Election Watch: Spectrum Group analyzes impact of certain Presidential candidate tax policies

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When individuals talk about taxing the rich but giving breaks to normal middle class Americans, who are they talking about? What is "rich"? What is "middle class"? How do Presidential candidates define "rich" and how will their policies impact the households that aren't named Hilton, Gates, Clinton, or Bush?

Based on research that Spectrem Group has completed with wealthy households of various levels over the past 20 years, we find that at year end 2007 there were 34 million households that could be considered part of the "Mass Affluent." Who is Mass Affluent and what do these households look like?

The Mass Affluent households are primarily Baby Boomers. They are the sons and daughters of the World War II generation. Two-thirds of these households represent two career households. Over 90% have a college degree and almost half have a graduate degree of some type. Almost 60% of their wealth is earned income and the remainder represents investments, defined contribution plans and IRAs. Some have investment real estate. They have between $100,000 and $1,000,000 of investable assets. This includes the money they have invested in defined contribution (i.e. 401(k)) plans but does not include the value of their primary residence. They have not inherited any significant amounts of money. Overall they are the representation of the American dream. They got an education, worked hard, remain employed, and many are frantically saving for retirement knowing they may not receive Social Security. Their primary goal is to maintain their standard of living throughout their retirement.

Believe it or not, the career choice of the largest percentage of these Mass Affluent households is Educator! A large number of these households are also small business owners and managers. As you move slightly up in wealth segments to the High Net Worth segment, you will find that there are 9.2 million households with $1 million of net worth, 1.16 million households with $5-25 million of new worth and only 125,000 households with over $25 million of net worth. As wealth level increases the number of doctors, lawyers and accountants increases. And as you get into the wealthiest levels the career choices often are senior corporate executive and business owner. Generally, the incomes of the Mass Affluent are approximately $153,500.

It is important to keep in mind that while it is easy to perceive that tax policies espoused by presidential candidates Barack Obama and John McCain seem to be aimed at the Donald Trump's of the world, the reality is that the Mass Affluent are the households that are being hit the hardest by many of these policies. They also are the households that are sending their children to college paying full tuition because due to the fact that they have two careers, most don't fall into the $88,000 of household income and under that allows for financial aid. Just like everyone else they are paying higher gas prices. Their ability to spend on vacations and other items generally fuels the economy. These households, however, are being hit by the economic challenges just like the rest of us. Remember, these are not the families travelling on private jets. They generally represent those going to Southwest for the cheapest fares. (How many teachers do you know that fly First Class?)

We have taken a look at the tax positions presented by both Barack Obama and John McCain and have tried to anticipate the impact of each of their policies on the Mass Affluent. Keep in mind that some of these policies may change as the election comes closer. Also, some of the specific policies of the candidates are often unclear.

Tax Policy Current Rules Obama Position McCain Position Impact on the
Mass Affluent
Overall Tax Rate Bush tax cuts reduced overall tax rates and set to expire in 2010. Would increase overall tax rate for these households from 28% to 31% and from 35% 39.5% prior to 2010 Make permanent the Bush tax cuts keeping the highest rate at 35%. Mass affluent will clearly benefit from McCain policy.
Alternative Minimum Tax Current "patch" expires in 2008 and will change the number of households subject to the tax from 3.5 million to 26.5 million. Unclear whether supports patch but would have taxpayers pay the higher of the AMT or the new tax rate. Would extend and expand the patch that indexes for inflation. Unclear. Dependent on whether subject to AMT and whether Barack supports any indexing of AMT. Likely that McCain strategy better for mass affluent.
Payroll Taxes Pay 12% social security tax up to $102,000. Wage cap would not apply so individuals would be taxed on wages over $102,000. Additional tax or and/or different rate may apply over $250,000. Unclear. Seems to support no additional taxes but recent responses more uncertain. Obama policy will have major impact on the large percentage of working mass affluent households that earn over $102,000.
Estate Tax Set to decrease in next two years but if legislation not enacted tax will apply to households with $1,000,000 and will have a 55% tax rate. Apply to households over $3.5 million with rate of 45%. Apply to households with over $5 million with rate of 15%. If no legislation enacted, many Mass Affluent will have $1 million of assets as they age and rate would be 55%.
Capital Gains Currently at 15%. Unclear but seems to support raise to 20-28%. Keep at 15%. Lower rates clearly beneficial for all Mass Affluent especially on sale of home.

General Tax Rate

Senator McCain intends on making permanent the tax cuts enacted by President Bush in 2001 and 2003, which are both set to expire at the end 2010. Were the expiration of the tax cuts allowed to take place, the 10 percent tax bracket would disappear and the 28, 33, and 35 percent tax rates will increase to 31, 36, and 39.5 percent. This increased tax rate would not only have an impact on the tax payments of those who are extremely wealthy but would also affect those in the Mass Affluent segment as well.

Obama frequently cites $250,000 as the line between those who would be subject to higher taxes and those who wouldn't. Indeed, under Obama's tax plan, married couples with at least $250,000 in gross income are likely to see their taxes go up if Obama is elected president. And for single filers, the line for them would likely be about $200,000. Those citizens could end up paying anywhere from several thousand dollars to tens of thousands of dollars more to the IRS than they do now, according to the Tax Policy Center.

Unfortunately for the affluent, Obama would restore the top two income tax rates to their pre-2001 levels. Obama's proposal would also reinstate some limitations on how much of a given deduction or personal exemption high-income taxpayers may take. He has stated that families making less than $75,000 will see a tax cut while families making over $250,000 will probably pay higher taxes. His policy is somewhat unclear for those families making between $75,000 and $250,000. Many of the Mass Affluent have retired so they fall within that $75,000 to $250,000 income range. An even larger percentage will fall above $250,000 in income (especially dual income families) and therefore they will be subject to the AMT or the increased tax rates.

