"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?
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President Obama's Five Tax Reform Principles (page 46) - http://www.whitehouse.gov/sites/default/files/omb/budget/fy2012/assets/jointcommitteereport.pdf |
Comments
Company: Peak Business Solutions
Annette, there is a fundemental flaw with the so called "Buffett Rule" that simple makes this a ruse for raising taxes on wage earners.
Mathmatically it is impossible for someone makeing over $1,000,000 of W-2 income and pay less in both dollars and effective rate than someone making $50,000. You can take away every single deduction and still not get there.
Buffett pays an effective rate of roughly 17%, per his own statements. He gets there because the overwelming majority of his income is from capital gains, which is taxed at 15%. Nowhere in Obama's "Buffett Rule" plan does it mention raising the Capital Gains tax rate. Unless this is done, tinkering with the tax code will not be effective and will violate the 5th principle.
Double the capital gains tax from 15% to 30% and then let's see if Buffett is in such a hurry to raise taxes.
Company: Calif. State Univ., Northridge
Hello, Annette. Long time no see.
One of the reasons our tax codes (corporate and individual) are so complex is a tendency to achieve an objective indirectly rather than directly. While I have some sympathy with the situation represented by the "Buffett Rule", I have great difficulty with the proposed path to address that situation. I also have some sympathy for the existing "lower than normal" rate for capital gains and dividends as a way to moderate the combined income tax rate on corporate earnings. However, the end-around approach described in the President's proposal is pretty ridiculous. My counter proposal for taxing those with total incomes above $1 million is to compute a tax on AGI of, say, 25%, compare it to the tax computed under regular rules and pay the higher of the two.
Company: Peak Business Solutions
Robert, interesting concept. But isn't that what the AMT attempts to accomplish?
My take is that preferential treatment of capital over labor is counterproductive to the long term vitality of any economic system. In any economic system, capital cannot exist without labor and vis versa. Therefore preferencing one over the other via tax code, or other policies for that matter, distorts economic outcomes and stacks the deck. This is the fundemental problem when Governments try to regulate economic activity. By the vary nature of implementing policy, they are picking economic winners and losers based on politics, since all governmental policies are fundementally political decisions, and not based on sound economic criteria.
Back to Capital Gains. If I buy a stock on one of the exhanges, did I provide capital to an enterprise? No, therefore did I stimilate any economic impact? No. All I did was buy a stock from another 3rd party, which is a zero sum economic game with no net benefit or cost to the economy as a whole.
The only time the sale of a stock funds an organizations' activities is with an IPO or secondary offering where the funds flow directly to the organization.
So why can't tax rates for capital gains be based on buying ONLY offerings that directly contribute to the working capital of the enterprise? This, I believe would spur capital investment in companies truly in need of capital to expand and would provide less economic distortion.
With all other forms of capital gains being treated similar to earned income. This would allow the tax rates to be lowered while at the same time increase the tax base.
I would be interested in yours or others thoughts.
Company: Calif. State Univ., Northridge
Steve. thank you for your interesting responses and questions. You make a critical point, which is that all governmental policies, including tax policies, are political decisions rather than logical economic policies. That's part of the reason I get such a kick out of the political rhetoric in the presidential race, when candidates make proposals as if their ideas can/will be enacted without going through the political washing machine and wringer. Unfortunately, I don't know how we can get to tax policies that are based solely on economic principles. Tax policies always, and inherently, pick winners and losers. Much of the complexity of our tax policies was inserted with the objective of eliminating or moderating some perceived injustice.
The original "minimum tax on tax preferences" (circa 1969) was an add-on tax. It later was converted to an alternative tax computation, and that is when the real complexity began. It has been an insidious part of taxation ever since. I would vote in a heartbeat to eliminate AMT.
