Camp tax reform plan points to a more retirement unfriendly tax system

[kmt1972]

House Ways and Means Chairman Dave Camp released a plan for tax reform which is dead on arrival but it seems to be a statement of principles of a tax reform plan which has lots of elements that could alter the tax code in the future.

See The Basics of Chairman Camp’s Tax Reform Plan | Tax Foundation

It has several elements which I think is not "friendly' to the retirement lifestyle.
a) It removes the deduction for medical expenses.
b) Instead of the 0% tax rates for qualified dividends/capital gains for those in the 15% tax bracket, it instead puts its at 6% (60% of 10% tax bracket). Those in the 25% tax bracket would still get qualified dividends/capital gains taxed at 15% (60% of 25%).
c) For those of you that retired in a location with high local taxes that deduction goes away.

To be fair, there are lots of things in this plan that makes a lot of sense and does simply that code. Reading through details one take away I get is that this shift the relative tax burden away from earned income toward passive income.

 

[samclem]

I'm not sure the net impact would be negative for most retirees, even those with a high percentage of investment income.

b) Instead of the 0% tax rates for qualified dividends/capital gains for those in the 15% tax bracket, it instead puts its at 6% (60% of 10% tax bracket). Those in the 25% tax bracket would still get qualified dividends/capital gains taxed at 15% (60% of 25%).

................................Present...................Camp Proposal
Std Deduction.............$12,400.................$22,000
Personal Exmptns (ea).. $3,950..................None
Top of 10% Bracket......$18,150.................$71,200
Top of 15% Bracket......$73,800................. N/A
Top of 25% Bracket.....$148,850.................Approx $450,000
Top of 28% Bracket.....$226,850..................N/A
Top of 33% Bracket.....$405,100..................N/A
Top of 35% Bracket.....$457,600..................Unlimited (all income above 25% rate)
Top of 39.6% Bracket..Unlimited (all income above 35% bracket)

For those with a pension or other taxable non-investment earnings, the much higher top of the 10% bracket along with the higher standard deduction will provide some relief. For retiree households (2 persons) which don't itemize, the elimination of personal exemptions is more than offset by the higher standard deduction.

For many/most of us, this proposal would significantly reduce the attractiveness of Roth accounts and conversions into them. Until retirement income exceeded $93,100 (MFJ), the money taken out of a tIRA would be taxed at just 10%, so it doesn't make sense to pay a tax of 15% now to convert tIRA money to a Roth.

I'm not seeing how this reform addresses the big problem of complexity. It reduces the number of brackets, but the number of brackets isn't a problem at all. The problem is deductions and other adjustments to taxable income. If we can't muster the political courage to kill them individually, then cap them and reduce their value with progressively lower caps.

 

[meierlde]

I'm not sure the net impact would be negative for most retirees, even those with a high percentage of investment income.



................................Present...................Camp Proposal
Std Deduction.............$12,400.................$22,000
Personal Exmptns (ea).. $3,950..................None
Top of 10% Bracket......$18,150.................$71,200
Top of 15% Bracket......$73,800................. N/A
Top of 25% Bracket.....$148,850.................Approx $450,000
Top of 28% Bracket.....$226,850..................N/A
Top of 33% Bracket.....$405,100..................N/A
Top of 35% Bracket.....$457,600..................Unlimited (all income above 25% rate)
Top of 39.6% Bracket..Unlimited (all income above 35% bracket)

For those with a pension or other taxable non-investment earnings, the much higher top of the 10% bracket along with the higher standard deduction will provide some relief. For retiree households (2 persons) which don't itemize, the elimination of personal exemptions is more than offset by the higher standard deduction.

For many/most of us, this proposal would significantly reduce the attractiveness of Roth accounts and conversions into them. Until retirement income exceeded $93,100 (MFJ), the money taken out of a tIRA would be taxed at just 10%, so it doesn't make sense to pay a tax of 15% now to convert tIRA money to a Roth.

I'm not seeing how this reform addresses the big problem of complexity. It reduces the number of brackets, but the number of brackets isn't a problem at all. The problem is deductions and other adjustments to taxable income. If we can't muster the political courage to kill them individually, then cap them and reduce their value with progressively lower caps.

The proposal simplifies by doing away with most itemized deductions, so that it is said to lead to 95% using the standard deduction. It limits mortgage interest to the first 500k of the mortgage, does away with the state and local tax deduction, medical expense deduction, causality deduction, and limits the charitable deduction to amounts above 2% of AGI.
So the simplification is about essentially eliminating schedule a for most folks.

 

[Tadpole]

So what is the effect on a retiree that needs to withdraw enough from a deferred account to cover a spouse in a nursing home? If medical goes away I would think it would be a substantial hit.

 

[samclem]

The proposal simplifies by doing away with most itemized deductions, so that it is said to lead to 95% using the standard deduction. It limits mortgage interest to the first 500k of the mortgage, does away with the state and local tax deduction, medical expense deduction, causality deduction, and limits the charitable deduction to amounts above 2% of AGI.
So the simplification is about essentially eliminating schedule a for most folks.

