Much has been made in the days following Obama’s State of the Union speech about the presence of Warren Buffett’s secretary alongside 
Michelle Obama, and the president’s support for a minimum tax rate on millionaires. The so-called Buffett Rule would require individuals with an income above $1 million per year to pay a minimum tax rate on their income of 30%. This, Buffett and the president say, is only fair. I think that blanket statement is wrong and can damage the economy; but I think there is a basis of truth and logic in thinking there are elements of the current tax laws for millionaires that are unfair and leave them paying less than a reasonable tax rate on certain income.
The most simplistic approach to thinking about tax rates is this: if I bust my butt every day to earn enough money to house, feed, clothe, and generally care for family why should I be paying a much higher tax rate than a retired multi-millionaire couch potato clipping bond coupons and earning dividends? There are several answers to this question that dispel this thinking but there is also some truth to the accusation. Dividends are payments from corporations to shareholders – after-tax payments. In other words, corporations pay taxes on their income (presumably) and the remaining money can then be allocated to shareholders as a dividend. Taxing that dividend distribution amounts to double taxation and this is the basis for the argument to eliminate taxes on dividends or, at least, keep them at levels substantially below income tax rates. I support this view and think dividend income should be kept at current 15% levels. Unfortunately, this changes at the end of 2012 when dividends will revert to being taxed at regular income tax levels.
The other big income item for wealthy hedge fund managers and investors is capital gains taxes. These too are at 15% for long term holdings of greater than 1 year (the rate increases to 20% at the end of this year) and keep taxes down for the wealthy. This I find troubling and believe there is ample room for a more nuanced approach. From my perspective there is a HUGE difference between buying IBM stock and making money on the investment versus investing money in a budding company and making money if the company succeeds. Buying the stock of an established company on a listed stock exchange is hardly the same as providing vital capital for a new and growing company. I’d have no problem seeing the gains on the IBM stock trade taxed at regular income tax levels while the gains on venture capital investment are taxed at substantially lower levels (if not at zero). Of course introducing such a dramatic change in tax rates on listed stock capital gains would be an immediate disaster for the stock market so it would require a very long period of introduction – even 10-20 years of slow, deliberate rate hikes which would undoubtedly be changed by future Congress….such is our political system.
Hedge funds are generally created to trade actively, earn excessive gains, and provide investors with outsized returns. In general, they provide no marginal benefit to society, they create no new businesses, no new jobs, no anything except inordinate income for successful managers and investors. And yet both the managers and the investors get incredible tax breaks. The gains are very often long-term so the returns to investors are taxed at 15%. The managers, who invest nothing but get paid out a percentage of the profits generated by their investing prowess, also pay only 15% on their take of the profits. They get a tax break called “carried interest” that effectively says they are earning income based on risk-capital (even though it isn’t their capital at risk) so the income they receive should be taxed the same as the investors. This is sheer lunacy. That is income, pure and simple. It’s no different from the bonuses received by Wall Street traders and those bonuses are taxed as regular income. This is really a pet peeve of mine – drives me absolutely nuts.
The Democrats continual harping on the “fair share” language seems to be resonating with a lot of Americans. In poll after poll 70-75% of respondents support an increase in the tax rates of the wealthiest Americans – pretty easy to say “yeah, tax the rich guy more.” But that’s a resounding majority and I admit I’m surprised that few conservatives support the measure since “we the people” have clearly spoken in those polls. I’m equally surprised that there isn’t a greater hue and cry over the Dems chosen method of tax breaks to stimulate the economy – a “temporary” reduction in Social Security taxes. Of course it’s a clever method to choose since it’s extremely progressive (the rich get relatively little as a percentage of income and Warren Buffett gets nothing while his secretary gets her full share) but it does nothing for the elderly and unemployed and it leaves a growing hole in the Social Security fund that will need to be made up for later. Why not reduce SS taxes for only the lowest income earners and reduce tax rates .25% for low and middle income tax brackets. Too much class warfare there if we don’t do it for the rich too? I don’t think so – the rich aren’t stupid enough to make an issue about not sharing in a fractionally lower tax rate at a time when there is a potentially monumental tax rate increase in their future.
