uninspected, and a thinner safety net during job layoffs and other emergencies. On a broader scale, it also seems likely that many families would have to increase spending on necessities like their children's education and car repairs as the quality of essential government services would plummet.
And Then There's Medicare
Ryan's boldest plans have revolved around Medicare. His most recent proposal calls for insurance companies to make yearly bids, in which they would offer competitively-priced health care plans. The government, in return, would agree to fund the second-cheapest plan, and would allow retirees to enroll in it for free. For insurance over the level of that baseline plan, retirees would have to pay out of pocket.
Under Ryan's proposal, the cost for a person to enroll in Medicare would fluctuate every year, as the baseline insurance plan price and level of coverage would change. It's worth noting, however, that getting that privatized Medicare at the current level of coverage would have cost the average person an extra $64 per month in 2009, a significant amount of money for a middle-class retiree on a small fixed income. (And that will be a lot of people: 60% of workers have less than $25,000 saved for retirement.)
Ultimately, Ryan's economic plan might offer a slight tax break off the top for the middle class, but any savings would be wiped out by the loss of deductions and a big jump in the amount of money that taxpayers would have to spend to educate their children, fix their cars, deal with e. coli outbreaks, and handle all of the other services that the federal government would no longer provide. And, if anything was left over, they would be well-advised to set it aside for old age, when Ryan's proposal could leave them struggling to pay for health care.
In other words, Ryan's tax cut is a great deal -- if you don't actually rely on the federal government for anything.
Thanks Mitt and Newt: A Dozen Tax Tips for the Rest of Us
What Paul Ryan's Budget Plan Would Mean for an Average Family
If you think Romney and Gingrich disagree about undocumented immigrants, their tax returns suggest that they're polar opposites when it comes to investing in municipal bonds to earn tax-free interest.
The former speaker's 2010 return shows he earned $10,754 of tax-free interest, compared to $26,655 of the taxable variety. Romney's forms show just $557 of tax-free interest and $3,295,727 of taxable interest income.
Remember, to figure the taxable-equivalent yield of a tax-free bond, divide the tax-free yield by 1 minus your marginal tax rate. Since Gingrich's marginal rate is 35%, a 3.5% tax-free yield is worth the same as a 5.38% taxable yield (3.5/0.65). Romney was hit by the alternative minimum tax in 2010, so his marginal rate was 28%. Avoiding a 28% tax makes a 3.5% tax-free rate equal to a 4.86% taxable yield (3.5/0.72).
When you buy your principal residence, points you pay to get your mortgage are fully deductible on your tax return for the year you close. When it comes to a second home (or a rental property or a refinancing), however, that cost must be amortized over the life of the loan -- 1/30th a year if you have a 30-year mortgage, for example. That can lead to relatively small -- and relatively easy-to-forget -- write offs.
But if you follow Gingrich's example, you won't miss this tax break. His return shows a $19 deduction for a portion of the $2,261 it cost him to refinance the mortgage on a rental property he owns in Whitehall, Wisc. Since the refi was in October, 2010, he got to write off one-fourth of 1/30th of the cost on that year's return.
Anyone planning a substantial charitable gift this year should take a page from Romney's playbook and consider donating appreciated securities rather than cash.
As long as you have owned the asset for more than a year, you get to deduct the full fair market value of the gift, not what you paid for it. (And neither you nor the charity ever has to pay tax on the appreciation that accrued while you owned the stock.)
Romney's 2010 return shows that he and his wife, Ann, donated $1,525,167 in cash and another $1,458,807 in non-cash gifts -- much of it appreciated stock in Domino's Pizza.
Even if you don't itemize deductions, you can write off alimony paid to an ex-spouse ... as long as you also include the ex's Social Security number so the IRScan make sure he or she reports the amount as taxable income. Gingrich fulfilled that requirement and deducted the $19,800 he paid his ex-wife in 2010.
Tax law allows you to deduct the loss on a stock that becomes worthless, treating it as though you sold it for $0 at the end of the year in which it lost all value. That appears to have happened to at least one of Mitt Romney's investments. His return shows a $63,511 loss on shares in an investment fund that were disposed of for $0.
The stock market meltdown of 2007-2009 was not kind to Mitt Romney. He suffered losses so serious that, even after wiping out all of his capital gains, he carried $4,844,089 of long-term losses over to his 2010 tax return.
