White House Makes The Case For Buffett Rule

8/2/2019 White House Makes The Case For Buffett Rule

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THEBUFFETTRULE:ABASIC

PRINCIPLEOFTAXFAIRNESS

TheNationalEconomicCouncil

April2012

EMBARGOEDFOR6:00AMTUESDAYAPRIL10,2012


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TheBuffettRule: ABasicPrincipleofTaxFairnessTheBuffettRuleisthebasicprinciplethatnohouseholdmakingover$1millionannuallyshouldpaya

smallershareoftheirincomeintaxesthanmiddleclassfamiliespay.WarrenBuffetthasfamously

statedthathepaysalowertaxratethanhissecretary,butasthisreportdocumentsthissituationisnot

uncommon.This

situation

is

the

result

of

decades

of

the

tax

system

being

tilted

in

favor

of

high

income

householdsattheexpenseofthemiddleclass.Notonlyisthisunfair,itcanalsobeeconomically

inefficientbyprovidingopportunitiesfortaxplanninganddistortingdecisions.ThePresidenthas

proposedtheBuffettRuleasabasicruleoftaxfairnessthatshouldbemetintaxreform.Toachievethis

principle,thePresidenthasproposedthatnomillionairepaylessthan30percentoftheirincomein

taxes.

WhytheBuffettRuleIsNeeded

TheaveragetaxratepaidbytheveryhighestincomeAmericanshasfallentonearlythe

lowestrate

in

over

50

years.

The

wealthiest

1in

1,000

taxpayers

pay

barely

aquarter

of

their

incomeinFederalincomeandpayrolltaxestodayhalfofwhattheywouldhavecontributed

in1960.And,thetop400richestAmericansallmakingover$110millionpaidonly18

percentoftheirincomeinincometaxesin2008.

AveragetaxratesforthehighestincomeAmericanshaveplummetedevenastheirincomes

haveskyrocketed. Since1979theaverageaftertaxincomeoftheverywealthiestAmericans

thetop1percenthasrisennearlyfourfold.Overthesameperiod,themiddlesixtypercent

ofAmericanssawtheirincomesrisejust40percent.ThetypicalCEOwhousedtoearnabout

30timesmorethanhisorherworkernowearns110timesmore.

SomeoftherichestAmericanspayextraordinarilylowtaxratesastheyhirelawyersand

accountantstotakeparticularadvantageofloopholesandtaxexpenditures.TheaveragetaxratemasksthefactthatsomehighincomeAmericanspayneartheirstatutorytaxrate,while

otherstakeadvantageoftaxexpendituresandloopholestopayextraordinarilylowratesand

itisthesehighincometaxpayersthattheBuffettruleismeanttoaddress.

Ofmillionairesin2009,afull22,000householdsmakingmorethan$1millionannually

paidlessthan15percentoftheirincomeinincometaxesand1,470managedto

paidnofederalincometaxesontheirmillionplusdollarincomes,accordingtoIRSdata.

Ofthe400highestincomeAmericans,oneoutofeverythreeinthisgroupofthemost

financiallyfortunateAmericanspaidlessthan15percentoftheirincomeinincome

taxesin

2008.

ManyhighincomeAmericansarepayinglessintaxesthanmiddleclassAmericansintaxes.Nearlyonequarterofallmillionaires(about55,000taxpayers)faceataxratethatislowerthan

morethanmillionsofmiddleincometaxpayers.Thisisfundamentallyunfair.


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InhisStateoftheUnionaddress,PresidentObamacalledforcomprehensivetaxreformthatcutsrates,

cutsinefficienttaxloopholes,cutsthedeficit,increasesjobcreationandgrowth,andsetsoutavery

simpleprincipleoffairness: Nohouseholdmakingover$1millionannuallyshouldpayasmallershareof

incomeintaxesthanmiddleclassfamiliespay.Toachievethis,thePresidenthasproposedthatno

millionairepaylessthan30percentoftheirincomeintaxes.