All the noise out there right now over “fair share”, class warfare, the 99%, and “we the people” strikes me as totally misplaced and directionless. They blunt the real argument — that Obama and Congress have failed by caving in to the demands of the loudest and most partisan elements of their parties. Obama failed miserably by ignoring Simpson-Bowles because it contained a few items that would offend some of his constituents. And then he failed to introduce any plan that would address meaningfully our deteriorating financial picture. The GOP failed miserably by fawning over Grover Norquist and drawing an ill-advised line in the sand against any and all tax increases. It’s sad that not a single GOP presidential candidate was willing to accept even a $1 tax increase for every $10 in spending cuts. Seriously? Conservatives wouldn’t accept a $500 billion tax increase combining higher rates on the wealthy and the elimination of tax disparities if it was accompanied by $5 trillion in spending cuts where the timing of both were well matched? How do we make progress when both sides have taken such strict positions?
There is some rumbling about introducing Simpson-Bowles as a bill in the Senate. It may pass a majority but either way it will go nowhere in the House. Still, it would be good to see a truly bipartisan plan get some airtime so the American people see who wants to act and who wants to play politics. Congress’ approval rating is in single digits and it’s time we saw who are the people’s representatives and who are the pure politicians…and then let’s throw the bums out.
You raise some good points, Mike, and I’m not arguing with your conclusions (nor do I necessarily agree with all of them). But I’d just like to make a few points:
1. It’s usually assumed that investment income is the arena of the wealthy. However, many–most– securities are held by mutual funds, individual small investors, pension funds, charitable endowments and the like that are for the benefit of ordinary folks (mindful that some of these entities are already tax exempt). We need to be careful that, in the name of tax “fairness” for the wealthy, we don’t throw the baby out with the bath and hurt everyone.
2. Your distinction between double-taxation of dividends, and the rationale for the tax treatment of capital gains (which are NOT automatically double-taxed) is valid enough. But one of the main arguements against taxation of capital gains is that it impedes the mobility of capital to the best uses, and is therefore anti-growth. Let’s say my Ford Motor stock has appreciated dramatically over time, its profit potential has now been fully realized and it now represents an inordinate proportion of my portfolio value. If I decide to sell half and invest the proceeds in, say, Boeing Aircraft, I would pay a capial gains tax on the profit from the securities I sold. My portfolio of stocks would now have lower overall value due to the tax I paid, even though my aim was simply to optimize my holdings (and in so doing provide needed capital to Boeing). Many investors would simply (wisely) continue to hold Ford and not readjust their portfolio. So the tax merely penalizes the mobility of capital, and does not tax any new wealth or spending power.
Complex and admittedly dry issues, but the full impact of taxation decisions needs to be thoroughly thought through, rather than following knee-jerk impulses to punish the wealthy.
I understand your objections but I think some of them are accounted for: I don’t think either charities or pension funds don’t pay taxes on investment income (not sure but I don’t think so). Mutual funds don’t pay either — they allocate realized gains and losses to shareholders so those investors would pay capital gains at same rate as their income which is, inmy opinion, fair.
To your example about Ford I’d say you’re correct but I don’t know if it matters. Investors will change their analysis of investment decisions to reflect a higher rate of taxation on capital gains and sell, or not, accordingly. My point is to emphasize the difference between buying Ford or Boeing vs investing in the new high tech company, manufacturer, or whatever and gives those two investment gains a different tax treatment.