Great, thanks. That does sound like simplification.

 

[FUEGO]

Sounds pretty good to this very early retired individual. We'll have a lot of Trad IRA conversions and/or withdrawals over the next several decades. Making the 0% bracket fatter and the 10% bracket way fatter would help with the ordinary income from the trad. IRA.

Interesting they want to get rid of the personal exemptions. Our state (North Carolina) just did that and made the std deduction a little larger for a couple. Which means a sizable tax increase for a family with three kids like ours (~$1500/yr extra taxes).

 

[pb4uski]

The proposal simplifies by doing away with most itemized deductions, so that it is said to lead to 95% using the standard deduction. It limits mortgage interest to the first 500k of the mortgage, does away with the state and local tax deduction, medical expense deduction, causality deduction, and limits the charitable deduction to amounts above 2% of AGI.
So the simplification is about essentially eliminating schedule a for most folks.

That sounds good, but if you're going that far why not just get rid of itemized deductions entirely (easy for me to say since I'm not in or running for office, I'm retired!!!).

 

[meierlde]

That sounds good, but if you're going that far why not just get rid of itemized deductions entirely (easy for me to say since I'm not in or running for office, I'm retired!!!).

That would kill completely the charitable deductions, which would bring the churches, the colleges and universities, and other organizations against it. As it stands only contributions above 2% of AGI would be deductible.

 

[kmt1972]

Obviously, high tax states like HI, NY etc etc would be out against it as well.

 

[pb4uski]

That would kill completely the charitable deductions, which would bring the churches, the colleges and universities, and other organizations against it. As it stands only contributions above 2% of AGI would be deductible.

So what? Do you think that people contribute to charity only because of the tax benefit? I don't (though I concede it is nice to have) and I don't think most people contribute principally for the tax benefit.

In eliminating itemized deductions there are all sorts of constituencies that will be upset, particularly the real estate and mortgage industries and charitable organizations. So be it - they'll get over it and while I'm sure they will claim that the sky is falling as the change I considered I doubt it will have a significant impact - people will still want to own houses rather than rent and will still donate to charities.

 

[scrabbler1]

Obviously, high tax states like HI, NY etc etc would be out against it as well.

I agree. As long as the federal tax brackets and rates do not vary by state, there should remain in place the ability to deduct state and local taxes to partly counterbalance the federal inequity.

 

[samclem]

I agree. As long as the federal tax brackets and rates do not vary by state, there should remain in place the ability to deduct state and local taxes to partly counterbalance the federal inequity.

Why? The federal government taxes citizens based on their income in order to support federal spending. The states do the same thing. It's not clear to me why citizens who live in states which tax their citizens less should, in effect, pay a higher share of federal taxes than those who live in states that tax their citizens more.

I wonder if Camp's proposal contains any mechanism to thwart the re-growth of various itemized deduction giveaways. We've been down this road before, and the thicket of deductions and credits regrows faster than kudzu.

 

[scrabbler1]

Why? The federal government taxes citizens based on their income in order to support federal spending. The states do the same thing. It's not clear to me why citizens who live in states which tax their citizens less should, in effect, pay a higher share of federal taxes than those who live in states that tax their citizens more.

I wonder if Camp's proposal contains any mechanism to thwart the re-growth of various itemized deduction giveaways. We've been down this road before, and the thicket of deductions and credits regrows faster than kudzu.

Because someone who lives in New York City who earns $80k is not really earning "more" than someone earning $75k who lives in Mississippi, for example, because of the presence of higher state and local taxes. The income levels in lower-tax states tend to be lower so they are already paying less in federal income taxes.

The current tax code already allows a little bit for high-tax areas the way it handles deductible sales taxes in lieu of income taxes. It is not enough overall but it is helpful. Removing that would only exacerbate the inequities.

 

[samclem]

Because someone who lives in New York City who earns $80k is not really earning "more" than someone earning $75k who lives in Mississippi, for example, because of the presence of higher state and local taxes.

Someone who is earning more is earning more. What their state takes from them in taxes should be entirely irrelevant to their federal tax obligation.

The income levels in lower-tax states tend to be lower so they are already paying less in federal income taxes.

That's the progressive tax code for ya. Lots of people favor it.

I can't see a reason that a person's obligation to support federal spending should be reduced just because they live in a state that taxes them more.

 

[scrabbler1]

Someone who is earning more is earning more. What their state takes from them in taxes should be entirely irrelevant to their federal tax obligation.

I don't agree. The feds and states don't act in separate vacuums. Many government programs are shared, either directly or indirectly, between the states and the feds.

That's the progressive tax code for ya. Lots of people favor it.

I am talking about within tax brackets, not necessarily across tax brackets.

 

[kmt1972]

I did some simulations of what my taxes during semi-retirement and full retirement might be under the current system and under this proposed system. It pretty much confirmed what I suspected, that this proposal would shift the relative tax burden from earned income to passive income.