Remember, losses are used to offset gains dollar for dollar, but then only $3,000 of excess loss can be deducted against other kinds of income such as salary or interest income. Any excess is carried over to the next year. On his 2010 return, Romney used nearly $5 million of such losses to offset gains that would have otherwise been taxed at 15%, saving him $726,613.
If you had carryover losses on your 2010 return (as the Gingriches did), be sure to revive them when you complete your Schedule D this spring.
Congress has created special rules for what it calls "passive activities," a group that includes most investments in real estate and limited-partnerships.
Basically, losses from such investments can only be deducted against gains from similar activities. There's an exception that allows up to $25,000 of loss from rental real estate to be deducted if you are "actively" involved in the rental.
We don't know if Gingrich is actively involved in the rental in Wisconsin, but even if he was, he would not have been permitted to deduct the $4,646 loss he reported. The $25,000 allowance gradually disappears as adjusted gross income moves between $100,000 and $150,000. With AGIof $3,142,066, Gingrich is out of luck. (He can stockpile the disallowed loss and deduct it when he sells the property.) By the way, the Romneys return shows that the passive loss rule blocked the deduction of over $2 million in losses from limited partnerships.
Plenty of politicians have gotten in trouble in the past for failing to pay Social Security taxes for their child-care providers and household help. For 2012, if you pay household help more than $1,800, you are required to file a Schedule H with your return and pay Social Security and Medicare taxes for your employee.
Both Romney and Gingrich included the form and paid the piper for their household help in 2010. Ann Romney reported that she paid four household employees a total of $20,603 in 2010 and paid $3,152 in taxes for them. Gingrich reported that he paid household help $14,774 and paid $2,260 in Social Security and Medicare tax.
The federal income tax is on a pay-as-you-earn system. If you don't pay in enough during the year -- via withholding from paychecks or estimated tax payments -- the IRSwill slap on an underpayment penalty. Generally, you avoid the penalty if your payments during the year are at least 90% of what you owe. Gingrich owed an extra $382,734 when he filed his $2010 return, 38% of his tax bill for the year. That triggered an underpayment penalty of $1,543.
The opposite side of the coin from the underpayment penalty is paying in too much doing the year. About 75% of all taxpayers are in this boat, and get tax refunds every spring. We think that's silly, and have a calculator to help you match withholding from your paychecks to what you'll owe for the year. Our calculator won't help Romney, though, since he has no wages from which to withhold. He overpays via quarterly estimated tax payments, and boy does he overpay! His 2010 return shows that he paid in $1,609,441 more than the $3,009,766 that he owed. He didn't ask for a refund, though. He let the IRSkeep the cash as a down payment on his 2011 tax bill.
For 2010, the 6.2% employee share of the Social Security tax applied to the first $106,800 of wages. (The wage base is $110,100 for 2012; the rate is 4.2% for January and February and will jump back to 6.2% if Congress fails to extend the payroll tax holiday.) If you work more than one job and your combined salary exceeds the wage base, too much tax will be withheld from your pay. That happened to one of the Gingriches in 2010, so they claimed a credit of $367 to reclaim the excess tax withheld.
A special rule allows qualifying self-employed workers to deduct 100% of their medical insurance premiums, even if they don't itemize deductions. That might have helped Romney, who reported that he paid $14,176 in self-employed health insurance premiums in 2010. But he didn't get the tax break. Rather than claim the special deduction, Romney reported the premiums as medical expense on Schedule A, where a deduction is allowed only to the extent such expenses exceed 7.5% of adjusted gross income. Romney's $14,176 of premiums fell well short of $1,623,488 (7.5% of his AGI).
If you use vehicles in your small business, how and when you deduct for the business use of those vehicles can have significant tax implications. It pays to learn the nuances of mileage deductions, buying versus leasing and depreciation of vehicles. Special rules for business vehicles put in use in 2017 can deliver healthy tax savings.
Some common income tax deductions that can lower your annual taxes include mortgage interest, state and local property taxes, charitable contributions, and non-reimbursed work expenses. Find deductions that you are eligible for with help from TurboTax in this video on annual tax filing.
Under new rules that took effect in 2010, you can convert a traditional IRA into a Roth IRA no matter what your income is. If the conversion turns out to have adverse tax consequences, you'll have plenty of time to reverse the whole transaction, but only for tax years prior to 2018.