ThisistheBuffettRule.AsWarrenBuffetthaspointedout,hiseffectivetaxrateislowerthanhis

secretarysandthatiswrong.Tobeclear,thereistremendousvariationintaxratesforhighincome

households,withmany,likesmallbusinessownerswhoreceiveprimarilylaborincomeandtake

advantageoffewspecialtaxbenefits,payingtaxesataneffectiveratenotdramaticallylowerthantheir

statutoryrate.ButasarecentanalysisbytheCongressionalResearchServiceconcluded,thecurrent

U.S.taxsystemviolatestheBuffettruleinthatalargeproportionofmillionairespayasmaller

percentageoftheirincomeintaxesthanasignificantproportionofmoderateincometaxpayers.

Thisbasicsourceofunfairnessiswhatthisprinciplewouldaddress,bylimitingthedegreetowhichthe

most

well

off

can

take

advantage

of

tax

expenditures

and

preferential

rates

on

certain

income.

In

a

time

whenallAmericansarebeingaskedtocometogethertomakethesortofsharedsacrificesthatwill

allowourcountrytocontinuemakingthecrucialinvestmentsthatarenecessarytogrowoureconomy,

continuingtoallowsomeofthewealthiestAmericanstousespecialtaxbreakstoavoidpayingtheirfair

sharesimplycannotbejustified.Moreover,addressingtheseinequitiesthroughtaxreformthatincludes

aBuffettRulecanalsoimprovetheefficiencyofthetaxsystembydiscouragingtaxplanningand

reducingdistortionstobehavior.

I. TheAverageTaxRatePaidbytheVeryWealthiestAmericansHasFallen

to

Nearly

Its

Lowest

level

in

Over

50

Years

FortheverywealthiestAmericans,theamountoftaxestheyhavepaidonaveragehasfallensharply

overrecentdecades.

Amongthetop0.1percentthehighestincomeoneoutofeverythousandAmericanhouseholdstheaveragetaxrate,includingFederalincomeandpayrolltaxes,hasdropped

astunning50percentoverthelast50years,from51percentto26percent(seeFigure1).

Thisisnearlythelowestrateinover50yearsandis,infact,onehalftheratetheywould

havepaidin1960.

To

take

even

a

thinner

slice

the

400

highest

income

households,

all

of

whom

made

over

$110millionin2008,themostrecentyearforwhichdataareavailable,foranaverageof

$271millionpaidjust18.1percentoftheirincomesinFederalincome(excludingpayroll)

taxonaverage,accordingtotheIRS.In2007,itwasjust16.6percent.Thisisnearlyhalfthe

29.9percentratethosehouseholdspaidonaveragein1995.


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Incontrast,themiddleclasshaveseentheirtaxesroughlyconstant,orslightlyincreasing,overthisperiod.Themiddlequintile,forexample,paid14percentofitsincomeintaxesin

1960and16percentin2010.

Partofthisremarkabletrendisaresultofthe2001and2003taxcutsforthehighestincomeAmericans

that

were

unfair

and

unaffordable

at

the

time

they

were

enacted

and

remain

so

today.Between2000and2008,incometaxratesforthetop0.1percentfellby4.7

percentagepoints.

Figure1showsthetrendinaveragetaxratessince1960fortop andmiddleincomeearners.

Importantly,theseestimatescalculateeffectivetaxratesineachoftheseyearsbasedontheactual

incomedistributionin2005,withtheirincomesadjustedforthenationalaveragewagegrowtheach

yearbeforeandafter.Thiseffectivelycontrolsforchangesinthedistributionofincomesoastogivea

clearreadingofwhathappenedpurelyasaresultofchangesintaxpolicy.Incontrast,otherestimates

alsoshowthatthetaxsystemhasbecomesubstantiallylessprogressivebutunderstatethemagnitude

ofthischangebecausetheycoverthesameperiodthatthehighestincomeAmericanswereearning

morerelativetoothers.

