I was hoping to end my discussion of the Buffett Rule with this post last Friday. However, no rest for the weary. On Tuesday, an organization named "Citizens for Tax Justice" entered the fray. CTJ published a report advocating for the Buffett Rule.
I've been critical of CTJ in the past. On June 1, CTJ published a report "analyzing" the financial statements of 12 "illustrative" U.S. corporations. I believe that the purported "analysis" contained material inaccuracies and omissions. I sent a letter to Tax Notes suggesting that CTJ's report was borderline unethical (131 Tax Notes 1199 (June 13, 2011)). I was concerned that unsophisticated readers would take CTJ's misleading "analysis" at face value. As expected, the political left feigned outrage over CTJ's dubious conclusions.
The latest report from CTJ has its weaknesses, but raises some interesting questions. Unlike the June report, CTJ's advocacy of the Buffett Rule doesn't taint the organization's credibility. Five observations:
Distortions
[1] Mega-billionaire Warren Buffett hasn't released his tax returns, so this is speculative. CTJ states that Buffett has long criticized the "loopholes" in the tax code that allow him to pay a lower effective tax rate (at 17.4%) than his middle-class secretary (at 30%). A "loophole" is defined as "an ambiguity in a system, such as a law or security, which can be used to circumvent or otherwise avoid the intent, implied or explicitly stated, of the system."
The tax code is filled with loopholes (as defined), but it is unlikely that Buffett is exploiting one. More likely, he simply derives a large proportion of his annual income from qualified dividends and capital gains. Qualified dividends are taxed at a 15% rate, because the distributing corporation was previously taxed on its earnings at a 35% rate. The same principle applies to capital gains from the disposition of stock in a corporation with accumulated earnings. The tax preference reflects an explicit Congressional judgment to blunt the "double taxation dilemma" associated with the taxation of C corporations and their owners. It is no more a "loophole" than any number of tax preferences that are widely available to virtually all taxpayers.
CTJ may not be happy with the result, but they should tone down the misleading rhetoric.
[2] CTJ claims that Buffett's effective tax rate (17.4%) is "typical" of taxpayers with $10 million or more of income. CTJ's claim is inconsistent with the data on page 3 of its report. Based on those numbers, the "average" taxpayer with $10 million or more of income pays an effective tax rate of approximately 24.6%.
Again, words are important. Buffett is not "typical" of uber-wealthy individuals. The data suggests that the $10 million club is comprised of two groups. One group recognizes a large proportion of its income from qualified dividends and capital gains, taxable at the 15% rate described above. The other group recognizes a large proportion of its income as ordinary income (wage income or other income for services (athletes, celebrities) or short-term capital gains (hedge fund managers)).
CTJ wants the first group (the investors) to pay tax at rates comparable to the second group (the athlete/celebrity/hedge fund VIPs).
Consensus and Questions
[3] I agree with CTJ on a fundamental principle. I believe that all income should be taxed at the same tax rates.
I suspect we disagree on the next principle. I believe that we should lower income tax rates for corporations and individuals (with the decrease in revenue offset, in part, by an increase in tax rates applicable to capital gains). My two principles work in tandem. The decrease in the top marginal corporate income tax rate would undermine much of the rationale for the 15% tax rate (as described above).
[4] CTJ compares an individual taxpayer with $60,000 in wage income and an individual taxpayer with $60,000 in qualified dividends and capital gains. The former pays an effective tax rate of approximately 30% (including employer and employee payroll taxes; more on that in my next post). The latter pays an effective tax rate of 4%. I would lower the tax rate applicable to the wage earner, offset in part by higher taxes on the investor. Does this increase the overall "fairness" of the tax system in CTJ's view?
[5] On a similar note, CTJ states that "it’s downright unfair when millionaire investors pay effective tax rates far lower than those of most middle-income people." (To get there, note that CTJ is including payroll taxes in the computation of effective tax rates for middle-income taxpayers.) But isn't it unfair when middle-income investors (the individual with $60,000 in investment income above) pay effective tax rates far lower than those of middle-income wage earners? And isn't it unfair when gazillionaires pay effective tax rates far higher than other gazillionaires?
The "fairness" point highlights why the proposed Buffett Rule is a class warfare strategy, as discussed here and here. CTJ compares the tax rates paid by millionaires to the tax rates paid by the middle class. I'm concerned about the disparate treatment of wage earners and small business owners relative to the investor class. I'm concerned about efficiency and fairness, but I don't need class warfare rhetoric to articulate the concern. We don't need a "Buffett Rule" to accomplish fundamental tax reform. We simply need legislators who are willing to prioritize and compromise.
Friday, September 30, 2011
Wednesday, September 28, 2011
Prioritize and Compromise
On Monday, Michael Durst elaborated on a previous tax reform proposal (see Durst, "An Employment, Equity, and Competitiveness Tax Act," Tax Notes, Sept. 26, 2011; discussing Durst, "Radical Centrism and the Corporate Income Tax," Tax Notes, Sept. 5, 2011).
Durst describes his proposal as "a two-pronged, radically centrist tax package" with two key elements:
Our corporate tax rate is uncompetitive by international standards. Capital is mobile and ruthlessly unpatriotic. As such, it migrates to the highest after-tax return opportunities. The uncompetitive U.S. tax rate discourages capital allocation to U.S. businesses by decreasing after-tax returns to investors. This has a pernicious ripple effect that hits the capital-intensive manufacturing industry particularly hard. Less capital means a higher cost of capital. A higher cost of capital means higher input costs. Higher input costs mean higher-cost products and services. Higher-cost products and services are less competitive in domestic and international markets (and more expensive for domestic consumers).
Compounding matters, the U.S. transfer pricing regime is porous, favoring multinational enterprises that can migrate intangibles offshore over U.S. businesses with tangible assets, operations and employees in the United States. The deck is effectively stacked against U.S. businesses relative to their multinational and international competitors.
A growing consensus of tax professionals, academics and economists has acknowledged the need to reform the corporate tax system by lowering rates. Hopefully, that message will begin to resonate with legislators, who are struggling to cope with our lapsed economic hegemony. Although I don't expect a "grass roots" movement for corporate tax reform, I hope that the most zealous advocates of high corporate tax rates achieve irrelevance.
Meanwhile, there is no free lunch. Although corporate tax reform is a priority, we can't escape the fact that government obligations will continue to swell as the Baby Boom generation enters retirement. Realistically, we'll need to offset a decrease in corporate tax revenues with another source of revenues. Legislators should consider a VAT, and they should consider progressive increases in average tax rates as a trade-off for corporate income tax reform.
In particular, a reduction in the corporate tax rate could be partially offset by eliminating the tax preference for certain investment income. Corporate earnings are taxed at a 35% top marginal rate, and the 15% rate applicable to qualified dividends and long-term capital gains reduces the overall tax burden on the underlying business income. By lowering the corporate tax rate, legislators would undermine the conceptual justification for the 15% rate.