As I pointed out, pension funds, charities and the like are tax exempt anyway so the distinction between classes of income and even tax brackets is irrelevant to them. Again–many securities are held by ordinary, median income earners and raising rates on qualified investment gains hurts them. In my own case, I am by anyone’s standards in the middle class (not even close to the fabled 1%) but had to save up myself for retirement–401K and IRA limits were too low to provide for retirement income. Under Clinton’s tax rates, it was painfully difficult.
And you’re right the mutual funds do not pay the taxes, but pass them on to their shareholders. But when saving in mutual funds, I got a tax bill every year for dividends and capital gains tax, even though I was not withdrawing a penny from the funds (and could not afford to do so if I was to retire at a reasonable age). So it’s not just or even primarily the wealthy that are hurt.
Finally, many mutual funds are aware of the tax impact on their holders, and advertise strategies of not selling securities they own where there would be a capital gain, and not investing in securities that pay a good dividend. This is known as a tax strategy or tax managed stock fund. Again, free market forces that would otherwise permit the remobilization of capital into better uses are throttled here. Of course, the same forces are at work in portfolios of individually owned securities.
Finally, differences in the tax treatment of dividends versus capital gains influence corporations’ decisions to pay earnings in dividends, or reinvest internally instead to add to corporate value and ultimately to stock appreciation. Again, the tax code acting to disrupt capital flows and investment optimization. It’s way more important than people might imagine.
More technicalities than anyone is likely interested in, but I stand by my assertion that higher taxes on dividends and/or capital gains are unfair to the little guy and anti-growth.
History has shown that the nominal income tax rate is largely irrlevant in determining the actual revenue generated. Regardless of where the rate has been set on the “rich” (as high as 90%) the revenue has remained flat. Why? People like Warren Buffett have teams of accountants who ensure he pays as little as possible. He must have been laughing his tail off during the State of Disunion Address knowing the tax man won’t cathc him regardless of what Congress does with the rates.
As a libertarian I’m opposed to taxes as a general principle (it’s theft, pure and simple), but there is actually one tax I would support. Namely, I’d like to see government bonds lose their tax-exmpt status and get taxed like any other investment.
I suppose it’s possible but if Buffeett or anybody else is getting the bulk of their income from dividends and capital gains on listed stocks (which is the vast majority of Buffett’s investments) then I’m not clear how that gets circumvented.
Any time a politician uses the term “fair share” listeners (including reporters) should demand he define the term or shut up.
Gotta agree with you — “fair share” is just a terrible term.
Compromise between Republicans and Democrats in the federal government ALWAYS has the effect of moving government policy leftward. Why? Because Democrats always act to satisfy their base which is left and growing far left. The Republican base is center right, so any compromise winds up going left by increments.
Moreover, how do you compromise with The Anti-capitalistic Mentality? Republicans have been doing so for more than a hundred years and look where it’s got us. In his book, The Anti-capitalistic Mentality, Ludwig von Mises writes:
“All those rejecting capitalism on moral grounds as an unfair system are deluded by their failure to comprehend what capital is, how it comes into existence and how it is maintained, and what the benefits are which are derived from its employment in production processes.”
Compromise is good when both parties are aiming at the same goal. Compromise is bad when one party opposes capitalism on moral grounds and aims to destroy it.
The time for solving our American fiscal and monetary crisis by tweaking the edges of the tax system has come and gone. You write: “How do we make progress when both sides have taken such strict positions?” The implication is that progress toward a more capitalistic system is possible by compromise. It isn’t. Even a good share of the Republican negotiators are of the anti-capitalistic mentality.
You ask incredulously: “Conservatives wouldn’t accept a $500 billion tax increase combining higher rates on the wealthy and the elimination of tax disparities if it was accompanied by $5 trillion in spending cuts where the timing of both were well matched?”
I wouldn’t. To believe the Democrats would actually cut (and I mean REALLY cut) federal spending by $5-trillion is fantastically naïve. Why? Because Democrats are rabidly anti-capitalistic and Republicans are only moderately less so. Until that mentality changes, there is no hope in compromise. Now is the time for those of us who are of the capitalist mentality to take a strict position and stand firm.
