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Thursday, April 12, 2012

Buffett Rule, Upper Income Taxpayers and Errors and Omissions

The White House has released more information about the "Buffett rule" which calls for individuals making over $1 million to have a higher effective tax rate - higher than those that make less. The additional information includes:
  • An 8-page report - The Buffett Rule: A Basic Principle of Tax Fairness, explaining why it is needed.
  • A 5-minute video from Brian Deese, the Deputy Director of the National Economic Council, explaining current tax rates for different income groups. He notes that the Buffett rule is intended to be sure millionnaires (those earning over $1 million per year) pay at least 30% of their income in taxes.
  • An April 11 speech from President Obama

Yet, the details of how the 30% effective tax rate is achieved are missing. In the FY2013 revenue proposals, President Obama proposes not renewing tax cuts for "upper-income" individuals defined as those with income over $200,000 ($250,000 if married filing jointly). These individuals would also be limited to a 28% tax benefit (rather than a 35% or 39.6% benefit) of itemized deductions as well as from exclusions for foreign excluded income, tax-exempt interest income, employer-provided health insurance, and a few other items. (See pages 73 - 74 of FY 2013 Greenbook.)

Code Section 1411, a new Medicare tax created with health care legislation, kicks in starting 2013 for upper-income individuals with investment income. The Greenbook proposal and Medicare tax should be enough for individuals with mostly wage and dividend income to meet the Buffett rule threshold. For individuals where their millions of income is mostly capital gains, they would have roughly a 23.8%  tax on that income so it would be subject to the Buffett rule.  One fairly simple way to draft the Buffett rule is to have everyone calculate their taxable income and tax liability. For those with income over $1 million (I assume President Obama means gross income rather than either adjusted gross income or taxable income), they would multiple their gross income by 30%. If that number is greater than their "regular" tax calculation, they would pay the higher amount.  It would be a sort of alternative minimum tax only simpler than the current AMT. The AMT would still exist, but with its 26% and 28% tax bracket, it mostly affects individuals not subject to the 35% and 39.6% brackets or the Buffett rule.

In his April 11 remarks, President Obama reminds us that "upper-income" taxpayers represent only 2% of all individual taxpayers. Unfortunately, this seems to get lost in the discussions. For example, in Congressman Ryan's speech of April 10, 2012 (around the 3 minute mark), he implies that the rates after 2012 when tax cuts expire will affect all small businesses. While "small" business is defined many ways, netting $1 million from a small business is rare and perhaps not even a "small" business at that net income level.

Some suggestions for the discussions:
  • Focus on progressivity and what range of tax rates are appropriate. The Deese video points out that for 2008, the average income of the top 400 income earners was about $110 million.  Why place them in the same brackets as a single person making $200,001?  Why not a greater range of rates at the upper income levels?
  • Why not use pies to illustrate the Buffett rule? A pie represents a person's total income. Then show what size the slice of pie is that represents federal income taxes. There should also be a slice for the 15.3% of payroll taxes workers and self-employed pay - averaged for each income level. Then it will be more clear that the percentage of income left to live on is today much larger for the highest income individuals.
  • In talking about effective tax rates, also include payroll taxes. How do they fit in? I think the Buffett rule is only looking at income taxes. If true, many millionaires will still have a smaller piece of their income pie going to federal taxes. For example, assume tax cuts are made permanent for individuals with income below the $200K and $250K thresholds. So, someone making $150,000 of wages is subject to 10% and 25% brackets, but also 15.3 on up to about $110,000 of wage income and 2.9% on the remaining $40,000.  That is going to result in a bigger pie slice labeled "taxes" than the millionaire with $2 million of capital gains with an effective rate of about 23.8% bumped up to 30% under the Buffett rule.
  • Details needed!  Explain how the Buffett rule works, rather than only why it is needed. Explain how it works with President Obama's proposal for tax increases on "upper-income" individuals.
What do you think?

1 comment:

Clark W. Griswold said...

I agree with Professor Nellen that President Obama’s proposal for tax increases on “upper income” individuals and the Buffet rule need clarification. The lack of details in the National Economic Council’s Buffet rule report suggests that the National Economic Council does not know how it will achieve the desired result, which is to have individuals making over $1 million per year to have a higher effective tax rate than taxpayers in the middle class. If that is the case, I recommend that the National Economic Council focus on reforming the provisions of the tax code that have caused millionaires to have such low effective tax rates instead of adding more complexity to the Code through adding yet another code section. To increase millionaire’s effective tax rates, I recommend having capital gains and qualified dividends taxed at the same rate as ordinary income and adding another tax bracket for individuals making over $1 million per year.

My recommendation to reform provisions of the tax code that contribute to the undesirable result of millionaires paying lower effective tax rates is from a tax policy perspective than adding a surtax for millionaires. Applying the same tax rates for capital gain and ordinary income promotes fairness because taxpayers with similar amounts of income will pay the same tax rates regardless of how the income was derived. Applying the same tax rates to capital gains and ordinary income simplifies the tax code because one rate structure would apply to both categories of income. My recommendation would decrease the tax gap because wealthy taxpayers, such as hedge fund managers, would not be able to game the tax system and pay less in taxes by misclassifying their salary as capital gain income.

In contrast, adding a Buffet rule may actually be unfair to certain millionaires. The Buffet rule doesn’t appear to consider the possibility that millionaires may have made a portion of their fortunes from foreign source income, on which they have already paid considerable foreign taxes. These taxpayers would qualify for the foreign tax credit and this could lower their effective U.S. tax rate considerably. Is it fair for these taxpayers to pay a minimum tax rate on their income when they have already paid their share of taxes to the foreign governments?