Time to pay up, rich people. “If you make more than $1 million a year,” President Obama said during his State of the Union address the other night, “you should not pay less than 30 percent in taxes.”
And why should that be the case, exactly? Is it because the secretary of billionaire investor Warren Buffett — who attended the speech — apparently pays a higher tax rate than her boss, a relatively rare situation that strikes the president as unfair?
Well, it’s a reason, and perhaps a politically persuasive one when the issue of income inequality has re-entered the public consciousness. But “fairness” is not a particularly good reason to raise taxes during an anemic economic recovery, at least if you care about boosting growth. And the more one looks at the Buffett Rule, the more it looks like a solution in search of a problem.
Buffett says he pays around 17 percent tax on all his income, while his assistant for the past two decades pays more than twice as much, at 35.8 percent. That weird disparity — one that confuses even tax experts unless she makes $200,000 to $500,000 a year — would certainly strike many as unfair, not just a president trying to score political points during election season.
But their example shows how unwise it is to legislate from anecdotal evidence. The U.S. tax code overall is amazingly progressive. The rich pay much higher average effective rates than middle- or low-income folks. According to the Tax Policy Center, in 2010 the top 0.1 percent paid an average tax rate — including income and payroll taxes — of 30.7 percent, right at the Buffett Rule level. By contrast, middle-income voters — defined as those in the middle fifth of income distribution — paid just 12.8 percent. The bottom 40 percent of taxpayers had an average total tax rate of even less, just about 3 percent when you take into account various tax credits.
And if you look at the tax burden by amounts paid rather than tax rates, the system looks even more lopsided. In 2009, the top 1 percent paid 36.7 percent of federal income taxes as they earned 16.9 percent of adjusted gross income. And the richest of the rich, the top 0.1 percent, paid 17.1 percent of income taxes while earning 7.8 percent of adjusted gross income, according to the Tax Foundation. The bottom 50 percent pays just 2.3 percent of income taxes.
There are certainly some rich investors, such as Buffett or Republican presidential contestant Mitt Romney, who pay far less than 30 percent because their income is taxed at the preferential capital gains tax rate of 15 percent. And it’s those folks whom Obama is targeting with this new alternative minimum tax. But to achieve some level of “shared responsibility,” he’s effectively raising the tax on investment income to 30 percent — at least for those who make more than $1 million.
But why would that be a good idea? A big problem with the American economy over the past decade has been too much consumption and too little investment as the U.S savings rate plunged to zero. Why would we want to double investment taxes and thus lower the return on savings put to work in the real economy?
An economic rule of thumb: You should tax what you don’t want, not what you do want. And what America should want is more investment and capital formation to create new businesses and ultimately new jobs. But the current tax code is actually biased against savings, since capital is taxed twice, first at the corporate level and then again as capital gains or dividends at the individual level.
Study after study has shown that eliminating this bias would boost long-term growth. One tax reform plan is the Bradford X tax, a progressive consumption tax. Households would not pay tax on interest, dividends, capital gains or other income from saving. Firms would immediately deduct business investments, rather than depreciating them over time.
What would be the economic impact? One widely cited study estimates a 6.4 percent gain in long‐run output from the adoption of an X tax, which could result in a full percentage-point gain — as a share of GDP — in government revenue. Indeed, a new study from Colgate University found that lower investment taxes “stimulate innovation and enhance labor productivity in the long run.” And that’s how you win the future, by being more innovative and productive year after year.
Obama should review the findings of his own debt commission. It recommended lowering tax rates while getting rid of tax breaks. This would simplify the tax code and improve efficiency. But the Buffett Rule does just the opposite. It adds a new layer of complexity and raises tax rates. Obama should go back and embrace what his own panel recommended. He could even call it the Obama Rule.
James Pethokoukis is a columnist and blogger for the American Enterprise Institute.
To submit an op-ed to The Daily, email opinions@thedaily.com.
And why should that be the case, exactly? Is it because the secretary of billionaire investor Warren Buffett — who attended the speech — apparently pays a higher tax rate than her boss, a relatively rare situation that strikes the president as unfair?
Well, it’s a reason, and perhaps a politically persuasive one when the issue of income inequality has re-entered the public consciousness. But “fairness” is not a particularly good reason to raise taxes during an anemic economic recovery, at least if you care about boosting growth. And the more one looks at the Buffett Rule, the more it looks like a solution in search of a problem.
Buffett says he pays around 17 percent tax on all his income, while his assistant for the past two decades pays more than twice as much, at 35.8 percent. That weird disparity — one that confuses even tax experts unless she makes $200,000 to $500,000 a year — would certainly strike many as unfair, not just a president trying to score political points during election season.
But their example shows how unwise it is to legislate from anecdotal evidence. The U.S. tax code overall is amazingly progressive. The rich pay much higher average effective rates than middle- or low-income folks. According to the Tax Policy Center, in 2010 the top 0.1 percent paid an average tax rate — including income and payroll taxes — of 30.7 percent, right at the Buffett Rule level. By contrast, middle-income voters — defined as those in the middle fifth of income distribution — paid just 12.8 percent. The bottom 40 percent of taxpayers had an average total tax rate of even less, just about 3 percent when you take into account various tax credits.
And if you look at the tax burden by amounts paid rather than tax rates, the system looks even more lopsided. In 2009, the top 1 percent paid 36.7 percent of federal income taxes as they earned 16.9 percent of adjusted gross income. And the richest of the rich, the top 0.1 percent, paid 17.1 percent of income taxes while earning 7.8 percent of adjusted gross income, according to the Tax Foundation. The bottom 50 percent pays just 2.3 percent of income taxes.
There are certainly some rich investors, such as Buffett or Republican presidential contestant Mitt Romney, who pay far less than 30 percent because their income is taxed at the preferential capital gains tax rate of 15 percent. And it’s those folks whom Obama is targeting with this new alternative minimum tax. But to achieve some level of “shared responsibility,” he’s effectively raising the tax on investment income to 30 percent — at least for those who make more than $1 million.
But why would that be a good idea? A big problem with the American economy over the past decade has been too much consumption and too little investment as the U.S savings rate plunged to zero. Why would we want to double investment taxes and thus lower the return on savings put to work in the real economy?
An economic rule of thumb: You should tax what you don’t want, not what you do want. And what America should want is more investment and capital formation to create new businesses and ultimately new jobs. But the current tax code is actually biased against savings, since capital is taxed twice, first at the corporate level and then again as capital gains or dividends at the individual level.
Study after study has shown that eliminating this bias would boost long-term growth. One tax reform plan is the Bradford X tax, a progressive consumption tax. Households would not pay tax on interest, dividends, capital gains or other income from saving. Firms would immediately deduct business investments, rather than depreciating them over time.
What would be the economic impact? One widely cited study estimates a 6.4 percent gain in long‐run output from the adoption of an X tax, which could result in a full percentage-point gain — as a share of GDP — in government revenue. Indeed, a new study from Colgate University found that lower investment taxes “stimulate innovation and enhance labor productivity in the long run.” And that’s how you win the future, by being more innovative and productive year after year.
Obama should review the findings of his own debt commission. It recommended lowering tax rates while getting rid of tax breaks. This would simplify the tax code and improve efficiency. But the Buffett Rule does just the opposite. It adds a new layer of complexity and raises tax rates. Obama should go back and embrace what his own panel recommended. He could even call it the Obama Rule.
James Pethokoukis is a columnist and blogger for the American Enterprise Institute.
To submit an op-ed to The Daily, email opinions@thedaily.com.
