Rich and Sort of Rich

How did $250,000 become the magic number?

In the debate over how to close the budget deficit, President Obama talks often about raising taxes on “millionaires and billionaires,” but his policy prescription is a bit different. He says that federal income taxes should be increased on families making more than $250,000. That seems to be the threshold. Under $250,000, you’re middle class; over it and you’re wealthy.

Where did this number come from? Is it based on a statistical metric of wealth in America — a true dividing line?

Empirically, these households are surely not middle income. Only 2 percent of households in the nation make more than $250,000, according to the Internal Revenue Service. But some economists and tax reform advocates are questioning whether those households are rich enough to be worthy of the same tax bracket as millionaires.

“The very round nature of it suggests that it’s arbitrary,” said Roberton Williams, a senior fellow at the Tax Policy Center and the deputy assistant director for tax analysis at the Congressional Budget Office from 1998 to 2006. “There’s nothing magical about $250,000 per year. It has no economic basis.”

It does have a political basis.

The dividing line appears to have its genesis in 1993, when President Bill Clinton created a new tax bracket at $250,000 and raised the rate to 39.6 percent. Prior to Mr. Clinton’s new bracket, the highest earners were those defined by making more than $86,500; they paid 31 percent under the first President George Bush.

Mr. Obama started using the $250,000 household income level to define wealthy Americans during his campaign in 2008. Under his budget proposal, a target of the Republicans in recent weeks as part of a fierce battle over raising the debt ceiling, the tax cuts enacted by his predecessor, President George W. Bush, would be reversed for those households. Mr. Obama’s proposed top household income tax bracket — starting at $250,000 — would pay 39.6 percent on federal income. (Single filers making $200,00 or more would also be in the highest bracket.) Currently, the highest tax bracket starts at $379,150, and they pay 35 percent.

Aides that worked with Mr. Obama during his campaign said he latched onto $250,000 because it helped invoke President Clinton’s era of economic prosperity in the 1990s — a demonstration, the argument goes, that higher taxes did not hinder growth.

He was also following an analysis by Thomas Piketty, a widely followed economist at the Paris School of Economics, and Emmanuel Saez at the University of California, Berkeley. Their study on economic equality showed that the rich have gotten richer — income for the top 1 percent rose by $261,930, or 30 percent, from 2002 to 2008 — while the bottom 90 percent saw their incomes drop by $1,170, or 4 percent, on an inflation adjusted basis.

The economists concluded: “We need to decide as a society whether this increase in income inequality is efficient and acceptable and, if not, what mix of institutional reforms should be developed to counter it.”

Whatever the policy debates, households at President Obama’s dividing line might be wealthy, but that doesn’t mean they feel wealthy.

On a Yahoo message board, a poster named Mason, who lives in Manhattan with two young children, said his household income was $262,000. “I understand the need to raise taxes,” he wrote, “but I don’t understand why people like us are lumped in with millionaires and billionaires.”

On one level, Mason is feeling the effects of inflation; $250,000 isn’t what it used to be. If Mr. Obama were really trying to return to Mr. Clinton’s 1993 levels, he would have to adjust the bracket for inflation, moving it up to about $386,075. In fact, in Mr. Clinton’s last year in office, the top bracket had risen to $288,350 from $250,000.

Then there is the problem of keeping up with the Joneses. In 1993, earning $250,000 was a more exclusive club, making it easier to feel like one of the wealthy. Back then, households making more than $200,000 represented about .08 percent of the country.

And today, $250,000 households tend to be clustered on the coasts, where there are often better-paying jobs.

The Fiscal Times, a publication financed by Peter G. Peterson, the very public deficit hawk and former commerce secretary under President Richard Nixon, commissioned BDO, an accounting firm, to look at how households that make $250,000 fared in different parts of the country, mostly in middle- to upper-class neighborhoods.

The takeaway, according to the study: “It’s not exactly Easy Street for our $250,000-a-year family, especially when they live in high-tax areas on either coast.”

Even when including in its estimates an additional $3,000 from investment income, the report said, families “end up in the red — after taxes, saving for retirement and their children’s education, and a middle-of-the-road cost of living — in seven out of the eight communities in the analysis.”

There is also an issue of fairness, say some economists and advocates of tax reform. The truly rich — the “millionaires and billionaires” — often pay much less in taxes. The wealthiest 400 Americans in the country paid, on average, a rate of only 16.6 percent, according to the latest report from the I.R.S. that examined returns from 2007. That is because much of the income of the country’s wealthiest people comes from investments, which is taxed at the long-term capital gains rate of just 15 percent.

So far, neither Democrats nor Republicans dare talk about raising the long-term capital gains tax out of fear that it would reduce crucial investments that could produce jobs.

Tax brackets could be added for the wealthiest — for instance, a millionaire’s tax. In 2009, the House of Representatives included 5.4 percent surtax on millionaires as part its health bill, but the tax later morphed into the Medicare payroll tax on households making more than $250,000. 

Peter R. Orszag, the former director of the Office of Management and Budget under President Obama, said a millionaire’s tax “is an idea that has been discussed in Democratic policy circles,” but that ultimately it was outweighed by “economic concerns that marginal tax rates could creep over the 60 percent range” in certain cities in the country, when factoring in state and local taxes.

There is also a question about whether enough money could be collected from those “millionaires and billionaires” to make up for lost revenue from households making mid-six figures.

“The problem is that there’s not really enough income even at the top,” Mr. Williams, of the Tax Policy Center, said. “To close the deficit to 3 percent of G.D.P., we’d have to raise the top rate to 77 percent, which would change behavior, so you might have to raise the income tax even higher, perhaps to 90 percent.”

Right after World War II, the highest rate was roughly that. Indeed, for most of the 1950s, ’60s and ’70s the highest rate was about 70 percent. Even under President Ronald Reagan in 1986, the highest rate was 50 percent.

Of course, the Reagan revolution was about those high tax rates. And we are unlikely to see those rates anytime soon.