The existing political climate is depressing to those of us who don't extract power or lobbying money from gridlock. Tax reform seems virtually impossible before 2012. However, we don't need a "Buffett Rule" to jump start the process. Corporate tax reform is possible if legislators would simply prioritize and compromise. A reduction in corporate tax rates, offset by taxing investment income at the same rates as ordinary income, could be an important step towards fundamental tax reform.
Stay tuned for more details on my own corporate tax reform proposal.
Durst describes his proposal as "a two-pronged, radically centrist tax package" with two key elements:
1. A reduction in the corporate tax rate to 15 percent, along with elimination of opportunities to shift income to tax havens and other significant corporate base broadeners. The goal would be to increase U.S. job creation, both through the effects of the lower rate and by eliminating current tax haven techniques that encourage job creation outside instead of within the United States.I don't agree with Durst's entire reform proposal, but I agree with Durst that legislators need to prioritize and compromise. Our tax system is a ramshackle structure decomposing from within, and I'd love to strip it down to the studs and begin renovation. However, if we have to renovate incrementally, I'd start with corporate tax reform.
2. A reform of the individual income tax that would make the tax more progressive, primarily by increases in rates applying to the highest-income taxpayers. Maximum rates nevertheless would remain low by historical standards....
Our corporate tax rate is uncompetitive by international standards. Capital is mobile and ruthlessly unpatriotic. As such, it migrates to the highest after-tax return opportunities. The uncompetitive U.S. tax rate discourages capital allocation to U.S. businesses by decreasing after-tax returns to investors. This has a pernicious ripple effect that hits the capital-intensive manufacturing industry particularly hard. Less capital means a higher cost of capital. A higher cost of capital means higher input costs. Higher input costs mean higher-cost products and services. Higher-cost products and services are less competitive in domestic and international markets (and more expensive for domestic consumers).
Compounding matters, the U.S. transfer pricing regime is porous, favoring multinational enterprises that can migrate intangibles offshore over U.S. businesses with tangible assets, operations and employees in the United States. The deck is effectively stacked against U.S. businesses relative to their multinational and international competitors.
A growing consensus of tax professionals, academics and economists has acknowledged the need to reform the corporate tax system by lowering rates. Hopefully, that message will begin to resonate with legislators, who are struggling to cope with our lapsed economic hegemony. Although I don't expect a "grass roots" movement for corporate tax reform, I hope that the most zealous advocates of high corporate tax rates achieve irrelevance.
Meanwhile, there is no free lunch. Although corporate tax reform is a priority, we can't escape the fact that government obligations will continue to swell as the Baby Boom generation enters retirement. Realistically, we'll need to offset a decrease in corporate tax revenues with another source of revenues. Legislators should consider a VAT, and they should consider progressive increases in average tax rates as a trade-off for corporate income tax reform.
In particular, a reduction in the corporate tax rate could be partially offset by eliminating the tax preference for certain investment income. Corporate earnings are taxed at a 35% top marginal rate, and the 15% rate applicable to qualified dividends and long-term capital gains reduces the overall tax burden on the underlying business income. By lowering the corporate tax rate, legislators would undermine the conceptual justification for the 15% rate.
The existing political climate is depressing to those of us who don't extract power or lobbying money from gridlock. Tax reform seems virtually impossible before 2012. However, we don't need a "Buffett Rule" to jump start the process. Corporate tax reform is possible if legislators would simply prioritize and compromise. A reduction in corporate tax rates, offset by taxing investment income at the same rates as ordinary income, could be an important step towards fundamental tax reform.
Stay tuned for more details on my own corporate tax reform proposal.
Monday, September 26, 2011
Surprising C Corps
Today in Tax Notes, Martin Sullivan contributed an interesting article on "small business" C corporations (see "The Small Business Love-Hate Relationship With Corporate Tax").
Sullivan's article mines data in a new study prepared by a group of economists at the Treasury Department. The data indicate that nearly 900,000 small business employers filed tax returns as C corporations in 2007. The thresholds for a "small business employer": gross receipts or total income of less than $10 million; and wage or salary deductions of more than $10,000.
At first blush, the numbers sound pretty crazy. The income of a C corporation is subject to double taxation. Under the "double-taxation dilemma," a C corporation pays tax on its income (the first tax, up to a 35% marginal rate). Then its owners pay tax on dividend payments from the C corporation (the second tax, at a 15% rate for qualified dividends). Including state income taxes, a shareholder of a C corporation may suffer a 55-60% tax expense on income of the underlying business.
For small business owners, the "double-taxation dilemma" is essentially voluntary. And many individual owners of small businesses have elected out. Income earned by "pass-through" entities (e.g., S corporations and partnerships) is subject to a single level of tax. Unlike a C corporation, a pass-through entity does not itself pay tax. Instead, its owners report their share of income from the underlying business, and pay tax on that income (a single tax, up to a 35% marginal rate in 2011).
Sullivan's article explores why small business owners may elect into the "double-taxation dilemma" and operate their businesses through C corporations. Sullivan demonstrates that, "[u]nder the right conditions, a C corporation can be a nice little tax shelter for a small business. That helps explain why so many small businesses remain C corporations when they have the option of becoming LLCs or S corporations."
I follow Sullivan's conclusion. However, I'd guess that many of these C corporations owe their "existence" to bad tax advice or tax illiteracy (i.e., no tax advice). In the M&A context, I've seen numerous instances where a small business owner inadvertently grows a business under a C corporation "wrapper." They come to regret that planning (or lack of planning) when they decide to sell the business. (Due to the "double-taxation dilemma," in most instances, a purchaser will pay more for a "pass-through" entity than a C corporation.) Moreover, most "small" business owners are focused on their small businesses and are resource constrained with no "budget" for tax planning. To this point, Sullivan lists some of the pitfalls for a small business owner seeking to exploit a C corporation tax shelter.
Sullivan's article is worth a read for tax nerds. It encouraged me to jot down some corporate tax reform ideas that have been rattling around in my head. More to come in a subsequent post.
Sullivan's article mines data in a new study prepared by a group of economists at the Treasury Department. The data indicate that nearly 900,000 small business employers filed tax returns as C corporations in 2007. The thresholds for a "small business employer": gross receipts or total income of less than $10 million; and wage or salary deductions of more than $10,000.
At first blush, the numbers sound pretty crazy. The income of a C corporation is subject to double taxation. Under the "double-taxation dilemma," a C corporation pays tax on its income (the first tax, up to a 35% marginal rate). Then its owners pay tax on dividend payments from the C corporation (the second tax, at a 15% rate for qualified dividends). Including state income taxes, a shareholder of a C corporation may suffer a 55-60% tax expense on income of the underlying business.