It’s hard for me to respond to you Sherman because we begin with such different ideas of the starting point. I don’t consider the majority of Dems or GOP rabidly anti-capitalist but I do take your point that we have stretched the definition beyond it’s strict, original definition. Personally, I think Americans like the new definition that allows for labor unions and a social safety net; but the power of those unions and the size of that safety net has been expanded outrageously.
In my example, if there are no REAL spending cuts taking place then a deal won’t happen; but a deal won’t happen if there is no willingness to consider tax increases either. I share your pessimism about the Dems willingness to take the steps needed for progress but accepting the proposition of 1:10 changes shouldn’t be seen as a sign of weakness. Congressional failure to make any change at all is what’s weak. Calling my example fantastically naive is sort of silly since I was just trying to make a point not put forth a proposal.
The example you presented is telling. See this 11/10/11 article on the Super Committee in the Wall Street Journal: http://online.wsj.com/article/SB10001424052970204224604577028083997201376.html
According to Sen. Pat Toomey the GOP did offer the Dems $500-billion in revenue increases over 10 years (which we can both agree is a drop in the bucket relative to the spending and debt that will accumulate over 10 years). The Dems wouldn’t even agree to a spending cut of $750-billion over 10 years to close the deal! Why not? According to the WSJ:
“Democrats are insisting on at least $1 trillion in new revenues while refusing to allow any reduction in tax rates or to stop the tax increase that will hit in 2013.”
The truth is the Dems aren’t interested either in solving our fiscal “problems” or in returning to a more free market, individualistic economy. They are striving to create a high tax, high service, re-distributionist European-style welfare state.
I think everyone talking about this subject is missing the point on taxes. Why are we discussing tax rates when we need to be talking about whether or no personal income taxes are constitutional. There is no law in the US tax code that forces individuals to pay taxes, nor is there a law in the constitution. The government needs to do with less, not us!
This piece not only advocates the worst vices of Obamanomics – increases in taxes – but goes several steps further, it provides an economic reason for it, while Mr. Obama, at least, endorses the idea for reasons of “fairness” and “equality, both words that translate into “redistribution”. Senor Obama knows that “redistribution” is an economic loser, but notice that all these tax increases are not proposed but until 2013.
Nevertheless, I’m speechless! Not because I don’t know what to say, but because I have too much to say. I also don’t know whether to cry, laugh, or reason with the premises. I concluded that to reason with the premises I would have to charge, perhaps just as much as Harvard Business School charges, or similar, for an MBA in economics.
Since I’m not a crier, my third and only course is to laugh by proposing a better and an alternative idea. Since the proposition is to increase capital gains taxes by 100%, from 15% to 30%, and we know that by the start of 2013 marginal tax rates that are already in the Obama pipeline will increase to a maximum of 42%, I propose not waiting for such confluence of events and allow Obama to anticipate that policy (for 2013) effective immediately, with the add-on of the new capital gains proposal of 30%. This will put into effect an immediate tax rate of 57%, which will not only be the highest of the developed world, but will automatically reduce tax revenue for 2012 (have you heard of the Laffer curve?), increasing the deficit (and who know, probably another downgrade by S&P), and will be on time to allow the American economy to enter into a depression that will make us wish we were in Europe (and surely many entrepreneurs will be there by then with some heavy bags). The unemployment rate will soar to above 10-12% and allow the Republicans to sweep into office by November – when, ipso facto, they can cancel all this madness. Master Plan!
I say, the sooner the better!
Thanks John for your thoughtful response. I will try to address your issues:
1. I was not putting forth a comprehensive tax reform plan. I am opposed to higher taxes in general and strongly support a tax reform plan that would eliminate the myriad special tax exemptions out there and reduce overall tax levels across the board, especially for corporations.