Figure1


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II. AverageTaxRatesfortheHighestIncomeAmericansHavePlummetedEvenAsTheirIncomesHaveSkyrocketed

Overthepastfourdecades,incomeinequalityhasrisendramatically,severingthelinkthatpreviously

existedbetweeneconomicgrowthandmiddleclassstandardsofliving.Bythetimethefinancialcrisis

struck,these

trends

had

resulted

in

the

wealthiest

Americans

receiving

agreater

share

of

the

countrys

totalpretaxincomethanatanytimesincetheRoaringTwenties.

WhiletheeconomicgrowththatfollowedtheendofWorldWarIIwasbroadlysharedbyAmericansofallincomelevels,theincomegaphasincreaseddramaticallyinthepastfour

decades.

Since1979,theaverageaftertaxincomeofthehighestincomeAmericansthetop1percenthasrisennearlyfourfold.Overthesameperiod,themiddlesixtypercentof

Americanssawtheirincomesrisejust40percent.ThetypicalCEOwhousedtoearnabout

30timesmorethanhisorherworkersnowearns110timesmore.

Thewealthiestoneofeveryhundredhouseholdsthetop1percentnowtakehome17percentofthetotalincomeearnedbyallAmericanworkers(seeFigure2),amongthevery

highestsharesofanytimesincethe1920s.

Thisrisingeconomicinequalityhasmeantthattheveryrichhavereceived,overtheyears,anoutsizeshareofthecountryseconomicgrowth.ThetypicalAmericanfamilywhose

realincomeactuallyhasfallenoverthepastdecadebyabout6percentonaveragehas

beenleftfarbehind.

Figure2

6

8

10

12

14

16

18

20

1913 1923 1933 1943 1953 1963 1973 1983 1993 2003

Share of Total U.S. Income Earned by Top 1 Percent, 19132010Percent of total U.S. income

Note: Total income includes wages and salaries (including bonuses and stock-option

exercises), pensions, profits, farm income, dividends, interest, and rental income.Source: Piketty and Saez (2003, 2010)


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III. SomeoftheRichestAmericansPayExtraordinarilyLowTaxRates

TheaveragetaxratemasksthefactthatsomehighincomeAmericanspayneartheirstatutorytaxrate,

whileotherstakeadvantageoftaxexpendituresandloopholestopayalmostnothing.Forexample,a

hedgefundmanagermightcharacterizehisorhercompensationascapitalgains,therebypayinga

fractionof

the

taxes

they

would

pay

if

their

income

was

classified

as

wages,

the

same

as

other

working

Americans.ItisthesehighincometaxpayersthattheBuffettruletargets.TheBuffettRuleisnotan

acrosstheboardtaxincreaseonhighincomehouseholds;itisawaytoensurethatnomillionaireis

payinglessthanthemiddleclass.

Ofthosemakingover$1millionin2009,fully160,000householdspaidlessthan30percentoftheirincomeindirectincomeandpayrolltaxesin2009,accordingtoananalysisofthe

IRSs2009StatisticsofIncomefilebytheTreasuryDepartmentsOfficeofTaxAnalysis.

(Notethatthatnumberisprojectedtobelowerin2013whenthetemporarytaxrateson

highincomehouseholdsarescheduledtoexpire.)

Of

these

millionaires,

over

22,000

families

paid

less

than

15

percent

of

income

in

Federal

incomeandemployeepayrolltaxesand1,470managedtopaidnofederalincometaxes

ontheirmillionplusdollarincomes,accordingtotheIRS.

Thedistributionoftaxespaidamongthe400richestAmericansisparticularlystriking.OneoutofeverythreeinthisgroupofthemostfinanciallyfortunateAmericanspaidlessthan15

percentoftheirincomeintaxesin2008(seeTable1).And85percentofthe400highest

incomehouseholdspaidaneffectiverateoflessthan30percent.