For small business owners, the "double-taxation dilemma" is essentially voluntary. And many individual owners of small businesses have elected out. Income earned by "pass-through" entities (e.g., S corporations and partnerships) is subject to a single level of tax. Unlike a C corporation, a pass-through entity does not itself pay tax. Instead, its owners report their share of income from the underlying business, and pay tax on that income (a single tax, up to a 35% marginal rate in 2011).
Sullivan's article explores why small business owners may elect into the "double-taxation dilemma" and operate their businesses through C corporations. Sullivan demonstrates that, "[u]nder the right conditions, a C corporation can be a nice little tax shelter for a small business. That helps explain why so many small businesses remain C corporations when they have the option of becoming LLCs or S corporations."
I follow Sullivan's conclusion. However, I'd guess that many of these C corporations owe their "existence" to bad tax advice or tax illiteracy (i.e., no tax advice). In the M&A context, I've seen numerous instances where a small business owner inadvertently grows a business under a C corporation "wrapper." They come to regret that planning (or lack of planning) when they decide to sell the business. (Due to the "double-taxation dilemma," in most instances, a purchaser will pay more for a "pass-through" entity than a C corporation.) Moreover, most "small" business owners are focused on their small businesses and are resource constrained with no "budget" for tax planning. To this point, Sullivan lists some of the pitfalls for a small business owner seeking to exploit a C corporation tax shelter.
Sullivan's article is worth a read for tax nerds. It encouraged me to jot down some corporate tax reform ideas that have been rattling around in my head. More to come in a subsequent post.
Friday, September 23, 2011
All Sizzle, No Steak
Ask a Wall Street financial expert to name the most high-profile resident of Nebraska. They'll probably answer Warren Buffett, the legendary investor and "Oracle of Omaha." Now ask a Nebraska farmer. They'll probably answer Tom Osborne, the legendary football coach of the Nebraska Cornhuskers.
In Nebraska, Cornhusker football is a quasi-religious experience. When the 'Huskers play at home, their stadium becomes the third-largest city in the state (behind Lincoln and Omaha, Buffett's home city). While the 'Husker fans take their teams seriously, they don't converge on Lincoln solely for the football. With college football, comes serious tailgating. And with serious tailgating, comes grilled meat for the inner caveman.
During a 'Husker tailgating party, when the charcoal starts glowing, fans break out the brats and burgers and steaks. Nebraskans want their steaks fresh, juicy and big, with an anonymous American beer on the side. They're looking for the steak in steak, not the sizzle.
On Monday, September 19, President Obama announced five principles of tax reform (part of his plan for economic growth and deficit reduction). As I discussed in my last post, the fifth principle is "observe the Buffett rule." The Buffett Rule says that people making more than $1 million a year should not pay a smaller share of their income in taxes than middle-class families pay.
The rule is all sizzle, no steak. That's ironic, given its namesake. Then again, mega-billionaire Buffett would probably be more comfortable at an Obama fundraising event than a 'Husker tailgating party.
Sizzle, Drizzle, Fizzle
The Buffett Rule attracted immediate criticism. For tax professionals and economists familiar with tax data, the premise of the Buffett Rule didn't pass a "smell test." It just didn't seem like a widespread problem that should become a central plank of tax reform. Gene Sperling conceded as much this week on a White House blog post "clarifying" the Buffett Rule.
The $100 Million Man
For several years, Buffett has claimed that he pays a lower effective (or average) tax rate than his secretary, who earned $60,000 in 2007. Buffett claimed that he paid tax at a 17.7% average rate (for example, $1.77 million in tax on $10 million in income). He claimed that his secretary paid tax at a 30% average rate ($18,000 of tax on $60,000 in income).
The numbers recited by Buffett never made sense to me. I understand why an uber-wealthy individual taxpayer might pay a low effective tax rate. More on that below. I don't understand how a secretary earning $60,000 could get stuck with tax at a 30% rate. As discussed in the next section, it seems unlikely (impossible?) that Buffett's secretary pays tax at a 30% average tax rate.
Why can an uber-wealthy individual taxpayer pay a low effective tax rate? Seems kind of unfair, right? Under current law, qualified dividends and long-term capital gains are subject to tax at a 15% rate. The 15% tax rate is intended to reduce the double-taxation dilemma that occurs when a corporation distributes its previously-taxed earnings to its shareholders. If a high proportion of an individual's taxable income is derived from dividends or capital gains, that individual's effective tax rate gets "averaged" down towards 15%.
In fact, under current tax rules, a mega-millionaire could earn millions from tax-exempt bond investments, and pay an effective tax rate of zero! Imagine a successful Internet entrepreneur cashed out at the top of the bubble in 1999, paid taxes on his fabulous gains, and rolled $100 million of cash into tax-exempt bonds yielding 5%. His tax-exempt bonds would generate annual cash income of $5 million. However, the income from the bonds is exempt from federal income tax. Zero tax on $5 million in income results in a 0% effective federal income tax rate. That's a lower rate than Buffett, his secretary, and the other 99.99% of us endure.
Of course, Congress didn't exempt state and municipal bond income from taxation as a favor to our $100 Million Man. The exemption for interest paid on tax-exempt bonds represents a subsidy to state and local governments. The federal tax subsidy reduces the cost of financing by permitting state and local governments to issue debt at lower yields. The subsidy reflects a policy choice, and arguably a "bad" policy choice that encourages undisciplined spending by state and local governments.
Note that Congress could increase the 0% effective tax rate applicable to our $100 Million Man by eliminating the tax subsidy for states and municipalities. Eliminating the tax subsidy would increase borrowing costs and decrease the funds available for other state and local objectives. Maybe that's better policy in the long run. But the political left assaults common sense when it demagogues "millionaires and billionaires" who benefit from structural policy decisions (like the tax subsidy for state and municipal bonds). Our $100 Million Man isn't "gaming" the system to achieve a 0% effective tax rate. He's simply playing by the rules of the game that Congress put on the table.
Numbers Don't Lie
Let's get back to Buffett and his secretary. Buffett has complained that he pays a higher effective tax rate (at 17.7%) than his secretary (at 30%). President Obama has seized Buffett's complaint and incorporated it into his "principles" that should guide "fundamental tax reform."
Because the President has made Buffett's complaint a prime-time issue, it raises three questions. Is the complaint accurate, i.e., does Buffett really pay a lower effective tax rate than his secretary? Is the problem widespread based on existing tax data? And is Buffett's concern fundamental to our long-term fiscal solvency and economic competitiveness?
No, no, and no.
[1] Buffett's claim does not seem accurate, much less possible, based on prevailing tax rates. Of course, we don't have complete facts on Buffett's secretary. Is he or she married? Does he or she have children? If married, what kind of earnings does his or her spouse bring to the table? The list could go on for 10 paragraphs.
