Evaluating The “Buffett Rule”

Warren Buffett’s crusade for tax reform that began with an op-ed piece that he wrote in the New York Times in August took another step forward earlier this week. After months of calls from politicians to release his tax return Buffett sent a letter to Representative Tim Huelskamp (R-KS) which disclosed his gross income and federal income tax receipt from 2010.

Buffett had a gross income of about $63 million, almost $40 million of which was taxable income, on which Buffett paid slightly less than $7 million in federal income taxes, for an effective rate of 17.4%.Buffett’s argument is that it’s not fair that he has a lower effective tax rate than his secretary, who has an effective tax rate of about 30%. Buffett’s call for higher taxes on the wealthy has lead President Obama to call his proposed surtax on millionaires and billionaires the “Buffett Rule” as part of his $447 billion jobs plan. However, once one digs beneath the surface the numbers turn out to be misleading.

The main reason that Buffett pays such a low effective tax rate is that very little of his gross income comes from an annual salary; his salary has been set at $100,000 for years. He derives most of his income from other sources, most likely capital gains or dividends. Dividends and capital gains are only taxed at 15%, whereas ordinary income is taxed at a top marginal level of 35%. Though Buffett only pays 15% on those dividends and capital gains that’s not all of the revenue that the federal government draws from them. Capital gains and dividends are also taxed at 35% at the corporate level, which means that they are taxed twice at a combined effective rate of about 45%.

Buffett’s anecdote that he pays a lower tax rate than his secretary is an exception, not the rule. According to the Congressional Budget Office (CBO) in 2006, the last year with available data, the highest quintile by comprehensive household wealth paid a 25.8% effective federal tax rate, while the lowest and second lowest quintiles paid 4.3% and 10.2% respectively.

While I do agree with Warren Buffett that comprehensive tax reform is needed, the numbers just don’t back up his argument that the rich aren’t paying their fair share. Buffett just structures his gross income in such a way that he pays a low effective tax rate through taking advantage of deductions for charitable donations and by paying himself in capital gains and dividends instead of a salary. While his idea that the super rich are being coddled because he has a lower tax burden than his secretary is a good anecdote, it shouldn’t be the basis for changes in tax policy.

Tagged , ,

One thought on “Evaluating The “Buffett Rule”

  1. Bo-Shiun says:

    The characterisation of Buffett’s article is rather misleading. His primary suggestion is to close the loophole that allows those who derive their incomes from capital gains (ex. hedge fund managers) to be taxed at a lower rate (15% maximum). His focus is predominantly on the capital gain tax rate and less on the payroll tax rate.

    ‘Back in the 1980s and 1990s, tax rates for the rich were far higher, and my percentage rate was in the middle of the pack. 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.’

    Evidently, his main argument stems from the injustice of the capital gain tax rate. The reason why he urges the Congress to raise the tax on families making over $1 million (and even more tax for those making $10 million) ties in with his argument about the capital gain tax rate. There is absolutely no reason why capital gains should be taxed at a lower rate than payroll taxes. As a result, Buffett’s arguments are sensible to the vast majority of Americans.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s