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Tax Cut Myths: Fact Checking The Showdown

BERNARD CONDON   12/ 3/10 03:51 PM ET   AP

Taxes

NEW YORK — As debate rages on extending tax cuts set to expire at the end of the year, politicians are making misleading statements about who might be hurt or helped.

Before the midterm elections, President Barack Obama insisted that lower income-tax rates should be permanently extended only to those he called the "middle class." People in the top two tax brackets would face higher rates. Now, with Republicans triumphant, the White House is trying to hash out a compromise so rates don't automatically revert to their higher, pre-2001 levels for everyone in the new year.

One possible deal: extending all the lower rates for a yet-undetermined period of time, perhaps two or three years.

Time is running out, as is patience. In a purely symbolic vote, House Democrats on Thursday passed a bill extending lower rates for everyone but those in the top brackets. House Republican leader John Boehner said the vote ran counter to efforts to forge a deal, dubbing it "chicken crap" political maneuvering.

Here are a few myths, half-truths and short-hand distortions that have marred the debate:

_ Under the Obama plan, taxes will increase for families making more than $250,000.

Wrong. Actually, a family could make a lot more and still not face higher taxes. Obama wants to raise the top two brackets from 33 percent to 36 percent and from 35 percent to 39.6 percent. The first of the two – 36 percent – is widely assumed to kick in at $250,000. Obama says that himself.

But that's not right. The higher rate would apply to families with $232,000 or more of taxable income, or what's left after personal exemptions and deductions have been subtracted from income. Deductions can be sizable, especially for wealthy people. Think state and local taxes, mortgage interest and charitable contributions. The result is that a family making $300,000 or even more could have taxable income of less than $232,000.

"A lot of people making more than $250,000 won't be paying higher taxes," says Clint Stretch, a managing principal of Deloitte Tax.

So where does the $250,000 come from? That's a number for "adjusted gross income," which is total income minus a few things like 401(k) contributions and alimony payments.

A family that had adjusted gross income of $250,000 and took two personal exemptions, plus a standard deduction instead of itemizing, would have taxable income of $232,000.

So $250,000 is distorting. It refers to adjusted gross income, not total income. And most people in that income range itemize their deductions.

The key number for families is taxable income of $232,000; for individuals, it's taxable income of $191,000. Only 2 percent of U.S. households would face the 36 percent tax rate, according to the nonpartisan Tax Policy Center, a Washington think tank.

_ Tax hikes would prevent small businesses from hiring.

Well, maybe. But the numbers cited as proof are flimsy at best.

Critics say Obama's plan to raise taxes on the highest earners would hobble the businesses that generate most of the nation's new jobs. Yet fewer than 3 percent of small businesses produce enough income to face the higher rates, according to the Tax Policy Center.

Some Republicans note that this tiny slice accounts for half of total small-business income. So the damage to the economy would be more than you'd think, they say. But many of these businesses aren't what most people would consider small anyway.

The IRS doesn't have a category of tax filers called "small business." Analysts who study taxes use the next best thing, which isn't very good at all: business owners who use their personal 1040 to file taxes instead of a corporate return.

For example, some hedge funds and law firms pay their taxes through the personal returns of their individual partners. While these are lumped in as "small businesses" and would pay higher taxes, they are far different from the retail stores and small manufacturers that most people associate with the term and which would not pay higher taxes.

_ Keeping Bush's tax cuts for the top earners would swell U.S. debt by $700 billion, unconscionable in an age of budget-busting outlays.

Somewhat misleading. The lower tax receipts would accumulate over 10 years – not one year. On average, that means $70 billion less for the government each year, or about 1/30th of all federal receipts.

_ Bush tax cuts for millionaires average more than $100,000 a year and should be eliminated.

Misleading, again. The term millionaire can include people making tens of millions or even billions. Their tax breaks are much larger. An average doesn't capture the benefit for most millionaires. According to Deloitte Tax, a typical family making exactly $1 million pays about $50,000 less each year in federal income taxes than it would if the Obama plan were rejected and the tax cuts expired.

_ The rich would pay 36 percent or more of their income in taxes under Obama's plan.

Wrong. A rich family would pay 36 percent – and 39.6 percent – only on taxable income above $232,000. The family would continue to benefit from the other four brackets established earlier this decade – 10 percent, 15 percent, 25 percent and 28 percent – on taxable income below $232,000.

A family with taxable income of $350,000 would pay a higher rate on $118,000. The family would pay $42,480 in taxes on that amount, or $3,540 more than it pays now.

Of course, for the really rich, the two higher brackets would take a bigger bite. A family making $2 million would pay about $100,000 more in taxes under Obama's plan, according to the Tax Policy Center.

_ The tax debate is all about income tax rates.

Wrong. For all the attention given to higher taxes on earned income if current rates expire, the big hit to some families will come from taxes on capital gains and dividends. The government now takes 15 percent of both. If the Bush cuts aren't renewed, the tax on long-term gains would rise to 20 percent.

And the rate on dividends would shift to your income tax rate, or a maximum 39.6 percent. Under Obama's plan, the tax on dividends would rise to 20 percent for everyone.

If Congress doesn't act to stop taxes from reverting to their pre-2001 levels, new limits would be placed on deductions and exemptions, too. And a $1,000 child credit would be halved.

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Filed by Hunter Stuart  |