Having been deprived of the actual facts by Buffett and Obama, I plugged some assumptions into a tax calculator. I assume that Secretary reports $60,000 in taxable income, claims the standard deduction ($5,700), a single exemption ($3,700), and takes advantage of the reduced Social Security tax rate in 2011 (4.2%). On my assumptions, Secretary is in the 25% tax bracket, but pays income tax at a 17.3% average rate. (For another cut at the exercise, see this hypothetical from Peter Pappas.)
We'll never know if Buffett was exaggerating the numbers, confused about the fact that marginal tax rates exceed average tax rates, or had special knowledge about his secretary's tax position (e.g., secretary is married to a spouse with a $200,000 income). However, it seems highly unlikely that Buffett's claim was accurate. So the fifth "principle" guiding Obama's tax reform platform is based on exaggeration, confusion, or some combination of the two.
[2] The "problem" identified by Buffett (based on exaggeration or confusion) is inconsistent with the existing tax data, as discussed here and here.
The nearby table is copied and pasted from the Wall Street Journal article. Although the mega-billionaire Buffett (at 17.7%) may pay a lower effective tax rate than an average working professional married couple with taxable income of $250,000 (at 19.6%), that is not the case for the average "millionaire or billionaire." Both the average millionaire (at 23.3%) and the average working professional married couple (at 19.6%) pay significantly higher effective tax rates than the average middle-class secretary (at 8.9%, assuming taxable income in the $50,000 to $100,000 range).
White House Spin Fizzles
In Nebraska, Cornhusker football is a quasi-religious experience. When the 'Huskers play at home, their stadium becomes the third-largest city in the state (behind Lincoln and Omaha, Buffett's home city). While the 'Husker fans take their teams seriously, they don't converge on Lincoln solely for the football. With college football, comes serious tailgating. And with serious tailgating, comes grilled meat for the inner caveman.
During a 'Husker tailgating party, when the charcoal starts glowing, fans break out the brats and burgers and steaks. Nebraskans want their steaks fresh, juicy and big, with an anonymous American beer on the side. They're looking for the steak in steak, not the sizzle.
On Monday, September 19, President Obama announced five principles of tax reform (part of his plan for economic growth and deficit reduction). As I discussed in my last post, the fifth principle is "observe the Buffett rule." The Buffett Rule says that people making more than $1 million a year should not pay a smaller share of their income in taxes than middle-class families pay.
The rule is all sizzle, no steak. That's ironic, given its namesake. Then again, mega-billionaire Buffett would probably be more comfortable at an Obama fundraising event than a 'Husker tailgating party.
Sizzle, Drizzle, Fizzle
The Buffett Rule attracted immediate criticism. For tax professionals and economists familiar with tax data, the premise of the Buffett Rule didn't pass a "smell test." It just didn't seem like a widespread problem that should become a central plank of tax reform. Gene Sperling conceded as much this week on a White House blog post "clarifying" the Buffett Rule.
The $100 Million Man
For several years, Buffett has claimed that he pays a lower effective (or average) tax rate than his secretary, who earned $60,000 in 2007. Buffett claimed that he paid tax at a 17.7% average rate (for example, $1.77 million in tax on $10 million in income). He claimed that his secretary paid tax at a 30% average rate ($18,000 of tax on $60,000 in income).
The numbers recited by Buffett never made sense to me. I understand why an uber-wealthy individual taxpayer might pay a low effective tax rate. More on that below. I don't understand how a secretary earning $60,000 could get stuck with tax at a 30% rate. As discussed in the next section, it seems unlikely (impossible?) that Buffett's secretary pays tax at a 30% average tax rate.
Why can an uber-wealthy individual taxpayer pay a low effective tax rate? Seems kind of unfair, right? Under current law, qualified dividends and long-term capital gains are subject to tax at a 15% rate. The 15% tax rate is intended to reduce the double-taxation dilemma that occurs when a corporation distributes its previously-taxed earnings to its shareholders. If a high proportion of an individual's taxable income is derived from dividends or capital gains, that individual's effective tax rate gets "averaged" down towards 15%.
In fact, under current tax rules, a mega-millionaire could earn millions from tax-exempt bond investments, and pay an effective tax rate of zero! Imagine a successful Internet entrepreneur cashed out at the top of the bubble in 1999, paid taxes on his fabulous gains, and rolled $100 million of cash into tax-exempt bonds yielding 5%. His tax-exempt bonds would generate annual cash income of $5 million. However, the income from the bonds is exempt from federal income tax. Zero tax on $5 million in income results in a 0% effective federal income tax rate. That's a lower rate than Buffett, his secretary, and the other 99.99% of us endure.
Of course, Congress didn't exempt state and municipal bond income from taxation as a favor to our $100 Million Man. The exemption for interest paid on tax-exempt bonds represents a subsidy to state and local governments. The federal tax subsidy reduces the cost of financing by permitting state and local governments to issue debt at lower yields. The subsidy reflects a policy choice, and arguably a "bad" policy choice that encourages undisciplined spending by state and local governments.
Note that Congress could increase the 0% effective tax rate applicable to our $100 Million Man by eliminating the tax subsidy for states and municipalities. Eliminating the tax subsidy would increase borrowing costs and decrease the funds available for other state and local objectives. Maybe that's better policy in the long run. But the political left assaults common sense when it demagogues "millionaires and billionaires" who benefit from structural policy decisions (like the tax subsidy for state and municipal bonds). Our $100 Million Man isn't "gaming" the system to achieve a 0% effective tax rate. He's simply playing by the rules of the game that Congress put on the table.
Numbers Don't Lie
Let's get back to Buffett and his secretary. Buffett has complained that he pays a higher effective tax rate (at 17.7%) than his secretary (at 30%). President Obama has seized Buffett's complaint and incorporated it into his "principles" that should guide "fundamental tax reform."
Because the President has made Buffett's complaint a prime-time issue, it raises three questions. Is the complaint accurate, i.e., does Buffett really pay a lower effective tax rate than his secretary? Is the problem widespread based on existing tax data? And is Buffett's concern fundamental to our long-term fiscal solvency and economic competitiveness?
No, no, and no.
[1] Buffett's claim does not seem accurate, much less possible, based on prevailing tax rates. Of course, we don't have complete facts on Buffett's secretary. Is he or she married? Does he or she have children? If married, what kind of earnings does his or her spouse bring to the table? The list could go on for 10 paragraphs.
Having been deprived of the actual facts by Buffett and Obama, I plugged some assumptions into a tax calculator. I assume that Secretary reports $60,000 in taxable income, claims the standard deduction ($5,700), a single exemption ($3,700), and takes advantage of the reduced Social Security tax rate in 2011 (4.2%). On my assumptions, Secretary is in the 25% tax bracket, but pays income tax at a 17.3% average rate. (For another cut at the exercise, see this hypothetical from Peter Pappas.)