2. My point was not to advocate for higher taxes but for a change in tax policy that favors dividends and investment in new and growing businesses over existing businesses that don’t need the capital being deployed into and out of them each day via the stock market. Take the long-term cap gain on stock trades up to personal income tax rates, take the cap gains on new business investments to zero, and take the tax rate on dividends down perhaps to zero.
3. Doubling the capital gains tax from 15% to 30% doesn’t add 15 points to the overall marginal tax rate (from 42 to 57???) so your math is more than a little fuzzy…better look again.
The core of your thesis is the approval of the “fair share” concept of Obama in favor of the “Buffet Rule” – a 30% tax rate in capital gains. That I call a tax increase of substantial scope and of great detriment to the American economy and growth prospects. Not even Bernanke has expressed favor for an increase in the capital gains tax of any size, much less 30%.
But it gets even worse. You say, “I’d have no problem seeing the gains on the IBM stock trade taxed at regular income tax levels”. This “regular income tax level” is now 35% and it will be 39% by 2013. All in all, adding corporate tax rate, Healthcare Law special tax, state taxes (average), and the “Buffet Rule” 30% in capital gains, we can end up with a total tax rate of 65% [you were right, I way underestimated my previous example - I was too kind. I was making a concept point, not a rate point which is complicate and varies. To get it right you must start with the present 35% Corporate tax plus 15% CGT = 45% total Marginal Tax Rate (it is not apples to apples. You can ask your tax accountant)]. Now, if we calculate your suggestion of taxing capital gains at your “Regular-rate-capital-gains-tax” (39% by 2013), it adds another 6%+(E) to the final top Total Marginal Tax Rate for an incredible 71%+(E).
It is verifiably nutty!
You also misunderstand the role that stock markets play in the capture of capital as well as the double-taxation of capital gains. I really cannot explain it all in a comment page.
It is so crazy that it will never happen. Not even if Obama wins the election. He is just playing class warfare, and so is Buffet. The “Buffet Rule” is a red herring – don’t take it seriously!
Thank you for your patronizing comments. We are fortunate to have so learned a scholar of the financial markets as you to straighten us out when we err.
I think the key mistake in this is assuming that income has any relevance to taxation whatsoever. It shouldn’t.
Taxation should be an assessment of the benefit obtained from the community. Henry George got that absolutely right. You choose how much tax to pay, and are willing to pay it because it is in direct proportion to the benefit you receive, just like any other transaction.
Don’t you think greed gets in the way of making that system work? Will we get enough people choosing to pay amounts sufficient to provide for the national defense, infrastructure, schools, and other basic needs of society? I just don’t see that working in our society.
Not at all. Greed is what makes the Georgist system work. The basis of the system is that no taxation is levied on capital or on labour; only on the use of the monopoly assets of the state – primarily land and its natural contents.
We quite naturally value land in proportion to the benefit it offers us. It’s a market action, rising and falling with demand. So rather than paying a bank for the land, or storing our capital in it (with all the associated hazards of speculation), the value of land is charged on an ongoing basis.
Once you have a logical, market based system for taxation, most of the complaints about it go away. If a rich person uses / controls more land resources, they pay more in proportion. If a poor person uses less, they pay less. If you object to how much your paying, you are free to use less or cheaper land.
The truth is 97% of Americans pay less than 15% in taxes, which is the current capital gains rate. The 3% who pay more than 15% are earning around $200,000 or more. Furthermore it should be noted that in 2009 there were 8,276 Americans who earned more than $10,000,000. The total income for these people combined was $240 billion, which would pay for the Federal government for 24 days or so. So Obama’s class warfare argument is patently absurd on its face. It’s a shame none of the GOP candidates will call him out on the facts.
