Obama 2013 Tax Plan: Why the President is Gunning For the Rich

Let's be clear: Most consumers of the Obama post-campaign campaign agitprop have as much of an idea of the difference between an increase in the tax rate and an increase in tax revenue as they do the difference between profit and profit margin. President Obama campaigned relentlessly on raising the tax rate on the top earners. "Those people like me, who can afford to pay a little bit more to help reduce the deficit," he would say in that sotto voce that became so familiar on the stump.

And really, who could disagree that the filthy rich couldn't afford to pay "just a little bit more"? After all, a checkbook rounding error for them would fund my family for a year.

So what is the harm in raising the top rate from 35% to 39.6%? I mean, that was the rate during Clinton's final years in office, and those were the golden years. Look at the great shape the economy was in when he left office. (Discussion of the Internet bubble and comparatively low spending rates will be tabled for later.)

Here is why the higher tax rates are not wise: because my taxes will go up. I am a selfish bastard, aren't I? I only care about myself. I don't give a rat's ass about anyone else, right? Well, the truth is that with the upcoming, based-in-fairness tax increase, I will have even less money to invest in a lobbyist to keep my effective tax rate low. But don't cry for me, Argentina.

Remember how the media groaned when they learned that Romney paid an effective tax rate of under 15%? (An effective tax rate being defined as the amount of taxes paid divided by his reported income.) And that was after he held back on some legal deductions.

Here is the inconvenient truth: Rich people will only pay about 15% in taxes before they come up with creative ways to not pay them. Oh, they will say that they are investing in certain beneficial financial products, donating to a charitable trust (which always agrees with their opinion and usually employs friends and family), socking money into some government bonds, or some other noble cause. But suffice it to say, they will not pay nearly 40% of their income in federal taxes.

So where does that leave the much maligned small business owner? Yep, right up there with the highest tax rate. You see, we Americans only have so many tax brackets to choose from, and it isn't hard to get to the top.

Marginal Tax RateSingleMarried Filing Jointly or Qualified Widow(er)Married Filing SeparatelyHead of Household 10% $0 – $8,700 $0 – $17,400 $0 – $8,700 $0 – $12,400 15% $8,701 – $35,350 $17,401 – $70,700 $8,701 – $35,350 $12,401 – $47,350 25% $35,351 – $85,650 $70,701 – $142,700 $35,351 – $71,350 $47,351 – $122,300 28% $85,651 – $178,650 $142,701 – $217,450 $71,351 – $108,725 $122,301 – $198,050 33% $178,651 – $388,350 $217,451 – $388,350 $108,726 – $194,175 $198,051 – $388,350 35% $388,351+ $388,351+ $194,176+ $388,351+

(Table from Wikipedia)

For 2013, unless Congress and the president act to avoid the "fiscal cliff" our taxes are scheduled to change as follows: The 10% rate will disappear into the 15% rate, the 25% rate will become 28%, the 28% rate will become 31%, the 33% rate will become 36%, and the 35% rate will become 39.6%.

The president has been making a big deal out of no new taxes for those making less than $250,000, but as you can see from the above chart, $250,000 is in the middle of the 33% to 36% tax bracket. But, let's use the fact that the president wants taxes to go up for those making $250,001 and up. If a small business owner draws a salary of $120,000, and his/her spouse brings in $60,000, then the business need only show a profit of $70,000 to exceed the magic $250,000 number.

Most small businesses are S corporations which allows the profit of the company to flow through to the owners before being taxed. For a small company, this is a better situation than a C corporation because the C corp will be taxed at the corporate rate of 35%. Any remaining profit will be passed on to the shareholders to be taxed as capital gains at 15%, the double taxation you often hear about. It is also how Warren Buffett manages to pay a lower tax rate than his secretary since most of his income is from capital gains, not earned income.

Mr. Buffett has a big advantage in that he pays very little tax due to the aforementioned legal tax dodges deductions and credits. Meanwhile, Mr. SmallBiz will pay huge taxes on profit that his company shows even if he doesn't have the money.

How could this happen, you ask? Let's say that Mr. SmallBiz's company shows a profit of $100,000 on receipts of $1 million. This would be a decent sized company with 8-12 employees, and a profit margin of only 10%. Remember, you cannot sock this money away for next year. If it is profit, it must be shown as profit, claimed and taxed.

Like most small businesses, not all of Mr. SmallBiz customers are current on the amount that they owe him. Often the last bills to be paid are to the small business owners who do not have the power to cut off their delinquent customer's electricity, phones, or gas, reposess their vehicles, or take back labor that has already been expended.

So, let's say he has $80,000 in receivables. This means that theoretically at the end of the year he will show his $20,000 remaining profit in his bank account. Great. But, that money still belongs to the company, and Mr. SmallBiz is the one that owes the $39,600 in taxes on the $100,000 profit (assuming that his company's profit exceeds Obama's upper limit.) This tax must be paid from his own, previously taxed money. If he draws it from his company, he must pay income tax on it before he can pay the government.

You can begin to see how a business owner would tend to think a lot about taxes when he/she should really be spending their time planning on building their business. However, if taxes are due and they don't have the liquidity to pay them, not only will they be charged interest on the unpaid amount (and that interest is a LOT higher than what you are getting in your savings account) they will also be assessed a penalty of 0.5% per month plus failure-to-file penalties.

If someone is bringing home $14 per hour, I don't think they will be very sympathetic to Mr. SmallBiz's plight. But face it, folks. Unless everyone is on the government dole, there have to be a lot of small businesses out there hiring people and paying wages. Huge business alone cannot fuel this economy and if the entrepreneur who doesn't manage to hit the "jackpot" — by inventing the next big iPhone app, or by selling his company on Shark Tank — cannot make a decent amount of money to afford a comfortable existence, then why should he/she even bother?

Unless Congress decides to create a few more brackets at the top for the ultra-rich, there is no mathematical way that a reasonably successful small businessperson can avoid hanging out in the same tax bracket as Warren Buffett, Matt Damon and Bill Gates' father and we all have a pretty good idea how much tax they pay.

When the tax rate goes up for the top tax bracket, don't think for a minute that the IRS will get their pound of flesh from the ultra-rich. (Remember the 15% rule.) No, the people near the bottom of the bracket will bear the brunt of the increase while the president can brag that he fulfilled a campaign promise to punish the wealthy in the name of the little people. His rich Hollywood and Wall Street donors know that they will be well taken care of by their friends on the left.

I apologize for the length of this post, but it is difficult to talk about taxes without it becoming a long, drawn out treatise. Also, please note that I am not an accountant, nor do I play one on TV. All of my figures are anecdotal, but I have tried to be accurate in their presentation.

Just like in war, it is rarely the ones that cause the problem who suffer the most. It is the common guy in the middle. We are going to get squeezed. In the name of squeezing the rich, the upper middle class will get hit first. But rest assured, middle America ... You're next.