The 2013 Tax Hike–What You Need to Know

Taxes to rise for everybody in 2013

2013 Federal Tax Hike

(Source: WSJ)

As you’ve probably heard by now, our leaders in Washington have reached an agreement on tax hikes for 2013. While higher rates for the wealthy have dominated the news coverage, the deal reached actually raises tax on all workers.

While most of the tax hikes hit those making more than $1 million a year, the deal reached is more nuanced than a simple increase to tax rates. So here is a quick guide with everything you need to know about the 2013 increase in federal taxes.

Top Federal Tax Rate

The top tax rate is set to rise to 39.6% for couples with taxable income of $450,000 or more and for singles with taxable income of $400,000 or more. This was an increase to President Obama’s proposal of $250,000/$200,000 and a decrease from the Republican’s initial proposal of no tax hikes. The tax brackets remain unchanged for everybody else.

Increase in Capital Gains Tax

Cap gains tax rises from 15 to 20 percent for couples making more than $450,000 ($400,000 if you’re single). This increase makes tax planning all the more important. I tend never to sell investments, so my portfolio generates few capital gains every year. But you’ll want to make sure that any mutual funds you own in a taxable account are tax efficient.

Loss of Personal Exemption and Itemized Deductions

With this change, the new tax laws will affect those making a bit less. For married couples with taxable income of $300,000 ($250,000 for singles) or more, you’ll start to lose the benefit of your personal exemption and itemized deductions. The formula is a bit complicated. I always let my tax accountant handle the calculations. But if you do your own taxes, tax software such as TurboTax rips through the calculations in a matter of seconds.

As a general rule of thumb, the limitation on itemized deductions (known as the Pease provision after Rep. Donald Pease (D., Ohio)) adds one percent to the top tax bracket and top capital gains tax rate.

Increase in Social Security Tax

This is where taxes go up for all workers. Over the past few years we’ve been enjoying a 4.2% payroll tax rate for social security. This was a decrease from the standard rate of 6.2%. Beginning in 2013, the rate is going back to its 6.2% historical level.

Remember that the social security tax is levied on the first $113,700 in wages for 2013 (the number is adjusted for inflation each year). So this tax hits everybody with earned income.

Increase in Estate Tax

The estate tax rate will rise from 35 to 40 percent for estates over $5 million. While this doesn’t affect most of us, it makes estate planning for the wealthy all the more important. There are plenty of ways to avoid this tax for all but the largest estates, so its impact on revenue is minimal.

Now What?

So exactly how much revenue do these tax hikes raise? Good question.

The 2013 tax increases will raise an estimated $610 billion in revenue. Now you’re probably thinking that’s not too bad considering our projected annual deficit before the tax hikes is $1.1 trillion. So we’ll cut the deficit in half, right? Wrong.

The $610 billion in new revenue is over the next 10 years. In other words, the increased revenue is a drop in the proverbial bucket. And even if the Obama plan had been enacted (increasing taxes for joint filers with taxable income of $250,000 or more), the revenue raised would have been paltry.

So at this point you’re no doubt asking why in the world our politicians have been arguing over increasing taxes for the wealthy if such increases have such a miniscule affect on our fiscal crises. Good question.

Reality Check: I’ve been a member of the middle class all of my life. I was in the lower middle class as a child, the middle class as a young adult, and in the upper middle class today. And if there’s one thing I know it’s this–whether by increased taxes, decreased spending, or both, folks in the middle class will be the ones that pay for our profligate spending.

I don’t care if you worship the current administration or loathe it. Republican or Democrat. In favor of tax increases or not. The wealthy, however defined, cannot save us from $16 trillion in debt, $1 trillion in annual deficits, and entitlement programs heading for a real fiscal cliff.

Middle class, gird yourself. As surely as night follows day, we will sacrifice more than anybody to pull us out of our fiscal mess.

27 Responses to “The 2013 Tax Hike–What You Need to Know”

  1. Great synopsis. But “gird yourself” how? Let’s say you’re currently in the middle class, and you;re married with one kid and a home and you’re 30 years old….how do you best “gird yourself” for the next 50-60 years??

