Everything Keeps Coming Up Roses for the $200,000 to $500,000 Set

(Bloomberg Opinion) -- When the Tax Cuts and Jobs Act of 2017 took effect in 2018, with its $10,000 cap on state and local tax deductions, residents of Democrat Josh Gottheimer’s affluent, high-property-tax Northern New Jersey Congressional district feared big hikes in what they owed the government. Once 2018’s federal income taxes were all paid and tallied, though, members of every income group in the district ended up paying less on average than they had for 2017 (this was even true of those with incomes of less than $1, whom I left off the chart because their negative tax rates made it hard to read).

The Internal Revenue Service adds one more income category when it reports tax statistics at the state level, but in New Jersey — unlike in California, Connecticut and New York, which I wrote about earlier this year — the $1-million-and-up income group got a tax cut too.

This is just federal taxes. Local property taxes have gone up in New Jersey since 2017, and in 2020 the state raised its income tax rate for those with taxable incomes of $1 million or more. Also, just because members of an income group owed less in taxes on average does not mean that every individual in that income group owed less. In those groups where the average decline was small (in New Jersey it was smallest for those making $25,000 or less, $100,000 to $200,000 and $1 million or more) a lot of people faced bigger federal tax bills in 2018 than in 2017.

For one group in particular, though, the declines really weren’t small. Those with adjusted gross incomes of $200,000 to 500,000 saw their effective federal income tax rates fall 2.5 percentage points in 2018 both in New Jersey and nationwide, the biggest drop for any of the income groups tracked by the IRS. And as the Gottheimer-led effort to remove the cap on the SALT deduction gains ground — and is met by efforts by other Democrats to prevent most of the benefits of such a repeal from flowing to those making more than $500,000 a year — the income group seems to be on the cusp of yet another big tax cut.

This group has its own acronym: HENRYs, for high earners, not rich yet, coined in 2008 by Fortune magazine’s Shawn Tully to describe the “five million households that earn between $250,000 and $500,000 a year and pay a large chunk of it back in taxes.” By 2018, the most recent year for which data are available, there were 6.9 million tax returns in the $200,000-$500,000 adjusted-gross-income range.

These HENRYs faced a pretty big step up in tax rates from the income group just below them thanks to the alternative minimum tax. At its creation in 1969 the AMT was meant to target tax avoidance by the very rich, but since it wasn’t indexed to inflation it began to hit what you might call the upper-upper middle class in a big way in the 2000s. Because the AMT disallows many deductions, including SALT, it hit especially hard in states with high income and/or property taxes — which also happen to be states with disproportionately high numbers of HENRYs. Of U.S. taxpayers with incomes between $200,000 and $500,000 in 2018, nearly 28% lived in just three high-tax states (California, New Jersey and New York) that together account for a little over 20% of the country’s population. These states have not just high taxes but expensive real estate and social pressures to spend lots of money on other stuff, so many HENRYs there don’t feel rich. One will on occasion melt the internet down by complaining about this or just sharing the family budget with CNBC.

The 2017 tax bill made the HENRYs a little richer, though, by raising the income at which the AMT exemption begins to phase out from $160,900 in 2017 to $1 million in 2018, with inflation adjustments built in after that. That had a pretty huge impact in New Jersey, where the $200,000-$500,000 income group went from a collective AMT bill of $1.4 billion to one of just $35.9 million.

The losses from the SALT deduction cap canceled out most of those AMT gains but it didn’t cancel out all, and together with across-the-board rate cuts and other changes the impact of the bill was on balance quite positive for the HENRYs. Now they seem to be headed for an even better tax deal.

That’s not what most discussion of the SALT-cap repeal effort has focused on. Advocates emphasize the impact on the middle class while skeptics in the media note the potential windfall for those with very high incomes. The conservative Tax Foundation estimates that those in the top 1% of the income distribution, which in 2017 meant an adjusted gross income of $515,371 or more, would see their after-tax income rise 2.8% with full SALT repeal while those in the middle of the income distribution would see a gain of less than 0.05%. (Taxpayers in the 95th to 99th percentile — the HENRYs — would get a 1.2% income boost.) Perhaps in response to the bad press, not to mention the estimated $90-billion-a-year cost of full repeal, the text of the House legislation released Wednesday raised the cap to $72,500 from $10,000 while some Democrats are pushing to pair repeal with an expansion of the AMT. Both approaches would reduce the gains for very high earners but mostly or entirely spare those making less than $500,000 a year. The HENRYs seem to have landed in a political sweet spot. Republicans do nice things for them because they’re high earners, Democrats do nice things for them because they’re not rich yet.

This … doesn’t seem like the worst thing in the world. The kink in the tax progressivity curve that made rates rise quickly for the HENRYs has been pushed up the income distribution to taxpayers less likely to feel strapped, and may now move a little farther in that direction. HENRYs still pay lots of taxes — 21% of the federal income tax total in 2018, from just 4.4% of the taxpayers — and will continue to do so even if the SALT cap is repealed. Still, the Republicans’ commitment to cutting federal income taxes and the Democrats’ new commitment to never raising them for those making less than $400,000 together seem to be putting a crimp in the U.S. government’s ability to raise revenue. That hasn’t mattered much over the past decade because interest rates have been so low, but at some point in the future it might. The HENRYs, who will be lucrative targets in any revenue-raising effort, may want to set aside part of their windfall for that rainy day.

The percentages here aren't perfectly comparable to those in my previous column because I used total tax liability as the numerator then and — after reading the IRS footnotes and seeing that this includes self-employed Social Security contributions, among other things — have used "income tax after credits" here.

Disclosure:I used to work with Tully at Fortune. I no longer worked there in 2008, but was still in the same building and visited the magazine's offices a lot because they had a vending machine with Diet Dr. Pepper, so I heard about this article and while it was in the works. I don't think I influenced it, though, and I no longer drink Diet Dr. Pepper.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Justin Fox is a Bloomberg Opinion columnist covering business. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”

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