Under my semi-retirement scenario, our income in 2014 dollars would be around $310K, and the proposed tax system would actually reduce our taxes by around $1.5K even though we would be living in a high tax state (NY) with high real estate taxes. The main reason why is because the AMT is gone and since a good chunk of the $310K would be earned income they never got the 15% tax treatment of qualified dividends/long term capital gains under the existing system anyway.

Under my retirement scenario, our income in 2014 dollars would be around $265K, and under the proposed tax system would increase our taxes by around $2.5K even though we would be living in a low tax state (FL) with a condo that comes with medium level of real estate taxes. Of course the reason for this is I assume that our medical costs would be the cost of insurance premium plus the full OOP maximum. If instead I assume that our medical cost will be cost of insurance premium plus 50% of the full OOP maximum, the proposed tax plan would reduce our taxes by $0.5K since we would no longer itemize deductions under the current system as our itemized deductions would fall below the standard deduction.

So really for me the big difference between the proposed plan and the current system is that under the current system if you have a bad year in terms of medical costs the tax system provides a hedge for it as if those costs are more than 10% of AGI you can deduct those costs beyond 10% of AGI. Under the proposed system this hedge is lost.

A scenario that is not relevant to me that might affect some people reading this board is the situation where a retired couple has AGI of $80K which is mostly qualified dividends or long-term capital gains. Under the current system the tax burden would be almost zero if not zero. Under the proposed system the tax burden rises to $3K-$4K as qualified dividends/long term capital gains would be taxed at 6% and not zero.

 

[youbet]

Someone who is earning more is earning more. What their state takes from them in taxes should be entirely irrelevant to their federal tax obligation.
.

Try as I might not to, I have to agree with ya on this samclem. If you live in a high tax state and therefore are eligible for the benefits of living in a state that has money to spend, that is no reason to reduce your obligation to support the fed gov't.

 

[youbet]

It limits mortgage interest to the first 500k of the mortgage, does away with the state and local tax deduction, medical expense deduction, causality deduction, and limits the charitable deduction to amounts above 2% of AGI.

Elimination of the medical expense deduction would kick my plans to be self-insured for LTC right in the groin.

The other eliminations or changes are fine. For example, why should living in a McMansion with high property taxes and a whopper mortgage lower your fed income taxes?

 

[FIREd]

c) For those of you that retired in a location with high local taxes that deduction goes away.

In our case, the AMT already achieves that result.

 

[kmt1972]

In our case, the AMT already achieves that result.

You make a good point. I realized that as I was going through various simulation of the current tax code with the proposed one.

 

[samclem]

While most of us (including me) reflexively examine any tax reform by seeing what it would do to our own tax calculations, it's worth at least considering the bigger picture. Those with retirement portfolios holding stocks and bonds will benefit if businesses prosper. Some tax schemes make the economy more efficient and get out of the way so that capital can flow to where it produces the highest return. Other tax schemes distort the capital markets and reduce growth.

I'd rather pay a 10% tax on growth of 5% per year than get all kinds of special deductions and carveouts that result in a 5% tax rate on growth of 2% per year.

 

[mpeirce]

I'd rather pay a 10% tax on growth of 5% per year than get all kinds of special deductions and carveouts that result in a 5% tax rate on growth of 2% per year.

+1

This is crystal clear when one holds large indexes like the S&P 500 or total market.

You really are hoping the entire US economy does well.

 

[kmt1972]

While most of us (including me) reflexively examine any tax reform by seeing what it would do to our own tax calculations, it's worth at least considering the bigger picture. Those with retirement portfolios holding stocks and bonds will benefit if businesses prosper. Some tax schemes make the economy more efficient and get out of the way so that capital can flow to where it produces the highest return. Other tax schemes distort the capital markets and reduce growth.

I'd rather pay a 10% tax on growth of 5% per year than get all kinds of special deductions and carveouts that result in a 5% tax rate on growth of 2% per year.

At a certain level, it is hard to argue with this. Of course one should seek to optimize after tax income and for sure having the lowest effective tax rate is not the only way to do it. I am not sure for me the way to achieve this is for greater economic growth. Greater economic growth might mean higher inflation which erodes my retirement assets relative to retirement costs.

I would rather have 2% after inflation rate of return with 0% inflation than 4% after inflation rate of return with 10% inflation.

 

[samclem]

Greater economic growth might mean higher inflation which erodes my retirement assets relative to retirement costs.

True, but the right kind of economic growth won't cause inflation. If economic growth is the result of increased productivity (maybe resulting from tax policies that encourage capital to be put to the use that produces the highest absolute return, rather than the one favored by tax policy writers), then it will not produce inflation. Growth resulting from excessive growth in aggregate demand (e.g. maybe due to a tax policy that makes cheap money available for buying homes or paying tuition) without accompanying growth in productivity will result in inflation. More here.
On a yet bigger picture level: Economic growth is the only way to a brighter future for our kids, and the only hope we have of servicing our national debt. So, beyond the needs or retirees, we need growth.

 

[audreyh1]

AMT would totally screw the new plan unless they restructure it as well. Somehow they've never been willing to let go of the AMT.