21st Century Taxation: Complexity of the "Buffett Rule"

Wednesday, February 22, 2012

Complexity of the "Buffett Rule"

In September 2011, President Obama introduced the "Buffet Rule" as one of his five tax principles. It was part of his report - Living Within Our Means and Investing in the Future (page 46). Here is the rule:

"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."

President Obama's FY 2013 revenue proposals include to reduce the benefit of certain tax expenditures for upper-income individuals. As explained on page 74 of the Greenbook:

"The proposal would limit the tax value of specified deductions or exclusions from AGI and all itemized deductions. This limitation would reduce the value to 28 percent of the specified exclusions and deductions that would otherwise reduce taxable income in the 36-percent or 39.6- percent tax brackets. A similar limitation also would apply under the alternative minimum tax. The income exclusions and deductions limited by this provision would include any tax-exempt state and local bond interest, employer-sponsored health insurance paid for by employers or with before-tax employee dollars, health insurance costs of self-employed individuals, employee contributions to defined contribution retirement plans and individual retirement arrangements, the deduction for income attributable to domestic production activities, certain trade and business deductions of employees, moving expenses, contributions to health savings accounts and Archer MSAs, interest on education loans, and certain higher education expenses. This proposal would apply to itemized deductions after they have been reduced by the statutory limitation on certain itemized deductions for higher income taxpayers. The proposal would be effective for taxable years beginning after December 31, 2012."

There are no examples or details on how the calculation would be made. Also note that the above reduction is different from what President Obama proposed in FY 2011 which was to limit the value of itemized deductions to 28% (see page 132 of the FY2011 Greenbook). The current proposal goes much further.

So how the FY2013 proposal calculated? Let's consider the exclusion for employer-provided health insurance. If an upper-income taxpayer has $12,000 of such insurance, there is no income or payroll tax consequence today. If the taxpayer is at a marginal tax rate of 39.6%, then the savings of the tax expenditure is $4,752. A 28% benefit would provide a savings of only $3,360. So I'm guessing that this person has to include the difference in their taxable income ($1,392).

I know that tax prep software can handle the calculations, but there is still complexity of obtaining the information. There is also lack of transparency as to the person's effective and marginal tax rates.

What do you think? Also, do you think my calculation is correct?