Tuesday, September 20, 2011

It's Not Just Math

What is so special about $1 million? Is it that much more special than $999,999? Not to me. They would both represent a significant amount of income for one year -- more than I ever expect to see. What is so special about a defined benefit pension plan having a funded status (AFTAP) of 90% or 92% or 94% or 96% or 100% instead of 0.01% less than any of those magical percentages? Nothing that I can see.

Yet, much of public tax policy seems to revolve around hitting or missing these thresholds or cliffs as I think of them. Make the mark and all is well. Miss it by the smallest of margins and you fall off ... perhaps to your death.

I'm sorry. Cliffs may exist in the landscape, but putting them into tax policy is just plain stupid. I repeat, it's just plain stupid. You want to know what I really think about cliffs in tax policy? Let's move on.

I decided to read the President's version of the American Jobs Act of 2011 (AJA). If you want your own copy, you can get it at http://www.whitehouse.gov. It's 199 pages and it's not a fun read. It doesn't have a real good plot; in fact, there is no mystery in this thriller.

I am going to focus on something specific here, and I am going to tie it back to 401(k) plans. According to the current version of AJA (not Steely Dan's version or Louie Gohmert's version), a married couple filing jointly becomes more fortunate when their combined earnings equal or exceed $250,000. By my quick reading, it would suck to have combined earnings of $250,000. $2,500,000 would work out just fine, but if my earnings (combined with those of my wife) were exactly $250,000, I would be looking to find a way to give up one of those dollars to get to $249,999.

Because of the cliff-like nature of tax policy, trust me, the couple earning $249,999 would be far more fortunate than the couple earning $250,000. Their deductions (also known these days as loopholes) wouldn't go away.

What is one of those deductions? How about the one that you get for deferrals to a 401(k) plan or the one that you get for pre-tax payments of health care premiums? At $249,999, you still seem to get them; at $250,000, to quote Phil Rizzuto (that is scary), those deductions will be gone, gone, goodbye. So, after figuring in the tax bill, earning one dollar more costs you a whole bunch. That is just plain stupid.

To quote President Obama, "[I]t's not class warfare; it's just math." President Obama is a very smart man. He taught constitutional law, and I presume that he knows far more about it than I do. However, I taught math and he didn't. This is not just math (I leave the proof that it is or is not class warfare to the reader as that's what authors do in math books).

When there is a literal incentive to earn less or a disincentive to earn more, that's not just math. It's stupid. When a cliff causes you to be worse off than if you had successfully begged for a $1 lower salary, that's stupid.

Some of my readers tend Democrat, some tend Republican, some do not tend at all. This is not about that, however. You can tax the high earners more or not as you choose, but as for the AJA, it's not just math!

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