Work and Taxes

If I earned more than a million dollars a year, I would be for the Buffett Rule – not for the reasons that famous billionaires like Warren Buffett and George Soros are for it: because it’s just fair.  I’d be for it because in the long run it would save me money by distracting the public from seeing the roots of class warfare as it is fought in the U.S. Tax Code.

The Buffett Rule says simply that anyone who earns more than $1 million a year should pay at least 30% of their income in federal income taxes.  Legislation to institute this rule is supposed to be voted on this week in the U.S. Senate, sponsored by Democrats and ballyhooed by the Obama Administration.  It won’t pass the House, of course, so it won’t actually affect anyone’s taxes, but it’s a helluva good campaign talisman for Obama and Democrats to run on.

The point of the Buffett Rule is to avoid the kind of obvious inequity that Warren Buffett pointed to in his August New York Times op-ed:  In 2010 Buffett, the second richest man in the world, paid only about 17% of his income in federal taxes (income and payroll taxes) while the 20 people who work directly for him paid an average of 36% of their much smaller incomes.

The Buffett Rule was not devised by Buffett, but by the Obama Administration.  And the first thing that should be noted is that even at 30%, Buffett and other millionaires will still be paying less than the 20 people who work for Buffett, including his now-famous secretary.  More importantly, however, Buffett was clear about why he and other investors paid lower effective tax rates than most workers: income that you do not work for is taxed at a lower rate than income you do work for.

Why this isn’t a scandal in a country that supposedly prides itself on its “hard-working people” is a mystery to me.  If you get your money by investing in stocks and bonds, your income is taxed at a 15% rate because it is unearned.  What’s more, you pay nothing in payroll taxes (i.e., nothing for Social Security and Medicare) because you’re not on anybody’s payroll.

Buffett himself actually still works and draws a salary, and on that part of his income he pays a top rate of 35% and regular payroll taxes on the first $110,000 of that income. But the vast majority of his income comes from investments – capital gains and dividends – and on that part he pays only 15% and no payroll taxes.  Here’s how Buffett explains it: “If you make money with money . . . your percentage may [even] be a bit lower than mine.  But if you earn money from a job, your percentage will surely exceed mine – most likely by a lot.”

Fair shares and percentages aside, the U.S. Tax Code literally says that investors are more valuable than workers, and therefore, should be taxed less. Or it says that investors need more encouragement to invest than workers need to work.  In any case, our tax code fairly screams that only losers and suckers work for a living.

The obvious remedy to this moral abomination is to tax capital gains and dividends (called “unearned income”) the same as wages and salaries (called “earned income”) on the principle that you should not be taxed at a higher rate for earning your income.  That’s how it was after Ronald Reagan signed the 1986 tax reform law, and for most of our history before that.  It was under Presidents Bush I, Clinton, and Bush II that investor privilege was installed in our tax code.  (See the Citizens for Tax Justice’s recent report, “Policy Options to Raise Revenue.”)

Taxing capital and labor income at equal rates would produce much more revenue for the government: $53 billion a year, according to Citizens for Tax Justice, while the Buffett Rule would raise only $17 billion (with other estimates being as low as $5 billion).  You can see why as a greedy, but rational millionaire I’d embrace the so-called Buffett Rule in order to shift the focus away from the basic class bias of our tax code.

There is a theory behind privileging investors by taxing them less.  Namely, investors are “job creators,” and any additional taxes on them will lead to less investment and, thus, slower economic growth, fewer jobs, and even higher unemployment than we have now.  I’ve critiqued this theory before, giving it some credence when it was initially articulated in the 1970s, but showing how it is clearly irrelevant today because investment lags not for lack of money (of which investors have plenty), but for lack of consumer demand that would give investors a reason to invest.  But that’s just me.  I’m not one of the greatest investors of all time.  Here’s what that guy said in his August op-ed:

Back in the 1980s and 1990s, tax rates for the rich were far higher . . . . .   According to a theory I sometimes hear, I should have thrown a fit and refused to invest because of the elevated tax rates on capital gains and dividends.  I didn’t refuse, nor did others. I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then: lower tax rates and far lower job creation.

There are a lot better rules to derive from Buffett’s puckish op-ed than the one the Democrats are using to embarrass Mitt Romney, whose effective tax rate of 14% is even lower than Buffett’s.  Taxing all income at the same graduated rates, for example, would be both simpler and fairer.

While I was writing this post, the Obama-Biden campaign sent me an e-mail asking that I sign a petition supporting the Buffett Rule.  I signed it because Obama’s tax policy is way better than Republicans’ proposed tax cuts for the wealthy.  But the at-least-30%-for-millionaires is a political gimmick without principle, and it leaves in place a tax code that dishonors work and the people who do it.

