Monday, August 15, 2011

Decoding Buffett's tax plan

NEW YORK (CNNMoney) -- Warren Buffett is once again begging Congress to tax him more.

"My friends and I have been coddled long enough by a billionaire-friendly Congress. It's time for our government to get serious about shared sacrifice," the founder of holding company Berkshire Hathaway (BRKA, Fortune 500) wrote in a New York Times opinion piece on Monday.

Unlike President Obama, who wants to raise the top two tax rates on individuals making more than $200,000, Buffett wants income and investment tax rates raised only on those making more than $1 million in taxable income. In 2009, they represented just 0.2% of tax returns -- as opposed to the 2% to 3% who would be affected by Obama's proposal.

In Buffett's view, the very rich don't pay enough in taxes. And he doesn't think asking them to pay more will discourage investment or job creation. Some people will disagree with him on one or both those points. But here's a breakout on what he is talking about.

Why Buffett only pays 17.4% of his income in federal taxes: "Last year my federal tax bill ... was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income -- and that's actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent."

Millionaires who pay no income tax

Unlike most Americans, Buffett and the country's wealthiest taxpayers make much of their income from investments. The capital gains and dividends those investments generate are taxed at a much lower rate than wages. Long-term capital gains and dividends are currently taxed at 15% -- well below the 35% top income tax rate.

Managers of hedge funds and other investment partnerships, meanwhile, enjoy that same rate on the portion of their pay known as carried interest.

In addition, the wealthiest only pay a very small percentage of total payroll taxes, which support Medicare and Social Security. That's primarily because the payroll tax only applies to wage income, not investment income. Come 2013, however, a Medicare tax will be added to a portion of the wealthiest Americans' investment income to help pay for health reform.

How much money could be raised by hiking taxes on the super rich? Without specifics, it's hard to say. But it's possible to get a ballpark idea if one assumes nothing else changes about the current tax structure.

If lawmakers added a new 50% tax rate to taxable income over $1 million, that could raise an additional $34 billion, according to the Tax Policy Center. So adding that new top rate might raise at least an additional $340 billion over 10 years.

And if lawmakers opt to tax carried interest as ordinary income, the change could raise an additional $21 billion over 10 years, according to Joint Committee on Taxation estimates.

What about tax rates on capital gains and dividends? If they were raised to 20% for individuals making more than $200,000 (and couples making more than $250,000) that could raise roughly $107 billion over a decade, the Treasury Department estimated last year. The rate increase would raise less if it were limited to just those making more than $1 million.

All told, if one combines the three changes -- setting aside the economic effects if they were all implemented -- it's possible that Treasury could pull in more than $450 billion over a decade.

In the context of deficit reduction, $450 billion is less than 5% of the new debt the country is on track to accrue over the next decade. But it's a lot of money in terms of potentially valuable government programs that might otherwise need to be slashed absent additional revenue.

Higher rates won't discourage investment: "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."

It is unlikely that the wealthiest investors will pack up their marbles and go home if Congress raises the capital gains rate.

But an investor's calculus for what makes a "sensible" investment may change a little since the expected profit from an investment would go down once taxes are factored in.

Higher rates won't hurt job creation: "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 may well be a correlation between tax rates at the top of the income scale and job creation, but it's hard to nail it down.

Conservatives often contend that hiking taxes on high-income taxpayers will hurt small business job creation. Liberals say that's nonsense.

The truth is probably somewhere in the middle. "Tax policy is one of many, many things that affect it. Job growth, for example, depends on a host of demographic factors," said Donald Marron, a former acting director of the Congressional Budget Office.

What's more, there's no uniform definition for what constitutes a business on the federal tax return. So some of the business income reported by the wealthiest taxpayers may come from owning rental property or belonging to an investment partnership, neither of which are big job-creating businesses.

And nowhere on the 1040 does a tax filer indicate how many jobs his business has created in a given year.

What might help job creation, though, which Buffett's opinion piece doesn't address, is an overhaul of the tax code. Such reform would reduce income tax rates and pare down many of the very expensive tax breaks.

When Congress has that debate, the issue of how much the rich should pay will be front and center.


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I have been a resident of Coldstream since 1976. I have had 15 years of experience on Council, 3 years as Mayor. As a current Councillor I am working to achieve fair water and sewer rates and to ensure that taxpayers get fair treatment. The current direction regarding water supply is unsustainable and I am doing all I can to get the most cost effective water supply possible.