Table1

Percentofthe400HighestIncomeAmericansPayingLessThana

GivenEffective

Federal

Income

Tax

Rate

in

2008

Under10% Under15% Under 20% Under 25% Under 30% Under35%

Percentoftop400 8% 33% 61% 74% 85% 100%

IV. ManyHighIncomeAmericansArePayingLessAsaShareofTheirIncomeThanMiddleClassAmericans

BecausesomeoftherichestAmericanspaytaxesatsuchextraordinarilylowrates,theyenduppaying

lessintaxesasashareoftheirincomeintaxesthanmiddleclassAmericans.Tobeclearonaverage,

high

income

Americans

do

pay

more.

That

is

because

the

United

States

has

a

progressive

tax

system

in

whichtaxratesgenerallyrisewithincome,albeitnotasmuchastheyhaveinthepast.

However,theseaveragetrendsmaskthesubstantialvariationintaxrates,whichisevengreaterforvery

highincomehouseholds.SomeofthewealthiestAmericanscanhirelawyersandaccountantstotake

advantageoftaxexpendituresandloopholesthatenablethemtopayalowershareoftheirincomein

taxesthanaverageAmericans. Inparticular:


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Nearlyonequarterofmillionairespaylessintaxesthanmillionsofmiddleclassfamilies:o Twentyfourpercentofallmillionaires(about55,000taxpayers)faceataxratethatis

lowerthanthetaxratefacedbynearly1.5milliontaxpayersmakingbetween$100,000

and$250,000(the90thpercentileforthisgroup).

o Twentyonepercentofmillionaires(about50,000taxpayers)faceataxratethatislowerthanthetaxratefacedby3milliontaxpayersmakingbetween$50,000and$100,000

(the90thpercentileforthisgroup).

ThisisillustratedinFigure3whichshowsthedistributionofeffectivetaxratesbyincomeclass.Thisfigureshowsthat,whileaverageratesgenerallyrisewithincome,asignificantportionof

thehighestincomeAmericanspaylessintaxesasashareoftheirincomethanmiddleclass

families.ThefigurealsoshowsthatthehighestincomeAmericanshavemuchmorevariabletax

ratesthanmiddleclassfamilies.

Figure3


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V. TheEconomicArgumentfortheBuffettRule

Economicresearchhasshownthattaxesaremoreefficient(orlessdistortionary)whentaxpayershave

feweropportunitiestoavoidthem.TheBuffettRulewouldreducetheseopportunitiesforthehighest

incomeAmericans,limitingtheextenttowhichtheycantakeadvantageofinefficienttaxsheltersor

accountingmechanisms

to

avoid

paying

taxes.

Inarecentpaper,NobelprizewinningeconomistPeterDiamondandrenownedtaxeconomistEmmanuelSaeznotetherelativelygreaterabilityofhighincometaxpayerstoavoidtaxes,and

arguethatthenaturalpolicyresponseshouldbetoclosetaxavoidanceopportunities(Journal

ofEconomicPerspectives,Fall2011).

ResearchbyeconomistWojciechKopczukhasdemonstratedthatbasebroadeningreducesthemarginalefficiencycostoftaxation(JournalofPublicEconomics,2005).Kopczukalsofound

thattheTaxReformActof1986,whichbroadenedthetaxbaseandclosedtaxloopholes,

limitedtheextenttowhichhighincometaxpayersactedtoavoidtaxes.

Highincometaxpayershavebeenshowntoavoidtaxesbychangingthetimingofincomereceived.Forexample,Goolsbee(JournalofPoliticalEconomy,2000)foundthattheprimary

responsebyexecutivestothe1993taxincreasewastochangethetimingoftheirstockoptions.

ApermanentBuffettRulewouldlimittheseopportunitiesfortaxavoidance,whichwould

enhanceeconomicefficiency.

Manytaxsubsidiesaredesignedtosupportimportantgoals,manywithbroadereconomicbenefits,likeencouragingandsupportinghomeownership,retirementsavings,andhealth

coverageforthemiddleclass.Butthesesubsidiesareoftenupsidedown,withthelargest

incentivesgoingtothehighestincomehouseholdsthatoftenhavetheleastneedforthem.This

notonlycostsmoney,itcanencouragetheperceptionorrealityofunfairness,andis

economicallyinefficient.

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White House Makes The Case For Buffett Rule