We'll never know if Buffett was exaggerating the numbers, confused about the fact that marginal tax rates exceed average tax rates, or had special knowledge about his secretary's tax position (e.g., secretary is married to a spouse with a $200,000 income). However, it seems highly unlikely that Buffett's claim was accurate. So the fifth "principle" guiding Obama's tax reform platform is based on exaggeration, confusion, or some combination of the two.
[2] The "problem" identified by Buffett (based on exaggeration or confusion) is inconsistent with the existing tax data, as discussed here and here.
The nearby table is copied and pasted from the Wall Street Journal article. Although the mega-billionaire Buffett (at 17.7%) may pay a lower effective tax rate than an average working professional married couple with taxable income of $250,000 (at 19.6%), that is not the case for the average "millionaire or billionaire." Both the average millionaire (at 23.3%) and the average working professional married couple (at 19.6%) pay significantly higher effective tax rates than the average middle-class secretary (at 8.9%, assuming taxable income in the $50,000 to $100,000 range).
[3] Finally, the "problem" identified by Buffett (based on exaggeration or confusion) is not fundamental to our long-term fiscal solvency or economic competitiveness, as I discussed in my last blog post.
White House Spin Fizzles
In light of the numbers, the Obama administration went into spin mode. Gene Sperling posted this defense of the "Buffett Rule" on the White House blog last week. Sperling clarified several of the questions that jumped to my mind when I heard about the proposal. Ironically, however, Sperling's attempt to rebut criticism of the proposal confirmed that the "principle" is a class-warfare tactic that will distract from actual tax reform.
So what did Sperling say?
[1] The Buffett Rule will only potentially apply to those with taxable income over $1 million -- approximately 0.3% of American taxpayers. We're off to a shaky start. I thought this was supposed to be a "fundamental" principle of tax reform. And it only potentially applies to 0.3% of taxpayers?
[2] Even among that 0.3% of American taxpayers, it affects only those within that group that pay low tax rates:
[3] The Buffett Rule is not about "all taxpayers." It is about those taxpayers who are able to pay at lower tax rates than middle-class families:
[4] Sperling then launches into a series of hypotheticals where he, perhaps channeling Buffett, confuses marginal tax rates for average tax rates.
Conclusion
I'm pretty much sick of Warren Buffett and his bumbling foray into tax policy. Team Obama has taken an alleged "problem" involving 100-200 uber-wealthy taxpayers, and begun marketing the "solution" as fundamental tax reform. The emphasis on average tax rates might be a good class warfare tactic, but it misses the critical question. The critical question is: how much of the total income tax burden should we impose on the top 0.1% of taxpayers (or top 0.3%, or 1%, and so on). Perhaps we'll look at the numbers and conclude that they're paying their "fair share." Perhaps we'll conclude that they're not. A focus on "average tax rates" simply distracts from the question.
Meanwhile, the Nebraska Cornhuskers are 3-0 going into a game against Wyoming. Break out the steak, and leave the sizzle to Team Obama.
So what did Sperling say?
[1] The Buffett Rule will only potentially apply to those with taxable income over $1 million -- approximately 0.3% of American taxpayers. We're off to a shaky start. I thought this was supposed to be a "fundamental" principle of tax reform. And it only potentially applies to 0.3% of taxpayers?
[2] Even among that 0.3% of American taxpayers, it affects only those within that group that pay low tax rates:
In fact, many — if not most — of the few true small business owners making over $1 million already pay ordinary income tax rates (and not the preferential rates) and thus would not be impacted at all by the Buffett Rule.Okay, so the Administration believes that "many" but not "most" taxpayers reporting more than $1 million in taxable income pay tax at ordinary income rates (35% in 2011). That seems consistent with the data (see table above; the average tax rate paid by taxpayers in this group was 23.3%). However, now we're talking perhaps 0.1% or 0.2% of American taxpayers under the microscope.
[3] The Buffett Rule is not about "all taxpayers." It is about those taxpayers who are able to pay at lower tax rates than middle-class families:
Take IRS data on the taxes paid by the 400 highest-income households in 2008, all making over $110 million per year and making an average of $271 million per year. Some of those 400 taxpayers do pay their fair share, but according to that data, one-third of this group pays less than 15 percent of their income in taxes and 85 percent pays less than 30 percent.Now, we're getting somewhere. It appears that the Administration is obsessed with roughly 133 taxpayers (one-third of 400). Because 133 taxpayers recognize a disproportionate amount of income from qualified dividends and capital gains (see above), the Buffett Rule has become a central plank of tax reform? Excuse me while I read the White House blog again, because I must be missing the joke.
[4] Sperling then launches into a series of hypotheticals where he, perhaps channeling Buffett, confuses marginal tax rates for average tax rates.
Conclusion
I'm pretty much sick of Warren Buffett and his bumbling foray into tax policy. Team Obama has taken an alleged "problem" involving 100-200 uber-wealthy taxpayers, and begun marketing the "solution" as fundamental tax reform. The emphasis on average tax rates might be a good class warfare tactic, but it misses the critical question. The critical question is: how much of the total income tax burden should we impose on the top 0.1% of taxpayers (or top 0.3%, or 1%, and so on). Perhaps we'll look at the numbers and conclude that they're paying their "fair share." Perhaps we'll conclude that they're not. A focus on "average tax rates" simply distracts from the question.
Meanwhile, the Nebraska Cornhuskers are 3-0 going into a game against Wyoming. Break out the steak, and leave the sizzle to Team Obama.
Wednesday, September 21, 2011
White House Clarifies "Buffett Rule"
Late on Wednesday afternoon, Gene Sperling posted on the White House blog (see Buffett Rule Fact and Fictions).
Sperling commences the blog as follows:In my last post, I criticized the Buffett Rule (a/k/a Vanderbilt Rule) as motivated by class warfare politics. My critique was partly motivated by the lack of detail underlying the "principle." If the principle were not motivated by class warfare politics, why announce the principle without detail as to its application?
Sperling's post added some meat to Obama's bare-bones "principle." Meanwhile, Sperling tried to rebut the critics who viewed the Vanderbilt Rule as class-warfare politics. I appreciate the effort to clarify some of the obvious question marks. But I'm still convinced that Obama's proposal was motivated by class-warfare politics. I'll touch on that point in this blog post. I'll have some more observations about Sperling's rebuttal argument in my next blog post.
Class-Warfare Politics
Take another look at Obama's five principles for tax reform. The first two principles would require amendments to (or perhaps replacement of) the Income Tax Code, impacting tens of millions of individual taxpayers and many thousands of businesses. The third principle would require a contentious bipartisan effort to begin restoring the nation's long-term fiscal health. The fourth principle acknowledges that our broken tax system and uncompetitive business tax rates increase the cost of doing business in the United States, crippling economic growth and job creation.