Your point, Steve, is very well-taken. The popular debate over Romney’s or Buffet’s 15% rate, versus a secretary’s 27% rate confuses the issue of the average or “effective” tax rate versus the “marginal” tax rate. The latter, of course, is the rate applied to the last dollar of taxable income, while the former is the overall % of tax compared with total income allowing for deductions, exemptions etc. Most so-called “middle class”–or median family income–taxpayers have a “marginal” rate in the twenties, but an “effective” or average rate well under 15% (generally less than 10%). So when Obama asserts that Buffet pays 15% while his secretary pays 27%, he’s mixing the effective and marginal concepts (without question, Buffet and Romney pay way more in taxes than the secretary and almost certainly have a higher marginal rate). Why? Without question, to enrage the technically uniformed electorate, divide Americans into antagonistic “classes”, and have the largest group of voters–his “middle class”–believe that he (Obama) is their protector and that it’s “fair” to make those that the majority are encouraged to resent pay for everyone’s free government stuff. For a president who claimed to hold Lincoln up as his model, this dishonest exploitation of mass resentment is shameful. But–as with negative campaign ads–what works is what will get done. We need to vote this Bozo out of office before it’s too late.
The other thing Obama fails to do is mention the fact that someone with a 27% income tax rate never really pays 27%. Deductions, credits and such reduce taxable income. These reductions disproportionally aid those earning under $200,000 to the point that half of Americans don’t pay income taxes despite the fact that they technically fall into a tax rate. The rich may be able to apply some of these deductions and credits but they are never able to wipe away income tax obligations like the poor and middle class can. Unless Buffet’s secretary is earning over $200,000, she isn’t paying 15% in income taxes even if she technically falls into a higher tax bracket
Excellent points, Steve. Once one “drills downm,” Obama’s deliberate misrepresentation of a complex issue for his own political purposes is even more maddening.
You try and provide a logical response to this tax issue but the Democrats impetus is simply income redistribution and facts will get you nowhere.
I think there is a certain amount of wisdom in the Republicans not offering tax increases in exchange for spending cuts. Ronald Reagan made such a deal in the 80′s, and George HW Bush broke his “read my lips” pledge. In both cases, the “revenue increases” went through, but also, none of the spending cuts ever took place. Why would they trust anyone on the other side when the other side has never lived up to their promises?
It is an excellent point, Matt. It is naive to give up an effective-immediately tax increase that will be set in stone for the future in exchange for ten year pie-in-the-sky cuts in spending.
Anything that is promise over ten years is for the sucking-thumb crowd – that is why politicians love it.
Mike: Although I understand your points, my question (as a Canadian conservative) is this: With the Canadian Feds currently having a 15% corporate tax rate and discussing ways to further reduce income tax to increase global competitiveness ….. what on earth is America doing discussing the “Buffet Rule” as if it had some sort of legitimacy?
Why not go to a flat tax? Why not replace Income tax, corporate tax, and estate tax with a consumption tax? It seems exceedingly unhealthy that there is such a large % of the population which pays no income tax whatsoever under your current system. It also seems (as is ours) fraught with special provisions to fuel the crony capitalist culture.
Increasing the incidence of tax while doing nothing about spending would seem to be an invitation for American Co’s to simply move portions of their production into Canada. Its not exactly as if these people would have to learn a new language, adapt to a vastly different culture, and they could fly home at a moment’s notice.
Thanks for your comments Cameron. I agree with many of your points but they relate to major changes in overall tax policy and that’s not where I was going. I think Simpson-Bowles and Wyden-Gregg both had more sensible approaches to tax policy and I’d be much happier with either one: they reduce or eliminate special tax preferences, reduce the number of tax brackets at lower rates including lower corp taxes, eliminate the AMT, and more in an effort to simplify our tax policy. I think the introduction of a consumption tax would be extremely difficult and be viewed as an enormous gift to the rich. The left would be very unlikely to support it even though it certainly is a more logical approach to taxation. Ditto for flat tax.
The rich will never pay their “fair share” They always pass the cost on to the common man in the form of higher prices for goods and services or less wages and benefits. This call to tax the rich is actually a calculated plan to complete the destruction of the middle class.