  2. The fact that the “[t]he wealthy, however defined, cannot save us from $16 trillion in debt, $1 trillion in annual deficits, and entitlement programs heading for a real fiscal cliff” doesn’t mean that the middle class will have to sacrifice more than anyone to fix this problem. There’s no reason why the wealthy cannot (or should not) bear a disproportionate burden of the financial mess we’re currently in. That taxing the wealthy is not the ONLY solution to this problem doesn’t mean it’s a good first step. Keep in mind that the current plan only raises taxes on the top 0.6%, and only by a couple percent. If we were to, say, raise taxes on the top 2% or 3% or even 5%, and raise them by 20% or 30%, you’d start to see real chunks being taken out of the deficit (especially if we keep making taxes on these top income earners progressive — say with a 30% increase on the top 1%, a 20% increase on the top 2%, and a 10% increase on the top 3%).

    • Rob Berger

      rob, I don’t disagree with anything you’ve said. But there are two problems with the fiscal cliff discussion. First, we’ve spent an extraordinary amount of time arguing over taxes on the top 2 percent when the revenue they will generate is so small compared to our problems. It would be like focusing all of our attention on patching a small hole in the Titanic while ignoring a huge hole on the other side of the ship. It’s all political gamesmanship. And second, we should be solving our problems by growing our economy and reigning in spending. While increased taxes could be part of this solution, they have been given far to much airtime, in my opinion.

    • Im sure that taking 20/30% is no big deal to you since it isnt your money.Obama can spend more money than there is on the earth.He is gonna cure csncer save the earth and stop pain but it’s gonna cost more than we’ve got or Canada’s got or Europe or….

      • Joel,

        Who says it’s not my money? Without going into too many specifics, I would be impacted by the hypothetical tax that I described above. Don’t get me wrong–increasing the top tax bracket by 30% would significantly impact me, but I can do without Starbucks most days, or wait another year or two before getting my next car (or, more likely, get a hybrid or an electric or something with a big tax incentive), or stay at 3 star hotels instead of 4 star hotels on my next international trip. Given the economic pain that so many in our country face, I don’t think that asking the wealthy to make compromises of this sort is wrong.

        Rob Berger,

        I agree that there’s been too much discussion of taxes. In my opinion we need to raise taxes on the wealthy significantly (WAY more than the current agreement does), and then move on to spending cuts. Increasing taxes can be a big part of the solution if we increase taxes more than the nominal amounts that Congress is currently allowing. It seems pretty obviously to me–as someone with a strong economics background–that any solution to this has to include both significant tax increases and spending cuts. I think it’s a shame that we’ve been so stuck on the issue of tax increases that we haven’t really been able to move to spending cuts, but really both need to happen. I also think it’s a whole lot harder to come up with politically palatable spending cuts as it is to talk about tax breaks — if there were easy things to cut, don’t you think that Republicans would be talking about them ad nauseum and not repeatedly insisting that Obama or the Dems give them a list of programs that they are prepared to cut? Nobody wants to be the one blamed for cutting x program, with x being just about any given program that the government spends significantly on.

        • Rob Berger

          I think we’ll have to agree to disagree on more tax hikes. With the new plan, the wealthy pay 39.6 % + 6% state tax (on average) + 1.45% Medicare tax + 0.9% Obamacare tax, for a whopping total at the margin of about 48%. And that doesn’t include the 3.8% Obamacare tax on cap gains and dividends or the loss of personal exemptions and itemized deductions. And we haven’t even begun to talk about the alternative minimum tax or estate tax. At some point the conversation has to turn from taxing the rich to reigning in government spending.

          • Correct me if I’m wrong, but doesn’t 39.6% describe the marginal tax rate, not the effective tax rate? E.g., if you make $1 over the income limit, that dollar will be charged at 39.6% and the rest of your income will be charged at lower tax rates? If that’s the case, a marginal tax rate of 48% sounds scary but actually amounts to something far less — something like an effective tax rate of ~30% (and far less than that for the richest among us, who realize most of their income in capital gains… didn’t Mitt Romney end up paying something like an effective tax of 20% this past year, and only even that much because he voluntarily chose NOT to write off his charitable deductions? How is a society in which hundred-millionaires pay a far lower effective tax rate than people who work two jobs equitable?).*

            So I agree — at some point the conversation needs to turn from taxing the rich to reigning in government spending. But it doesn’t seem like we’re even CLOSE to that point. Like I proposed in my initial comment, we really need to be doing both. E.g., we need to raise taxes on the wealthy significantly (and the middle class less significantly) while drastically cutting government programs. Doing just one or the other isn’t going to get us there.**

            *This is all assuming that tax rate is what matters. I don’t think it is. As someone who pays a ton in taxes every year, but can still afford many of life’s luxuries, my view is that we should not be cutting essential government services to allow me a bigger house or more restaurant meals. At some point, obviously, a high tax rate on high earners becomes inequitable but it doesn’t seem to me that we’re approaching that point in our current society — a society in which the middle class is rapidly disappearing in favor of a powerful moneyed elite and a large impoverished group of citizens who work multiple jobs to make ends meet and do not have access to the same pathways to success available to the upper class.