We can all agree on those four "principles." We can all agree that they are serious goals, and, in today's political and economic climate, will require heavy lifting by our political leaders. We may disagree on the tax and spending changes necessary to achieve those goals. But the goals are fundamental to our long-term economic competitiveness and prosperity.
How about the fifth principle? As Sperling's post confirms, the fifth principle reflects an unhealthy obsession with the 400 wealthiest American individuals. It is not about fixing the tax system, making life simpler and fairer for tens of millions of individual taxpayers, eliminating "tax expenditures" that distort fundamental economic decisions (contributing to the real estate bubble and the crisis in health care inflation), decreasing the costs of business tax compliance, addressing our long-term fiscal challenges, or improving our global competitiveness.
Compare the fifth principle to the other four principles. If a subset of the 400 wealthiest Americans pay tax at lower effective rates than the middle class, does that impact our long-term economic competitiveness and prosperity? Does that make business tax compliance more costly? Does that distort or complicate economic decisions of tens of millions of taxpayers? Of course not. A few billionaires who benefit from structural tax breaks, fairly or unfairly, are a microscopic tail on an 800-pound dogzilla.
Admittedly, the fact that those lucky billionaires pay lower effective tax rates than some middle-class and upper-middle-class taxpayers rubs me the wrong way. I would personally raise the capital gains tax rate to "pay down" ordinary income tax rates. But those changes are already contemplated by the first and second principles (cut rates; and cut inefficient and unfair tax breaks). We don't need to taint a serious tax reform effort with 2012 campaign slogans ("Hope, Change ... and Observe the Buffett Rule!").
From this independent's view, the Buffett Rule (a/k/a Vanderbilt Rule) does not belong on the list of fundamental tax reform principles. Obama included the "principle" in the list as a class warfare tactic to distract voters from his dismal economic record. I'll discuss the details of Sperling's rebuttal argument in my next blog post.
Sperling commences the blog as follows:
On Monday, the President proposed the Buffett Rule as one of five principles for comprehensive tax reform. This is a rule of simple fairness—no household making over $1 million annually should pay less in federal taxes* than middle-class families pay. Contrary to some misconceptions, the Buffett Rule is not designed as the sole or main source of raising new revenues, but one of five principles that should be achieved by tax reform:
1. Cut rates
2. Cut inefficient and unfair tax breaks
3. Cut the deficit by $1.5 trillion over 10 years
4. Increase investment and growth in the United States
5. Observe the “Buffett rule.”
Of these principles — all of which we believe are key to reform — the Buffett rule has received the most attention. It has been attacked with claims of “class warfare” that are completely without merit. How can it be class warfare to ensure that there is greater parity between the taxes paid by the most well-off and those paid by tens of millions of hardworking families? Still, since not all of the reports about the Buffett Rule have been accurate, I want to clarify what we mean – and why the President believes this is an important principle.
[*Note: Sperling probably meant to say that "no household making over $1 million annually should pay federal taxes at lower effective rates than the rates that middle-class families pay." The remainder of Sperling's post focuses on average tax rates paid by individuals with varying degrees of income. Alternatively, perhaps Sperling was referring to millionaire/billionaire investors who derive 100% of their disposable income from tax-exempt bond investments, and thus literally pay zero income tax to any jurisdiction.]
Sperling's post added some meat to Obama's bare-bones "principle." Meanwhile, Sperling tried to rebut the critics who viewed the Vanderbilt Rule as class-warfare politics. I appreciate the effort to clarify some of the obvious question marks. But I'm still convinced that Obama's proposal was motivated by class-warfare politics. I'll touch on that point in this blog post. I'll have some more observations about Sperling's rebuttal argument in my next blog post.
Class-Warfare Politics
Take another look at Obama's five principles for tax reform. The first two principles would require amendments to (or perhaps replacement of) the Income Tax Code, impacting tens of millions of individual taxpayers and many thousands of businesses. The third principle would require a contentious bipartisan effort to begin restoring the nation's long-term fiscal health. The fourth principle acknowledges that our broken tax system and uncompetitive business tax rates increase the cost of doing business in the United States, crippling economic growth and job creation.
We can all agree on those four "principles." We can all agree that they are serious goals, and, in today's political and economic climate, will require heavy lifting by our political leaders. We may disagree on the tax and spending changes necessary to achieve those goals. But the goals are fundamental to our long-term economic competitiveness and prosperity.
How about the fifth principle? As Sperling's post confirms, the fifth principle reflects an unhealthy obsession with the 400 wealthiest American individuals. It is not about fixing the tax system, making life simpler and fairer for tens of millions of individual taxpayers, eliminating "tax expenditures" that distort fundamental economic decisions (contributing to the real estate bubble and the crisis in health care inflation), decreasing the costs of business tax compliance, addressing our long-term fiscal challenges, or improving our global competitiveness.
Compare the fifth principle to the other four principles. If a subset of the 400 wealthiest Americans pay tax at lower effective rates than the middle class, does that impact our long-term economic competitiveness and prosperity? Does that make business tax compliance more costly? Does that distort or complicate economic decisions of tens of millions of taxpayers? Of course not. A few billionaires who benefit from structural tax breaks, fairly or unfairly, are a microscopic tail on an 800-pound dogzilla.
Admittedly, the fact that those lucky billionaires pay lower effective tax rates than some middle-class and upper-middle-class taxpayers rubs me the wrong way. I would personally raise the capital gains tax rate to "pay down" ordinary income tax rates. But those changes are already contemplated by the first and second principles (cut rates; and cut inefficient and unfair tax breaks). We don't need to taint a serious tax reform effort with 2012 campaign slogans ("Hope, Change ... and Observe the Buffett Rule!").
From this independent's view, the Buffett Rule (a/k/a Vanderbilt Rule) does not belong on the list of fundamental tax reform principles. Obama included the "principle" in the list as a class warfare tactic to distract voters from his dismal economic record. I'll discuss the details of Sperling's rebuttal argument in my next blog post.
Monday, September 19, 2011
The Vanderbilt Rule
President Obama has "branded" his proposal to increase taxes on "millionaires and billionaires." The new proposal will now be known as the "Buffett Rule."
The basic principle underlying the Buffett Rule is that uber-wealthy taxpayers should pay higher effective tax rates than middle-class taxpayers.
I'm not sure how the Buffett Rule is supposed to work in practice. Perhaps it is supposed to be a "Super AMT." Perhaps it is supposed to increase tax rates on capital gains for uber-wealthy taxpayers. Or limit the deductibility of charitable donations. Or cap the amount of qualifying tax-exempt income in a given year. Perhaps the President will limit the proposal to taxpayers that report more than $1 million in taxable income during a given year. Or perhaps he will extend it to working professional married couples with $250,000 taxable incomes.
Regardless of the mechanics, the spirit of the President's proposal is simple class warfare. It doesn't take a political messiah to persuade 90% of the voting public to favor increased taxes on the other 10%. You can play with the numbers (95/5, 99/1, etc.)
