A Revised Note: What is the Appropriate Tax-Base for President-Elect Obama's High-Income Household Tax?

Abstract

President-elect Obama has proposed taxing high-income individuals and using the funds to improve the solvency of the Social Security and Medicare Trust funds. Existing taxes, used to fund Social Security and Medicare, have only been applied to wages. Current proposals have been vague about what type of tax base might be used in the new tax. This note utilizes data from the Survey of Consumer Finances to compare potential advantages and disadvantages of a wages-only tax base proposal to a broader tax base proposal. The statistics from the Survey of Consumer Finances indicate a disproportionate number of high-income tax payers are dual-earner households and/or receive multiple types of income. The analysis shows a broad-based tax concept is more efficient than a wages-only tax concept for higher income households. Estimates presented here indicate the tax base for a tax based on broadly defined household income exceeding $500,000 could be 28 times larger than the tax base for a tax based exclusively on household wages over $500,000. The tax base for a broad income tax over $250,000 in broadly defined household income is around 2.5 times higher than the tax base for household wages over $250,000. The broad income tax base allows for lower marginal tax rates, limits incentives for reduced labor force participation among two-income households, and less tax avoidance than a wages-only tax base. President-elect Obama's proposed new tax is not a particularly liberal idea. The new tax is essentially a flat tax with a very high income threshold. Expansion of this tax could at some point stimulate discussion on ways to reduce marginal tax rates for the general income tax. A second related issue involves whether the new tax should result in increased Social Security benefits for impacted households. It is likely greater bipartisan support for this new tax could be obtained by linking the new tax to elimination of limits on contributions to Roth IRAs. Increased eligibility for Roth IRAs would also prove more effective at stimulating additional retirement savings for households near the tax threshold who were likely hurt by the recent market downturn.