Jack Metzgar

Chicago Working-Class Studies

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3 responses to “Work and Taxes

  1. Thanks for these constructive criticisms, Fred & Rick. This is the kind of broader public discussion that might actually bear fruit if Democrats and Republicans were equally committed to talking about fair returns to capital and labor — and to a simplified tax system that everybody could readily understand. A couple of replies to Fred:
    #1 — The effective corporate tax rate is about 18% (not the nominal rate of 35%), and all the percentages in my post and in Buffett’s op-ed are effective rates (what people actually pay). Counting that in, both Buffett and Romney are still paying less than the average of Buffett’s employees. But there still remains the common sense values issue that an actually existing person who does not have a job is taxed less than a person who does have a job. That just doesn’t seem right to me — or to Buffett.
    #2 — Of course, investors should get something for the value their investment provides and the risk they take, but right now they are getting way too much — somewhere between $500 billion to $2 trillion a year by my
    calculation. Those may seem like outrageous numbers, but that’s the “debatable” part that you recognize.
    #3 — Good example about municipal bonds, but we need a real public
    discussion of tax incentives/expenditures, the great majority of which (in number, if not dollar amounts) are there because of the political power of Big Money in all its forms.
    Both political parties and the folks who fund them do not want that kind of public discussion because in a fair and balanced, and rigorously fact-based public forum, Rick’s arguments might actually get a fair hearing. Wouldn’t that be something!

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  2. Dr. Metzgar;

    There are (at least) three rebuttals to your proposal:

    (1) If we count all of the taxes placed on the returns to investment, they are likely already higher than all of the taxes placed on the returns to labor. Progressives rightly get annoyed when radio talk-show hosts wax indignant about the 47% of our people — mostly working class — who “don’t pay any taxes”. (More truthfully, “don’t pay any income taxes.”) Honest discussants recognize that the returns to labor get substantially decremented by payroll taxes before what’s-left gets handed to the worker as his/her labor income. A fair discussant will recognize that the worker’s total tax burden includes both the payroll taxes and the income taxes. Yet by the same token, we need to recognize that the returns to investment get substantially decremented by corporate profits taxes before what’s-left gets handed to the investor as his/her investment income. A fair discussant will recognize that the investor’s total tax burden includes both the corporate profits taxes and the income taxes. And the U.S., at 35%, has the highest profits taxes in the world. Counting both, and with a 15% dividends tax rate, investors are already paying about 45% of any returns on their investment to the Federal government.

    (2) Returns to investment are not free money; rather investors bear burdens in order to earn that return — they bear risks of the loss of their capital and they forgo, for the duration of the investment, the use of their funds (i.e., the time value of money). It is debatable how much return these activities deserve, but they do deserve something, or people will not do them. Indeed, much of the objection to proposals to privatize Social Security was that the stock market’s returns might be too low to adequately compensate for the risk of loss. We are hypocrites if we argue that the returns are too low for us to place our life savings there, but unconscionably high for anyone else who is willing to risk his or hers.

    (3) Many instances of lower tax rates were intentionally put into the tax code to incentivize certain politically desired behaviors. Putting in place a minimum tax rate likely removes those incentives, and thus threatens the behaviors we were hoping for. For example, much has been made of Mitt Romney’s effective tax rate of 14%. Note that this is below the present 15% on dividends & capital gains. How did he do that? He invested a substantial amount in tax-free municipal bonds. But if we charge a flat 30% on your investment earnings, whether they come from IBM or Indianapolis, Indianapolis suddenly has no advantage over IBM in bidding for funds. That will make it harder for cities, school districts, sewer authorities, etc. to borrow funds. The only obvious fix is that they will have to pay interest rates that are competitive with those paid by the large corporations. And that means higher local taxes to meet the bond payments (or fewer civic projects). Probably the typical case will see poorer city residents giving up more of their scarce wealth in taxes so that we can make bigger interest payments to wealthy suburban investors — quite a regressive flow.

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  3. “…The obvious remedy to this moral abomination is to tax capital gains and dividends (called “unearned income”) the same as wages and salaries (called “earned income”) on the principle that you should not be taxed at a higher rate for earning your income….”

    Still a regressive proposal. A starting point for progressive tax reform should be taxing capital at double the rate of labor, with the ultimate aim being to get rid of 90-plus percent, or all, of the tax on labor. The tax code in its original form was very progressive. It was a tax on accumulated wealth and very high incomes. Today it is the other way around. Now workers have their pay docked before they even get paid, and the essential feature of payroll taxes is the regressive Social Security and Medicare taxes. What this post fails to mention is how Reagan paid for the top rate tax cuts he was able to get through the Congress at the time. It was done by doubling up worker payroll taxes.

    Actually, Social Security and Medicare have been a concealed tax on labor to help reduce the taxes on the rich since it was merged with the general budget in 1969, and Treasury started borrowing from the trust fund surplus to make the federal deficit appear smaller than it actually is. SS and Medicare will never be done away with. They are too popular for that. Expect the payroll taxes that support the programs to go up, more obstacles to receiving benefits created and top capital gains taxes to continue to go down for the foreseeable future.

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