            ** Technically you could get there ONLY through raising taxes or ONLY through cutting government programs…but the budget issues will require such drastic tax hikes / budget cuts if they are not done in a balanced way so as to destroy our society (e.g., neither an effective tax rate of 70% on the top 1% nor the elimination of social safety net programs will do great things for our society).

    • you are a crackhead- “real chunks taken out of the deficit” LOL!!!!!!!

      as far as a good place to start- how about SPENDING LESS- thats what we all do (no not you, you would rather spend other peoples money).

  3. The table you reference is inconsistent with the text. In the table, income limits defined as taxable income (shown by *). However, in the text, you state the top rate is base off of AGI. Which is correct? AGI or Taxable Income?

  4. Great post! Definitely will refer my family and friends to this post. Although your tone regarding the middle class shouldering the burden for pulling us out of the deficit/debt hole strikes me as a bit strange. You sound a little indignant. Isn’t that the reason for the “middle” class? You don’t expect the lower class to bail us out since they don’t have the means, you also don’t expect the rich to bail us out as that would afford them too much power. So it seems to me the middle class should be expected to shoulder the burden.

    • Rob Berger

      Bo, I didn’t mean to sound indignant. And I agree, it should be obvious that the middle class will shoulder the burden. But the discussion has been so focused on taxing the “rich” that I think we lose sight of role the middle class will play. In the final analysis, taxes on the rich will be at best a footnote in the entire discussion. What would really help us is to grow our economy. Imagine the tax revenue we’d be generating if the unemployment rate were 4.5%.

  5. Until America wakes up and realizes that the only true fair tax is a national sales tax on all goods without any deductions, we will continue in this mess. And cutting spending is a no-brainer…that’s what we do at home when we can no longer afford something. Do away with the IRS gradually over the next 10 years…pass a national sales tax for all. Now how unfair us that… then we all carry the burden …without the rich or poor finding loop-holes! Phase it in and phase out the income tax alltogether.
    Wild idea? It works at home.

    • A national sales tax would be wildly regressive. The poor spend a far greater proportion of their income on sales-taxable purchases than the wealthy, and therefore would be effectively taxed at a far higher rate than the wealthy. Now, does that sound fair to you?

    • Rob Berger

      David, the fiscal cliff deal doesn’t address corporate taxes, and I don’t think they should go up. Record profits are exactly what we want. The last thing we want to do is increase our already unbelievably high corporate tax rates because of strong profits. And remember, the more profits, the more tax revenue under the existing tax code.

  6. “The wealthy, however defined, cannot save us from $16 trillion in debt, $1 trillion in annual deficits…”

    Well they could. You actually CAN fix the deficit by taxing the high income earners. The top 10% pays about 70% of the income taxes. If you double their tax rate then that would close the deficit. Or, if you triple the tax rate of just the top 1% then that would do it. This isn’t realistic proposal, I mean they aren’t going to double or triple peoples taxes. But its not true to claim that you can’t close the deficit by taxing higher income earners. They could, but they won’t.
    Now you can’t ‘fix’ the deficit by increasing taxes 5% on the top 2%. Thats true. But you can close the deficit by doubling or tripling the taxes on the ‘wealthy’ (or high income earners, whichever label you prefer.)

    Since the top earners pay the bulk of income taxes, it makes sense to focus there. I mean you could double the taxes for the bottom 90% and only raise ~$300B a year. But double the taxes for the top 1% and you’d raise around $370B.

    I’m not saying we should tax the rich more. But I’m saying that doing so alone *could* technically close the deficit. Its not going to happen that way. But if you doubled or tripled the effective taxes paid by the top 1-10% then it could fix the budget deficit. Personally I think the increase in capital gains rate is potentially more impactful really. THe very highest earners tend to get more capital gains and so going form 15% to 20% there is a 33% increase. Now Warren Buffet will probably pay 1/3 more taxes. Thats a bigger deal than raising the top marginal income tax rate on someone making >$400k from 35% to 39.6%.

    • Rob Berger

      Jim, I don’t think you can fix the deficit the way you are suggesting. True, you could in theory increase rates to 70% or 80% for the top few percent and increase revenue by enough to cover the deficit. The problem is that if we did that, a lot of people would stop making money in the same way. Why work 70 hours a week if the government takes 80% of what you make? So rates would go up, but revenue wouldn’t.

