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Looking Closer at Taxes

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By:
Date:
Location: Washington, DC

Ancient philosophers, observing the world around them, theorized that animals could spontaneously generate given the right conditions. For centuries, this was assumed to be true. A 17th century scientist could famously "create" mice by placing a soiled cloth and wheat in a box for 21 days. It was only after more careful observation and controlled experimentation that the old theories were replaced with a more accurate view of how life begins.

President Obama is out with a new tax proposal to ensure that the wealthy always pay a higher percentage of their income in taxes than the middle class. To many, that sounds fair. Federal income taxes have been progressive since they were first created more than 100 years ago.

The President's name for his new rule is coined after his famous friend, and third richest man in the world, Warren Buffett. Buffett became a billionaire many times over through his investment company, Berkshire Hathaway. In a recent editorial, Buffett claimed that his secretary paid a higher percentage of her income in taxes than he did. Since this story is now going to be the basis for the way our nation is governed, we should probably ask some questions.

First of all, did Buffett provide hard evidence of this claim? Right now, we have to take him at his word. He has not made his tax return available to Congress. Members of Congress are, quite rightly, are barred from looking at the tax returns for either Buffett or his secretary. It may be unwise to pass a Buffett Rule when we don't have all the facts.

One thing we can surmise is that his secretary probably has an annual salary while most of Buffett's wealth is generated by his investments. When these investments pay dividends, or when he sells them at a profit, he pays the capital gains tax. This tax is assessed at a 15 percent rate, while the top tax bracket for income is 35 percent.

On the face of it, it might appear that Buffett is somehow "getting away" with paying less. But there is more to the story. Buffett owns 30 percent of Berkshire Hathaway. Almost all of his wealth is wrapped up in the company. Last year, the company paid $5.6 billion in corporate tax. That makes Buffett's share approximately $1.6 billion. Before he ever received a dollar of profit from his dividends, the company had paid a significant tax bill.

Are other millionaires and billionaires in the same situation as Buffett? The evidence from the IRS says "no." According to the Treasury Department, individuals making more than $1 million pay an average effective tax rate of 24.1 percent. This means that after they add up all of their deductions, average millionaires send one quarter of their earnings to the federal government.

By comparison, those making $75,000 to $100,00 pay an average of 8 percent. The data shows that the average taxpayer pays more in taxes as their income rises.

Has the Buffett Rule been tried before? We haven't seen the President's plan written up in legislative text yet, but it sounds suspiciously similar to the Alternative Minimum Tax. The AMT was created in 1969 after the Secretary of the Treasury claimed that 155 wealthy individuals had no tax burden. Decades later, a rule intended for a small group of the wealthy is hurting upper middle class taxpayers because the AMT was never designed to deal with inflation.

Congress needs to be careful not to legislate by anecdote. Warren Buffett may think that he needs to pay more taxes. He is free to do so at any time. The U.S. Treasury will cash any check properly made out.

The fact is that the Buffett Rule would add yet another complication to the tax code. More pages to the tax code might mean more IRS agents, but it doesn't always translate into more government revenue and it certainly doesn't make it easier on job creators.

A cursory examination of the natural world led to the incorrect scientific theory of spontaneous generation. Congress shouldn't base our tax policy on the casual observation of a single billionaire. We need to look closer.


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