In his sixth State of the Union Address on January 20 President Obama offered a number of proposals that would break new ground in federal government policy to help lower and middle-income households and increase taxes on high-income earners.  

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State of the Union: Policy or Politics?

Wed Jan 21, 2015

In his sixth State of the Union Address on January 20 President Obama offered a number of proposals that would break new ground in federal government policy to help lower and middle-income households and increase taxes on high-income earners.

Speaking to a joint session of Congress attended by Cabinet secretaries, Supreme Court justices and other officials, the President focused on “middle-class economics” and “helping working families feel more secure in a world of constant change.”

He outlined new initiatives that would raise $320 billion in taxes over the next ten years by targeting higher income individuals and large financial institutions and using the additional tax revenues for new and expanded tax credits and other assistance for lower and middle-income households.

Looming over the prime time address, however, is whether the President intends these proposals for realistic policy discussions or as themes for future political campaigns.  With the November 2014 elections having given Republicans control of both Houses of Congress, it’s not clear that the White House expects serious consideration of these proposals on Capitol Hill.

According to a White House background paper, the President’s plan proposes the following—

  • Increase the capital gains and dividends tax rate to 28% for couples earning more than $500,000 per year, from the present effective 25% rate.  The maximum income tax rate for these taxpayers would remain at 39.6%.
  • Impose a 7-basis point fee (0.7 percent) on the liabilities of the 100 biggest banks, i.e., those with assets in excess of $50 billion. The idea here is to discourage such institutions from taking on too much leverage and endangering the U.S. financial system.
  • Broaden the impact of the estate tax by repealing the so-called “trust fund loophole,” also known as “stepped-up basis,” that allows heirs to re-calculate the cost basis of inherited assets, thereby substantially reducing capital gains taxes on estates.
  • Require employers to “auto-enroll” workers in individual retirement accounts if they do not offer full-time and part-time employees the opportunity to participate in tax-favored retirement plans. Workers could opt-out of “Auto-IRAs” if they choose.

• The “Auto-IRA” proposal would be paid for by prohibiting additional contributions to employment-based tax-deferred retirement accounts once an individual’s total account balances reach $3.4 million, sufficient, says the White House, to generate an annual income of $210,000.

  • Create special tax credits for child care and 2-earner households. Specifically, the President would triple the existing Child and Dependent Care Tax Credit to $3,000 per year from the existing average of $550. He would also create a new $500 “second-earner credit” for married couples where both spouses work. The White House says the new two-earner credit would benefit 24 million couples. The two tax breaks are estimated to cost $175 Billion over ten years.
  • Double the Earned Income Tax Credit (EITC) for workers without qualifying children.
  • Provide free community college tuition for students who meet certain federal government specified requirements, the objective being to make community college a natural extension of the K-12 public school system.  The White House estimates that this would cost the federal government $60 billion over ten years.
  • Require employers to offer employees up to seven days of paid sick leave for their own illness or to care for a family member. The paid sick leave proposal will be discussed in detail in a subsequent blog.

Capitol Hill Outlook—

It’s difficult to predict how Congress will respond to the President’s State of the Union proposals. There is unanimity among Republicans and Democrats that middle class living standards have stagnated—that inflation-adjusted, median incomes have remained relatively constant for twenty or more years.

The disagreement between the two parties is likely to come down, therefore, not to whether a problem exists in equitably sharing the benefits of economic growth, but to the best policy prescription for fixing the problem.

Democrats, led by President Obama, advocate more redistribution through taxes, taking from the rich and transferring to lower and middle-income households. Republicans favor a broader tax reform, eliminating tax loopholes, cutting income tax rates and spurring faster economic growth.

While the President and Congressional Republicans have both urged bipartisan compromises to solve problems everyone agrees exist, it remains unclear whether the chasm in political philosophies can be bridged any time soon.