The irony of the "branding effort" didn't escape financial analyst Jeff Macke at Yahoo Finance Breakout:
Next time, why not link class warfare tax policy to someone with more historical gravitas? Personally, I think the "Vanderbilt Rule" has a much nicer ring than the "Buffett Rule." And after all, Vanderbilt was one of the richest Americans in history.
Meanwhile, Halloween is just around the corner. Would it be difficult to pull off the Ghost of Cornelius Vanderbilt?
The basic principle underlying the Buffett Rule is that uber-wealthy taxpayers should pay higher effective tax rates than middle-class taxpayers.
I'm not sure how the Buffett Rule is supposed to work in practice. Perhaps it is supposed to be a "Super AMT." Perhaps it is supposed to increase tax rates on capital gains for uber-wealthy taxpayers. Or limit the deductibility of charitable donations. Or cap the amount of qualifying tax-exempt income in a given year. Perhaps the President will limit the proposal to taxpayers that report more than $1 million in taxable income during a given year. Or perhaps he will extend it to working professional married couples with $250,000 taxable incomes.
Regardless of the mechanics, the spirit of the President's proposal is simple class warfare. It doesn't take a political messiah to persuade 90% of the voting public to favor increased taxes on the other 10%. You can play with the numbers (95/5, 99/1, etc.)
The irony of the "branding effort" didn't escape financial analyst Jeff Macke at Yahoo Finance Breakout:
Warren Buffett made billions off the financial crisis by getting Goldman Sachs (GS) and General Electric (GE) to pay him usurious rates in exchange for what amounted to endorsement deals. Buffett is giving his entire estate to the Bill and Melinda Gates Foundation because he is of the opinion that the government is a poor allocator of capital. Buffett would like me to pay higher taxes to the very government he's opting to stiff.Buffett is a legendary investor and has created fantastic wealth for thousands of his shareholders. However, Macke hits the nail on the head. Buffett's proclamation that millionaires and billionaires should pay higher taxes reeks of hypocrisy. And somehow, the hypocritical mega-billionaire has taken center stage in the debate over the President's second stimulus proposal (ahem, "jobs plan").
Mr. Buffett has never met a preferential deal he didn't like and has 56,000 times as much money as someone with $1 million. The only reason the White House is using Buffett to promote this tax hike is because the administration thinks voters are ignorant regarding who Buffett really is. Buffett has no more place in a Jobs Act conversation than does the ghost of Cornelius Vanderbilt.
Next time, why not link class warfare tax policy to someone with more historical gravitas? Personally, I think the "Vanderbilt Rule" has a much nicer ring than the "Buffett Rule." And after all, Vanderbilt was one of the richest Americans in history.
Meanwhile, Halloween is just around the corner. Would it be difficult to pull off the Ghost of Cornelius Vanderbilt?
Thursday, September 15, 2011
One Job Saved?
Obama's much-hyped speech outlining the "American Jobs Act" did not seem to resonate with anyone except this guy and this guy on YouTube. His cheerleaders on the political left questioned why Obama would rely so heavily on tax cuts, given the "obstructionist" bent of Congressional Republicans. His critics on the political right questioned why another round of temporary stimulus proposals would translate into net, long-term employment gains.
Various observers suggested that Obama's speech was primarily intended to launch his 2012 election campaign. He framed the stimulus proposal as a "silver bullet" that would create millions of jobs and reduce unemployment. A cynic would argue that he is mainly trying to save one job: his own.
The total cost of the new stimulus proposals is estimated to be $447 billion. How would that get "spread around"?
[1] The proposal would pump $175 billion into the private economy by cutting employee payroll taxes in half in 2012. This measure should be politically popular, because most working Americans will benefit, temporarily, from the payroll tax holiday. But we've been down this path before. Like a night of hard drinking, a temporary stimulus might be fun while it lasts. But the next day, or the next year, we'll wake up with a hangover. One "temporary" stimulus leads to the next (the "hair of the dog") and the next, and the next. President Obama (the politician) is perfectly happy to kick the can down the road. The rest of us see a looming budget crisis and desire a permanent improvement in the conditions to economic growth.
[2] The proposal has $62 billion in targeted spending intended to help the long-term unemployed. Most of that ($54 billion) involves a series of fuzzy changes to the unemployment insurance system, including a $5 billion "pathways back to work fund." Although not broken out, I'm guessing that a big chunk of the other $49 billion simply represents an extension of unemployment assistance.
The $62 billion also includes a tax credit of up to $4,000 for hiring workers who have been looking for a job over six months (projected cost of $8 billion). Although the price tag is low, this type of credit is frustrating tax policy at its worst. Very few (if any) managers or business owners would hire new employees for a $4,000 (or smaller) credit. The credit would primarily be a windfall to businesses that were otherwise intending to hire employees (so no stimulative impact). It would create an additional audit burden for the IRS, which is already overwhelmed by new responsibilities enforcing social programs. As such, it virtually invites fraud and abuse (which plagues all these ill-conceived stimulus efforts). Perversely, it does not reward employers that have struggled to retain employees during the Great Recession.
[3] The proposal includes $140 billion in "stimulus" measures, including $35 billion for "teacher rehiring" ($30 billion) and "first responders" ($5 billion), $30 billion for "modernizing schools," $50 billion for "immediate surface transportation," a $10 billion "national infrastructure bank" and $15 billion for "neighborhood stabilization."
The $50 billion in transportation spending is infrastructure spending that should be part of the regular Congressional budgeting process. We need first-class infrastructure if we are to remain a first-class global economic competitor. The funding mechanism should be part of the regular Congressional budgeting process.
The state grants for "rehiring" and "modernizing schools" represents a bail out for undisciplined state governments. State governments do not need federal funding to address local education and security objectives. They need to prioritize state and local spending on education and security over other spending measures. For example, if a state legislature cannot adequately fund teaching salaries, the state could impose cuts on other state employees (or other spending programs) and allocate the "savings" to the teachers.
[4] Finally, the proposal involves $65 billion in payroll tax cuts for employers (and $5 billion to extend 100% bonus depreciation into 2012). The main thrust of the proposal involves: a cut in the "employer portion" of the payroll tax from 6.2% to 3.1% in 2012; and a full payroll tax holiday for any expansion of payroll up to $50 million above the prior year. These proposals suffer from the same defects as the employee payroll tax cut and the $4,000 hiring tax credit. They are short-term in nature, are unlikely to "stimulate" hiring, and would primarily result in windfalls for businesses in growth mode.
President Obama's stimulus plan (ahem, "jobs bill") may save one job and get him re-elected. But its mix of short-term incentives and bad tax policy measures has failed before. Our political leaders should be focused on regulatory and tax reforms that will encourage private business investment and result in long-term employment opportunities. Short-term stimuli may appeal to a sitting President, but the rest of us will have to live with the hangover.
