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Wednesday, September 28, 2011

Buffett Rule - a New Tax Principle?

I think it is interesting to name a principle for tax reform after someone. That is what President Obama did in his recent tax reform proposal (9/19/11) that will help pay for some tax cuts intended to help with job creation and hiring. His 80-page plan lays out 5 principles for tax reform (page 46). These are:
  1. "Lower tax rates. The tax system should be simplified and work for all Americans with lower individual and corporate tax rates and fewer brackets.
  2. Cut Inefficient and Unfair Tax Breaks. Cut tax breaks that are inefficient, unfair, or both so that the American people and businesses spend less time and less money each year filing taxes and cannot avoid their responsibility by gaming the system.
  3. Cut the deficit. Cut the deficit by $1.5 trillion over the next decade through tax reform, including the expiration of tax cuts for single taxpayers making over $200,000 and married couples making over $250,000.
  4. Increase job creation and growth in the United States. Make America stronger at home and more competitive globally by increasing the incentive to work and invest in the United States.
  5. Observe the Buffett Rule. No household making over $1 million annually should pay a smaller share of its income in taxes than middle-class families pay. As Warren Buffett has pointed out, his effective tax rate is lower than his secretary’s. No household making over $1 million annually should pay a smaller share of its income in taxes than middle-class families pay. This rule will be achieved as part of an overall reform that increases the progressivity of the tax code."
These are not exactly the "principles" I'd advocate for reform. I prefer the set that includes equity, simplicity, transparency, certainty, neutrality, economic efficiency and minimum tax gap. The "principles" President Obama outlines above should really be called "outcomes" for tax reform.

Some of his suggestions in the 80-page plan are specific, he lists some provisions he wants to remove such as tax preferences for oil, gas and coal companies. He is not specific on whether any of the existing 100+ special rules for individuals should be removed or cut back. To really reduce deficits though, these will need to be cut back since the majority of the $1.1 trillion of "tax expenditures" (special deductions, exclusions and credits) are for individuals.

The Buffett rule is vague. When tax cuts expire, the capital gains rate for most capital assets (such as stock investments) will go back to 20% (18% if held over 5 years). The rate on qualified dividends could be as high as 39.6% (in addition to the Medicare tax of Section 1411 that kicks in starting in 2013). Will the capital gains rate on high income individuals need to be raised beyond 18% to be sure their effective tax rate exceeds someone making $200,000 ($250K) if married? Will high income individuals be denied use of the 50% capital gains exclusion if they sell qualified small business stock held over 5 years (Section 1202)? Will a special surtax apply for incomes above $1 million (regardless of whether the income is ordinary or capital gain)?

How will lower corporate tax rates be paid for? The tax raisers in the president's plan cover the jobs provisions. They also cover some deficit reduction since his tax increases are permanent while the jobs provisions are temporary. Or will the Buffett rule be enough to cover a lower corporate tax rate? How low?

So, I won't be adding the Buffett rule to my list of principles of good tax policy (and I acknowledge that President Obama isn't suggesting it as a principle of good tax policy, but of his reform agenda). I would like to see more details on how it works to ensure that a wealthy person with only capital gains income, including from Section 1202 stock, does have a higher effective tax rate than an individual who keeps the lower tax rates promised for those under $200K and $250K of income.

I would like to see more about cutting back on overly generous and unnecessary deductions, such as for interest on a mortgage on a second home or a home equity loan, as well as mortgages over an amount tied to regional home values (which would be something less than the current $1.1 million limit).

For more on the Buffett rule and likely effect, see:
What do you think about the Buffett rule or any other part of the 80-page tax proposal?

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