      Now, you could solve the deficit by raising taxes on everybody. If we went back to the rates in place during the Clinton administration, we’d raise about $550 billion. One could imagine tax increases over and above that amount to raise the remaining $550 billion needed to erase the $1.1 trillion annual deficit.

      But just talking about these numbers is depressing.

      • Rob Berger,

        Is there any evidence that top income earners are actually that rational about money? Sure, economic theory dictates that people will work less hard for their marginal dollar if it’s worth less (as it would be with a 70-80% marginal tax rate), but that assumes people behave rationally. Doesn’t the evidence with top income earners indicate otherwise? Why would someone like Mitt Romney, for example, structure his income such that he only has to pay a ~20% effective tax rate? The man knew he was running for president, desperately wanted to be president, and had hundreds of millions of dollars. He could have easily afforded to pay a 30 or 40 or 50% effective tax rate. He could have afforded to that without changing his lifestyle in the least. Surely, it would have been worth it to Romney to pay an extra couple million dollars if it significantly increased his chance of winning the presidency. And surely, Romney knew that his wealth and effective tax rates would be an issue when running for the presidency.

        In other words, were Mitt Romney a fully rational man, he would have quietly restructured his finances 5+ years ago to ensure that he paid a higher effective tax rate. So why didn’t he? Because people–especially the incredibly wealthy–are not rational about money.

        So, while it’s likely true that raising tax rates on top earners to 70 or 80% will lead to a decrease in top earner productivity — and consequently lower tax revenues — it would only lead to net revenue neutrality if top income earners were economically rational, which they most likely are not. Therefore, raising taxes on top income earners to 70 or 80% will net some (it’s hard to say how much) revenue, even if productivity in this income class drops somewhat.

  7. You talk about the “middle class”. It’s not just taxes which will really hit us hard. It’s QE decreasing the value of each dollar earned. I see it in the grocery store as I pay in cash. I see it at the doctor’s office and pharmacy because we have high deductable health insurance and pay out of an HSA. Those that have a small copay or subsidy or covered physicals won’t notice. Like a frog in hot water. But these have had steady and consistant increases and will continue to. Sale price on butter last year $2 a pound, this year $2.50. Mammogram 3 years ago $97, this year $330. That’s far more than 2%. We’re what you might consider lower middle class and QE is squashing us already. I hate to think what 2013 will be like.

    • Inflation has not been high in the past few years. Food and gas and healthcare have been going up but all sorts of other products are down in cost or flat. And on the other side low interest rates save people money. I pay a lot less on my mortgage now than I did 5 years or 15 years ago.

    • Rob Berger

      Olivia, there’s no question that the Fed has devalued our currency long-term. Inflation is modest today, but wait until the Fed has to unwind all of its purchases. There is no free lunch in this world, and we will pay a hefty price for the Fed’s actions.

  8. I am a lower income Canadian and my pay roll taxes are 25%. My boss makes about 2 and 1/4 times my income and his payroll taxes are 40%. That includes a contribution to the Canada Pension Plan., Unemployment Insurance and the bulk to federal tax. We have free health care and a huge social services safety net and it comes at a price that I am prepared to pay.

    We do not have all the deductions that you do (mortgage interest is not tax deductable as an example) so higher income people pay without the opportunities to avoid the tax.

    I have been enjoying all the media coverage of your fiscal cliff and I think that the coming arguments on the debt ceiling will be just as exciting.

    • Rob Berger

      Jane, we like to put on a show for our friends to the North!

      On the debt ceiling, it will be an interesting debate. When President Obama was a Senator, he had the opposite view of the debt ceiling. He fought then President Bush’s attempts to raise it. I guess when you are in the White House, your views change. Understandable.

      Frankly, I think we need to fight over the debt ceiling. It seems to be the only thing that helps us make progress on our debt.

  9. Lucinda

    All I can say is I was pretty upset to see my paycheck has gone even lower than as it has been. What is the easy answer for middle class not to suffer the most? Why parties change their views asap they enter the white house? Are we really in a democrat world or something empowered by the rich only.

  10. Rob Berger,
    I am curious to see what you define as the middle class, both the lower and upper limits. I agree with you that ultimately the cost will most likely be paid by the middle class (as it has historically) but I am in agreement with rob that both a change in taxation of the higher earners and a spending decrease would ultimately be a better solution for the current crisis. However, more than likely you are correct given our culture and political climate.

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