The Alternative Minimum Tax

Senator McCain has proposed that he would extend and expand the "patch" involved in the Alternative Minimum Tax. The AMT became operative in 1970, and was an additional tax intended to only affect certain very wealthy households who were able to take advantage of a number of tax loopholes, and would somehow end up paying almost no income tax. Individuals must compute their taxes under both the regular tax and the AMT. If the AMT tax exceeds the regular tax, taxpayers must pay the higher amount. The main problem most people see with the AMT is that over the years it has not been indexed for inflation, thus resulting in a much larger fraction of Americans being subject to the tax. As of right now, in 2008 the AMT exemption is set to return to its level back in 2000; which would be $45,000 for couples and $33,750 for singles and heads of household. This would obviously affect a significant number of American households, with the number of taxpayers subject to the AMT increasing from 3.5 million in 2007 to 26.5 million in 2008. Clearly many of the Mass Affluent fall within the group that will be impacted by the AMT if the "patch" is not extended.

Senator Obama does not seem to support indexing the AMT for inflation, although this has never been explicitly stated. Under his proposal there will be a comparison between the tax liability of a household under AMT and the liability without the AMT. If the AMT number is larger, that will be the new tax for that family. The Obama overall rate increase will narrow the gap between the two groups, those paying the highest rate without any tax loopholes and those that would be paying only a low tax due to loopholes. It seems more likely that the AMT might disappear, tax rates would increase and exemptions and deductions would be limited.

Estate Taxes

A critical issue for Affluent investors is the estate tax. At this point in time, due to the estate tax laws currently in place, the estate tax would be greatly reduced in 2009, and completely eliminated by 2010. The only caveat with this particular area of the policy is that when the 2001 tax cuts expire in 2011, the estate tax exemption will return to applying to all households with over $1 million, and the top estate tax rate will be 55 percent. Senator McCain has come out with a solution to this, calling for a permanent reduction of the tax in 2010 by escalating the estate tax exemption from its scheduled 2009 level of $3.5 Million to $5 Million. He plans to couple this policy with a tax rate reduction from 45 percent to 15 percent. These policies are especially relevant to the households in this country with $5 Million or more in net worth, not including primary residence. As of 2007, this particular wealth segment totaled 1.16 million households. The average age of these households is 65, with 56% of these folks already retired or semi-retired. For these aging households, a 45 percent tax rate compared to a 15 percent tax rate is a prodigious contrast. For those households in the Mass Affluent segment, many will never have $3.5 million in assets so the estate tax will not impact them.

Obama favors maintaining the estate tax, but he would limit its reach. Obama would freeze the estate tax exemption amount at $3.5 million - up from its current $2 million level and the $1 million level it's set to revert to in 2011. He would also keep the current top rate of 45%, which is below the 55% it is set to revert to in 2011.

Payroll taxes

John McCain's current position regarding whether to raise payroll taxes (i.e. social security) is unclear. Although he has stated he is against any tax increases, apparently in response to a recent question regarding this issue he stated that "everything is on the table".

Payroll taxes are clearly another area where the mass affluent will be affected by Obama's tax policies. In addition to wages up to $102,000, Obama would also tax amounts over $250,000. In other words, income between $102,000 and $250,000 would be protected, but those earning over $250.000 would be subject to additional tax. Many of the Mass Affluent would be taxed differently and more robustly in the future under this proposal.

Obama's goals are to better fund the Social Security program and to make the system more progressive, which will help the entire country, and especially the Baby Boomer generation, who are now nearing retirement. Currently, the vast majority of Americans pay the Social Security tax on 100% of their income because they don't make more than the $102,000 wage cap. By contrast, those who make over $102,000 only pay Social Security tax on a portion of their income. Obama hasn't said whether the Social Security tax on wages and salaries over $250,000 would be taxed at the same rate. We also don't know whether the benefits promised to the highest income workers would go up as a result of their paying more into the system.

That lack of specificity concerns some tax experts. If those making more than $250,000 would pay a higher payroll tax rate, it would fundamentally change the way Social Security operates and run the risk of making the program look less like social insurance and more like welfare.

Capital Gains Tax

Always a controversial topic because perceived to be a benefit to only the wealthy, the positions of the candidates on the Mass Affluent are very different. Today the capital gains tax for long term capital gains (those assets held longer than 6 months) is 15%. This applies to gains made on buying and selling securities as well as the sale of a home. McCain's proposal is to maintain the rate at 15%. Obama's position, while somewhat unclear, seems to support increasing the rate to 20-28%


Taxes are not currently issues that appear to be driving the overall election debates. For the Mass Affluent, however, it does seem that McCain's policies are more beneficial than Obama's. This critical group of voters do have an impact on the economy. In some ways, many of them represent the "good guys". They have accomplished what the American Dream seems to demonstrate. Maybe the real answer is to find additional ways to segregate levels of wealth and the related tax levels. Let's impact the 125,000 households with over $25 million of assets or even the 1.16 households with over $5 million dollars. Let's keep the dream of being mass affluent desirable and achievable to all Americans.

Catherine S. McBreen is Managing Director of Spectrem Group, a research and consulting firm that specializes in the affluent and retirement markets. Spectrem is publisher of the monthly Spectrem Affluent Investor Index㤠(SAII) and Spectrem Millionaire Investor Index㤠(SMII) as well as the newsletters "High Net Worth Advisor Insights," "Affluent Market Insights" and "Retirement Market Insights."

McBreen is also co-author with Spectrem President George H. Walper, Jr. of the upcoming book "Get Rich, Stay Rich, Pass It On: The Wealth-Accumulation Secrets of America's Richest Families" (Portfolio, January 2008). www.millionairecorner.com


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