Writing the new “Buffett rule” proposed by President Barack Obama to snare more tax revenue from millionaires will prove to be logistically and mathematically difficult.
The concept, named for billionaire investor Warren Buffett, would require Americans earning more than $1 million a year to pay at least the same tax rate as middle-class households. Such a rule would be problematical to craft or ineffectual because higher earners aren’t the only taxpayers benefiting from breaks; many middle-income families take advantage of deductions and credits that drive their rates below the 17.4 percent that Buffett pays.
Buffett has said he and other Americans earning more than $1 million a year should pay more in taxes than they currently do. The administration wants to include Buffett’s concept in a broad overhaul of the U.S. tax code. Obama didn’t include specific language in the proposal he released Monday.
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“We’re not going to give the Congress a detailed proposal for how to meet that principle because we think there are a bunch of different ways to do that,” said Treasury Secretary Timothy Geithner, adding that the details of the rule would depend on the rest of the structure of a new tax system.
Charles Schumer of New York, the third-ranking Democrat in the Senate, said on a conference call with reporters today that the proposal would have broad support in his party and would be a “game-changer” in the tax debate.
“It really works well as a defining principle, but I think it works even better as an actual piece of legislation,” Schumer, a member of the tax-writing Finance Committee, said. “Let’s draft the language and get it scored. Let’s put it on the floor and let’s have a vote.”
The example that Obama gave during his speech today illustrated the difficulty of applying the Buffett principle in practice. He said that a teacher earning $50,000 shouldn’t pay a higher tax rate than an investor making $50 million.
“I reject the idea that asking a hedge-fund manager to pay the same tax rate as a plumber or a teacher is class warfare,” Obama said at the White House. “It’s just the right the thing to do.”
That example isn’t as straightforward as it appears. Under current law, that teacher would have a maximum taxable income of $40,500, after subtracting the standard deduction and personal exemption. The teacher’s federal income tax would be $6,250, or 12.5 percent of the $50,000 income.
The teacher’s tax rate, though, would be higher if payroll taxes were included. It would be lower if the teacher took advantage of the specific breaks available to middle-income taxpayers: those for retirement savings contributions and health-care flexible spending arrangements, and deductions for student loan interest and out-of-pocket expenses of educators.
The tax rate would be even lower if the teacher were married or had children, which would allow for a larger standard deduction, personal exemptions and a child tax credit. A married couple with two children can earn as much as $45,776 without paying income taxes this year, according to the Tax Policy Center, a nonpartisan Washington research group.
As a result of those complexities, lawmakers trying to write a Buffett rule would have to make some choices about how to measure a middle-income family’s earnings and tax rate. They also face complicated arithmetic for higher-income taxpayers.
Assuming the millionaire investor received all of his or her income from long-term capital gains and dividends, the tax rate would be 15 percent, the preferential rate for investment income.
That rate could be much lower if the investor took itemized deductions for state and local taxes, mortgage interest and charitable contributions. It would be higher if the investor also had some wage income.
Writing a Buffett rule into law would require defining income and setting a minimum rate for it, said Roberton Williams, a senior fellow affiliated with the Tax Policy Center. That definition might need to address sources of income, such as municipal bond interest, that aren’t included under the regular income tax.
‘Opening the Door’
“Every time you set up something like this, you’re opening the door for the tax lawyers to come in and get around the attempt to raise revenues,” Williams said.
Obama’s prime target for what he calls income-tax fairness is the 20-point gap between the top rate for capital gains and ordinary income tax rates.
In 1986, President Ronald Reagan signed an overhaul of the tax code that equalized the tax rates on capital gains and ordinary income at 28 percent. Since then, Congress has raised the top income tax rate to 35 percent and dropped the top capital gains rate to 15 percent.
During a briefing at the White House Monday, Geithner said the rates of high-income taxpayers vary depending on their profession.
People who earn much of their income from wages, such as corporate executives and professional athletes, have relatively high tax rates. Investors who make money from capital gains and dividends tend to have lower rates.
Buffett, the 81-year-old chairman and chief executive officer of Berkshire Hathaway Inc., said his federal tax bill last year, or the income tax he paid and payroll taxes paid by him and on his behalf, was $6.93 million.
“That sounds like a lot of money,” Buffett wrote in an essay calling for higher taxes on millionaires in The New York Times last month. “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.”
Several bipartisan groups, including the fiscal commission appointed by Obama last year, have proposed eliminating the preferential tax rates for capital gains as part of a tax overhaul that would also lower rates on wage income.
That approach, rather than the calculation of a minimum tax, might be the most straightforward way to satisfy the Buffett principle, Williams said.
“That certainly makes it a lot easier,” he said. “But a lot of people would oppose that on the argument that there are good reasons to tax capital income at lower rates.”
The arguments for lower capital gains rates include the benefits of encouraging investment, and tax economists say that lower dividend rates minimize the double taxation of income already taxed at the corporate level.
The Buffett rule would essentially operate as a type of alternative minimum tax.
Since 1969, the U.S. has imposed a minimum tax of some sort on the nation’s highest earners to prevent them from using legal deductions, credits and exemptions to avoid paying taxes. That year, in response to a report that 155 people earning more than $200,000 had paid no taxes, Congress created the forerunner to the alternative minimum tax.
The AMT came into its current form in the 1986 tax-code overhaul. It requires taxpayers to compare their tax liability under the regular tax code with their liability under the AMT. Because the AMT doesn’t allow taxpayers the full benefits of the state and local tax deduction or personal exemptions, people with large families or who live in high-tax states in the Northeast tend to be disproportionately affected.
Congressional lawmakers’ efforts to prevent people from legally avoiding all taxes haven’t been successful. In 2008, the most recent year for which data is available, 18,783 people filed U.S. tax returns with adjusted gross incomes of at least $200,000 and owed no taxes. That represented 0.43 percent of high-income taxpayers, the biggest non-payer percentage in an Internal Revenue Service study that dates to 1977.
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