Tax the Rich?

A few weeks ago Warren Buffett wrote in the NYtimes that he pays a tax rate that is lower than anyone else in his office, including his secretary. This understandably concerns anyone who believes that U.S. is supposed to have a progressive tax system. It has brought forth calls for higher taxes on the rich, a sentiment that is now gaining some political traction. But how much should we really take from the so called Buffett Rule?

The WSJ makes some excellent points:

Just to summarize: The first thing to point out is that Warren Buffett is not the average rich tax payer. The average person who makes more than $1 million pays an "average tax rate" of 23.1 percent. It's important to keep the big picture in mind. This one anecdote should not be exaggerated.

The second thing is that rich people pay "higher average tax rates" than poor people. Someone who earns 50,000 pays an average rate of 7 percent. That’s about a third of what a rich person pays. (not including payroll taxes.... )

If the top marginal tax rate is 30 percent, and the average tax rate for someone who makes more than 1 million is 23 percent, why does Buffett pay less? The WSJ notes that a large portion of his income comes from capital gains and dividends on investments. This income is only taxed at 15 percent. This fact is important for two reasons: a) capital gains are not the biggest source of income for many rich people in the U.S., and Buffett is somewhat of an outlier on this;

To quote Greg Mankiw

If your image of the typical rich person is someone who collects interest and dividend checks and spends long afternoons relaxing on his yacht, you are decades out of date. The leisure class has been replaced by the working rich.

b) This calculation does not factor in the corporate tax rate, which is 35 percent. Because corporate taxes tax “profit” (not revenue), it is also a tax on capital gains. In short, Buffett is taxed twice, but doesn’t count the 35 percent corporate tax rate in his calculation. So he probably pays way more.

It’s depressing to think that Buffett’s one anecdote could serve as the basis for U.S. tax policy. Unfortunately, it has come to that. Obama has proposed a tax on millionaires.

Is this anything more than re-election politics? Probably not;

the WSJ is predictably sanguine about the economic effects:

Well, the plan Mr. Obama unveiled yesterday along with his Buffett Rule would sock the economy with $1.5 trillion in new taxes over 10 years, or about 1% of GDP. This includes the tax increases built into the 2013 expiration of the Bush-era tax rates but not those of ObamaCare. Anyone who believes this will help an economy that is creating few new jobs and growing by only 1% probably also believes that only the rich would pay the Buffett Alternative Tax.

AM: Instead of these ad hoc reforms that just add new layers to an already complex and burdensome tax system, Obama should undertake a more fundamental reform of the tax system. Lower the rates and broaden the base. This is what every economist seems to say. How would this work in practice? Maybe consumption taxes? A flat tax? It seems to me that there is some low hanging fruit here that could be picked through tax reform, rather than this ad hoc layering. It would be nice to see some evidence based public policy one in a while, and not simple political pandering.

Also, the Federal tax rates don’t include social security “contributions” (taxes). These are regressive taxes also, that fall more on those with lower income. When they are factored in, it may be that the tax rate of someone who makes $50,000 approaches 15 percent or something close to what Buffett says he pays (minus corporate taxes). Is this another argument in favour of a more streamlined, simple tax system like a flat tax? Get rid of these regressive elements like the SS contribution? After all, it just goes into the budget, and is in no way tied to the subsidy paid out to the elderly. Might as well separate them...