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.