In the debate over the effect of the expiring Bush tax cuts on small business, it’s already possible to do the math. And the Obama administration is pointing to the tax savings that all small-business owners would reap from its own plan to extend the cuts at all but the highest income levels — if, that is, the alternative is letting the cuts expire altogether.
That, of course, is because federal tax rates are marginal tax rates — they apply only to the additional dollars above the next-highest tax bracket. In other words, a person in the 25 percent tax bracket isn’t paying a 25 percent income tax, but paying (for 2010) 10 percent on the first $8,375, plus 15 percent on the next $25,625, and finally 25 percent on any income over that. (For someone making $50,000, the effective tax rate is actually 17.4 percent.) So if President Obama’s plan becomes law, while the top two brackets rise, the remaining four brackets will stay at their depressed rates, and people in the top brackets will pay less in taxes on the share of income that falls within those lower brackets.
President Obama himself tried to highlight this point in his recent press conference. “And by the way,” he said, “for those who make more than $250,000, they’d still get tax relief on the first $250,000; they just wouldn’t get it for income above that.”
So how much money would a top-brackets taxpayer save under the Obama plan compared to doing nothing and simply letting the tax cuts expire? The Tax Policy Center has a handy Tax Calculator to determine just that. Let’s invent a hypothetical small-business-owning taxpayer. To keep things simple, we’ll assume our entrepreneur is married but has no children, and that each spouse earns $50,000 in salary, and that the couple together earns $200,000 in business income. (In reality, only the total income matters, not the mix of salary and profit.) We’ll also forgo other sources of income and deductions.
Under the Obama administration’s proposal, that couple would pay $72,027, or $9,000 less than if all the tax cuts expire. On the other hand, if all the tax cuts were extended, they would owe $70,610, or $1,417 less than under the administration plan.
If the taxpayers earn $500,000, their tax liability under the Obama plan rises to $149,742 or almost $11,000 more than with all the cuts extended. (But a little over $9,000 less than if they all expire.)
You, too, can calculate how much you would pay under the administration proposal compared to the current law, or current law compared to letting all the tax cuts expire. One caveat, though: because Congress has not yet enacted the annual alternative minimum tax “patch” that indexes the A.M.T. exemption to inflation, the patch is not included in the calculator’s current law calculations. It is included in the administration proposal, because permanently fixing the A.M.T. is part of the administration’s proposal.
Congress, though, is likely to pass an A.M.T. patch regardless of the tax cuts, so this creates a somewhat unfair comparison. The Tax Policy Center is hoping to fix that soon, but in the meantime, most people will get a more accurate comparison looking at “Regular Income Tax After Credits” near the bottom of the results, rather than “Tax Liability” near the top. It’s not a perfect fix for everyone, though, because some people would owe the alternative minimum tax even with the patch in place.