Regarding the taxation of capital versus labor, I find it helpful to "look through" entities to see where the tax burden falls. Ultimately, the only taxpayers are individuals. Corporations are just collections of individuals for tax purposes, because individuals provide the capital for corporations and reap the results of operations (good and bad) eventually. Ideally (in a tax sense), the profits of corporations should be divided up among it owners in the same manner that partnership income is attributed to owners. However, that is not practical. Another approach is for the tax collector to tax corporate dividends as they are distributed. The political issue with the latter approach is pretty clear. Corporations would simply hold onto and reinvest their earnings for years (decades?) so that the value of owership shares would increase but there would be no concurrent tax on shareholders. Corporations are the only entities allowed to accumulate earnings. (Fiduciaries don't count because they have to follow the rules of accumulation versus distribution that are established by the creator of the entity.)
It's pretty easy to understand I think why tax policy makers would not be satisfied to leave the timing of taxation of corporate earnings in the hands of boards of directors. So, the question becomes, how should corporate earnings be taxed. Prior to the Bush tax cuts, the arguments were long and loud that corporate earnings were being taxed too heavily, first to the corporate entity and later to its shareholders.
Your point that capital is provided to corporations only through original share sales is a good one. However, subsequent sales of shares substitutes another owner (ultimately an individual) for the original owner. To the extent that the corporation has done things that raise the market value of its stock (accumulated earnings, accumulation of future value items such as patents, etc), the original owner gets that value through gain on shares, and the new owner has a larger investment in the shares that represent the same proportion of the corporation's equity. Should that gain be taxed below ordinary income rates? That was the successful argument that led to the Bush tax cuts that reduced tax rates on gains and dividends.
I've probably done enough pontificating at this point, but happy to continue the discussion if you wish.
Company: Advanced Predictive Analytics
If I remember correctly, the institution of lower taxes on long-term capital gains was based on the avoidance of double taxation. According to the argument, the taxes paid by the corporation reduce the value of the underlying shares. If the corporation paid no taxes, the share values would be higher and the capital gains would be higher.
The underlying premise is that corporations *do* in fact pay their full complement of income taxes. But what happens when they don't? If I hold stock in ABC company and during the three years (let's say) from the time I purchased the stock until I sold the stock, ABC paid far less than the statutory amount, why should I get a tax break? Where's the double taxation?
My thought is that a fair approach that preserves the theoretical foundation behind the principle would be to scale the tax break against what percentage of the statutory rate ABC actually paid during the holding period. Potentially cumbersome but if the rest of the world can run VAT, there's probably a manageable way to run this kind of system.
Company: TTX
The "Buffet rule" is not premised on 7 figure W-2 income, which will substantially increase the person's effective tax rate, but on investment and other "passive" income, subject to a 15% flat rate for capital gains, for example, and a 0% rate on municipal bond interest income. There are individuals with 7 figure W-2 income, although the W-2 portion is likely to be a small portion of their total income.
We ,might consider a 3 rate tax of 10%, 18%, and 25% [levels to be determined} with NO deductions or exemptions, NO credits, and NO favored income categories like capital gains. The rate schedule should be integrated with FICA/Medicare, providing for deduction of amounts paid, leaving a progressive structure with all income levels paying something, and the highest paying the most. Simple, too. Will need to re-deploy tax preparers in the economy.
Company: Peak Business Solutions
Barrett, to date I have not heard whether any "Buffet Rule" legislation includes such a change in the Capital gains rate. If you have, I would be interested if you could send me a link.
After reading the comments and considering a few options, it occurred to me that maybe the better question and discussion should not be whether people pay a fair rate but rather whether preferential treatment of capital should be continued. As this is the biggest driver of the difference in rates.
Something I have argued for the past 10 years and instinctively believe to be true, though have not had the time or resources to determine if the empirical evidence would support this view, is this: In our drive to become efficient and competitive in a global economy, have we reach a point were we have replaced so much labor in the production of goods and services that structural unemployment will continue to accelerate until our system collapses under its own weight. To me this is at the heart of why the wage disparity in this country is so much greater that in other countries. We value capital disproportional to labor and we simple do not need as much labor inputs to generate similar outputs.
Consequently, using the tax code to redistribute wealth (by disproportionately taxing labor) will not solve this problem but rather a rethinking of what the proper balance is between capital inputs and labor inputs in a capitalistic economy should be in order to maintain a long-term healthy and vibrate economy. And then devising a tax policy to effectively support this balance rather than disrupt the balance as has been the case over the past 40 years.