The Silly Tax Rule

“It’s not fair!” Average Joe screamed. “My boss pays a lower tax rate than I do. Warren Buffett pays a lower tax rate than I do. So does Mitt Romney. In fact, a lot of filthy rich people pay a lower rate than I do. This is not fair!”

President Obama came up with what seems like a noble idea that came out a few years ago and continues to be pushed by other elected officials today: raising the minimum tax rate to 30 percent for taxpayers who earn an adjusted gross income (AGI) of over $1 million annually or $500,000 annually for single filers. To most people, this plan sounds reasonable.

Dig deeper and you find how silly the so-called “Buffett Rule” really is. While the proposal is politically popular, it is bad public policy.

Firstly, some wealthy people pay lower tax rates because their income derives from capital gains and dividends. Such investment income has a tax rate of 15 percent. Some people in the financial industry make most, if not all, of their income from investment.

What Buffett Rule advocates do not understand is that there are a number of reasons why investment income (tax on money) has a tax rate lower than traditional income (tax on work). Firstly, it’s a “double tax,” meaning that it is first subject to the corporate tax rate, which is up to 35 percent. Secondly, it discourages people from investing money in stocks and bonds. As a result, public companies will invest less as well.

It is also an additional Alternative Minimum Tax, which is a rule already put in place to create a floor on one’s marginal tax rate after deductions. For example, a lot of wealthy people donate a substantial amount of money to charity, which decreases one’s tax rate. The AMT has an exemption for investment income for the very reasons stated above.

The tax would also place the United States at a comparative disadvantage. As Forbes noted, “every G7 country, even the taxpayers with the highest incomes pay capital gains tax at a significantly lower rate than on ordinary income.”

Okay, so it will hurt the economy. But could it help reduce the deficit?

The non-partisan Congressional Budget Office concluded that the “Buffett Rule” will reduce the deficit by $47 billion…over the next ten years. That’s $4.7 per year out of budget deficits that have hit up to $1 trillion, with a “T,” in recent years. Even as the deficit last year hit $680 billion, the “Buffett Rule” is still a drop in the bucket.

But, it’s not fair! Okay, so if the wealthiest 1 percent of Americans paid their “fair share,” what exactly would it look like?

According to the latest statistics from 2011, the extremely envied top 1 percent of Americans paid 35 percent of all federal income taxes, despite representing just 19 percent of the nation’s income.

Historically, did higher marginal tax rates for the 1 percent translate into a larger piece of the pie? Not necessarily. The Heritage Foundation’s Chief Economist Stephen Moore explained:

” In 1980 when the highest income tax rate was 70 percent, the richest 1 percent paid roughly 19 percent of the income tax. In 2007 when the top tax rate was 35 percent, the tax share of the richest 1 percent was more than twice that amount. How did that happen? Raising tax rates on the rich takes money right out from under small and medium-sized business owners and hurts the economy. It takes dollars from employers which leaves less left over for hiring more workers.”

Not exactly the ideal outcome The Left was looking for. Higher tax rates translate into less economic growth, fewer jobs, a bigger piece of the revenue pie for the middle-class, and dwindling opportunities to move up the economic ladder.

But, that’s not fair!

Author’s note: this article was updated on April 1, 2015.



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