Dissecting The Buffet Rule
By Steve Barlotta, CPA
President Obama’s supporters have expressed that it is unfair that higher income taxpayers are allowed to pay a 15 percent capital gains tax rate on their investment income, which is substantially lower than their ordinary tax rate. His opponents see the Buffet Rule as nothing more than an election year gimmick and that the President is engaging in textbook class warfare by pitting the “haves” verses the “have nots”. They also feel that enacting this provision will do little to reduce our massive deficit. So let’s take a look at these two topics; economic fairness and deficit reduction, and how it relates to the “Buffet Rule”.
Economic Fairness
The Obama administration has stated on many occasions that the tax code is tilted in favor of the wealthiest Americans and that passing the Buffet Rule would be a step toward economic fairness in our society. And because of the unfairness in our tax code, there are many instances where high-income taxpayers pay lower tax rates than middle-income Americans, which they feel further exasperates the growing problem of income inequality in our society. One thing is certain, the President will continue to make economic fairness and income inequality a reoccurring theme in his campaign as recent polls show that a majority of Americans feel the U.S. economic system favors the “wealthy”.
On the other hand, Republicans have dismissed the Buffet Rule as typical election year politics that would eliminate jobs in our economy and unfairly penalize investors. They also point to the fact when you include the tax increases that will be implemented in 2013 through the Obama Care law on top of the proposed 30% under the Buffet Rule, high-income taxpayers will actually be paying a top rate of 43.4% on their dividend and interest income. Some Republicans have also highlighted the fact that high-income earners pay the majority of federal taxes in our current system.
Let’s take a look at some recent data. According to the Tax Policy Center, a nonpartisan Washington D.C. think tank, roughly 45 percent of U.S. households paid no federal income tax in 2010; that comes out to 69 million Americans. The Heritage Foundation estimated this figure to be 49.5% in 2009. What these statistics don’t show also is that many Americans who pay nothing in federal taxes get money back from Uncle Sam through refundable credits like college tuition and having children. In a recent article, the Associated Press cited data that showed that individuals who made over $1 million pay, on average, 29.1 percent of their earnings to the government, while people earning $50,000 – $75,000 pay around 15 percent. Finally, the Tax Foundation, using the Internal Revenue Service as their source, found that in 2009 the top 5 percent income earners paid around 59 percent of the total federal income taxes, while the bottom 50 percent paid a little over 2 percent.
Deficit Reduction
President Obama has said that passing the Buffet Rule would be a major first step in reducing our massive budget deficit. Republicans have stated that this tax increase would do little to knock down our deficit. A recent Washington Post article explains that the Buffet Rule tax increase would raise only $47 billion dollars over the next ten years, which is, they point out, miniscule compared to our annual $1.3 trillion deficit. Another factor that doesn’t seem to get mentioned is that the Buffet Rule would also call for eliminating the alternative minimum tax for middle-class Americans. While the cost of doing away with the AMT has not been clearly quantified by the Obama Administration, many of his detractors are saying the net effect of the tax increase on the wealthy and the elimination of the AMT could very well add hundreds of billions of dollars to our deficit over this ten year period.
My Thoughts
The only thing that is certain is that little or nothing will get done over the next six months, as the Democrats and Republicans will continue to play political football in this highly-charged election year. Once again, the best interests of the American public will be thrown to the side as both sides slug it out.
On the subject of economic fairness, I think a good portion of the anger stems from large American corporations taking advantage of loopholes in our corporate tax code or direct subsidies from the U.S. government. I have to admit, it irks me when I read that General Electric paid no taxes on their 2011 federal tax return despite having $14 billion in profits, or that Apple legally avoids paying billions of dollars in taxes by having offices and subsidiaries in low-tax places like Nevada and Ireland. I also have a problem with individuals like hedge fund managers being allowed to pay the 15 percent capital gains rate on their income earned from their companies. I feel this is income earned in the ordinary course of employment, and therefore should be taxed at that individual’s ordinary rate just like everyone else. Many of my clients are small businesses, and I can tell you these tax-saving strategies are not available to them. The President or the media have no basis to direct their ire at a successful small business person who started from scratch with nothing more than a dream, who employs U.S. citizens and invests in capital goods and equipment. As an exercise, I randomly chose twelve of my clients whose taxable income exceeded $500,000 in 2011. The average effective tax rate of this group was 34.8 percent. It’s safe to say, that these individuals are not the loop-hole finding, tax-avoiding taxpayers painted by some.
On the subject of deficit reduction, I’ll put on my “accountant’s hat” and look at government revenues and expenses from 2003 – 2011. I’ll use 2003 as a starting point because that was when the final round of the Bush tax cuts were enacted. From 2003 – 2011, federal revenues increased from $1.9 trillion to $2.3 trillion, or 29.2 percent. Federal expenditures during this same time period increased from $2.2 trillion to $3.6 trillion, or 66.9 percent. During this time period, spending increased more than twice the rate of revenues. This has resulted in our deficit more than tripling from $378 billion to $1.3 trillion. The national debt has more than doubled as well, from $6.8 trillion to $14.8 trillion. These numbers, by the way, come from The President’s Budget for Fiscal Year 2013. So, let’s assume that we raise the Buffet Rule tax on millionaires from the current proposed rate of 30% to 60%. Let’s further assume that the federal government can raise $100 billion a year from this 60% tax. Our current deficit would be trimmed by only 7.7 percent. I use this scenario not to suggest that the government raise the tax rate on millionaires to 60%, but to demonstrate that without meaningful and long-lasting reductions in federal spending our trillion dollar deficits are here to stay. I feel we’re at a critical point in the history of our Republic and we must use a bottom-up approach and look at every aspect of government spending, including corporate welfare.
Finally, on to the topic of Warren Buffet. I find it odd that now, at the age of 81, he’s finally bemoaning the fact that he pays a tax rate that’s lower than his secretary’s. To the best of my knowledge, I don’t remember him previously complaining about our tax system as he amassed a multi-billion dollar fortune. The companies that he invested in and controlled employed many of the tax-saving strategies as, say, G.E. or Apple. I would imagine that some of the companies that he controlled even received direct subsidies from the U.S. government. I would also assume these companies took advantage of every savings that the U.S. tax system had to offer as he built his financial empire, which is bigger than the GDP of many countries. I can’t help but to find Mr. Buffet’s motives disingenuous.