Various observers suggested that Obama's speech was primarily intended to launch his 2012 election campaign. He framed the stimulus proposal as a "silver bullet" that would create millions of jobs and reduce unemployment. A cynic would argue that he is mainly trying to save one job: his own.
The total cost of the new stimulus proposals is estimated to be $447 billion. How would that get "spread around"?
[1] The proposal would pump $175 billion into the private economy by cutting employee payroll taxes in half in 2012. This measure should be politically popular, because most working Americans will benefit, temporarily, from the payroll tax holiday. But we've been down this path before. Like a night of hard drinking, a temporary stimulus might be fun while it lasts. But the next day, or the next year, we'll wake up with a hangover. One "temporary" stimulus leads to the next (the "hair of the dog") and the next, and the next. President Obama (the politician) is perfectly happy to kick the can down the road. The rest of us see a looming budget crisis and desire a permanent improvement in the conditions to economic growth.
[2] The proposal has $62 billion in targeted spending intended to help the long-term unemployed. Most of that ($54 billion) involves a series of fuzzy changes to the unemployment insurance system, including a $5 billion "pathways back to work fund." Although not broken out, I'm guessing that a big chunk of the other $49 billion simply represents an extension of unemployment assistance.
The $62 billion also includes a tax credit of up to $4,000 for hiring workers who have been looking for a job over six months (projected cost of $8 billion). Although the price tag is low, this type of credit is frustrating tax policy at its worst. Very few (if any) managers or business owners would hire new employees for a $4,000 (or smaller) credit. The credit would primarily be a windfall to businesses that were otherwise intending to hire employees (so no stimulative impact). It would create an additional audit burden for the IRS, which is already overwhelmed by new responsibilities enforcing social programs. As such, it virtually invites fraud and abuse (which plagues all these ill-conceived stimulus efforts). Perversely, it does not reward employers that have struggled to retain employees during the Great Recession.
[3] The proposal includes $140 billion in "stimulus" measures, including $35 billion for "teacher rehiring" ($30 billion) and "first responders" ($5 billion), $30 billion for "modernizing schools," $50 billion for "immediate surface transportation," a $10 billion "national infrastructure bank" and $15 billion for "neighborhood stabilization."
The $50 billion in transportation spending is infrastructure spending that should be part of the regular Congressional budgeting process. We need first-class infrastructure if we are to remain a first-class global economic competitor. The funding mechanism should be part of the regular Congressional budgeting process.
The state grants for "rehiring" and "modernizing schools" represents a bail out for undisciplined state governments. State governments do not need federal funding to address local education and security objectives. They need to prioritize state and local spending on education and security over other spending measures. For example, if a state legislature cannot adequately fund teaching salaries, the state could impose cuts on other state employees (or other spending programs) and allocate the "savings" to the teachers.
[4] Finally, the proposal involves $65 billion in payroll tax cuts for employers (and $5 billion to extend 100% bonus depreciation into 2012). The main thrust of the proposal involves: a cut in the "employer portion" of the payroll tax from 6.2% to 3.1% in 2012; and a full payroll tax holiday for any expansion of payroll up to $50 million above the prior year. These proposals suffer from the same defects as the employee payroll tax cut and the $4,000 hiring tax credit. They are short-term in nature, are unlikely to "stimulate" hiring, and would primarily result in windfalls for businesses in growth mode.
President Obama's stimulus plan (ahem, "jobs bill") may save one job and get him re-elected. But its mix of short-term incentives and bad tax policy measures has failed before. Our political leaders should be focused on regulatory and tax reforms that will encourage private business investment and result in long-term employment opportunities. Short-term stimuli may appeal to a sitting President, but the rest of us will have to live with the hangover.
Wednesday, September 14, 2011
Robin Hood: Man in Speedo
President Obama has tried to position himself as a post-partisan Robin Hood, protecting the interests of the working class against rapaciously greedy working professional married couples with $250,000 incomes (bling-bling). He better stock up on Speedos, because his tax policies will leave us treading water for the next decade.
As I discussed yesterday, a dart-throwing monkey could put together a list of Obama's talking points for any given speech on tax policy. But, all fun aside, the posture of the U.S. political left on tax policy contains the seeds of its own undoing.
So what's the major flaw with the direction of Obama's tax policy?
The Obama administration and its cheerleaders generally believe that the solution to any budgetary issue is to "raise taxes on the wealthy" and to "close tax loopholes for greedy corporations." They make exceptions for favored industries and favored campaign donors, but they stay pretty consistent on message.
On the surface, this seems like good politics. If you convince 98% of the voting public that 2% of the voting public is not paying its "fair share," you can generate healthy majorities in favor of higher taxes on the 2%. At a minimum, you can use the Robin Hood card to get yourself elected or re-elected!
However, the political left harbors a desire to expand government and socialize the funding mechanism for various services (health care, green energy, affordable housing, etc.). The left's appetite for new programs requires new tax revenues. Mind you, we're not talking 'new tax revenues to reduce the trillion dollar budget deficit.' We're talking 'new tax revenues to pay for the President's new stimulus plan,' or 'new tax revenues to pay for Obamacare.'
Let me pause and note that politicians on the right have been complicit in the federal spending orgy that created our long-term budget crisis. However, the emergence of the Tea Party has created significant pressure on the right to end its complicity.
So the left needs new revenues, and it boldly declares class warfare on working professionals and their distant cousins in Martha's Vineyard and Sun Valley, the "millionaires and billionaires." In its thirst for revenues, it amends the Internal Revenue Code to create a series of "pay fors."
What do I mean by "pay for"? A "pay for" is a change to the Code that is projected to raise enough revenue to "pay for" a liberal spending objective. In recent years, Congress has enacted numerous "pay fors" without carefully weighing the consequences. One such folly was expanded 1099 reporting for small business (subsequently repealed). Another was the codification of the economic substance doctrine (which has left everyone, from the IRS to the tax practitioner community, scratching their heads).
Here's the thing about "pay fors." Tax policy driven by "pay fors" is no tax policy at all. "Pay fors" are a series of effectively random changes to the Code that are driven by political momentum to pay for a desired spending program. It is impossible to verify that the projected revenues from a given legislative change ever materialize.
And here's the other thing about "pay fors." When the political left closes a "loophole" to fund a new spending program, the revenues from that "loophole" are not available for deficit reduction. For example, President Obama would "pay for" the cost of his proposed stimulus act (ahem, "jobs plan") by raising taxes on the various bad apples described above (working professional married couples, millionaires and billionaires, oil and gas companies, private equity fund managers). However, if that proposal is enacted, we are still facing trillion dollar deficits as far as the eye can see. If the revenues of a new spending program are financed with a "pay for" that changes the existing tax rules, we're effectively trading water.
In this sense, the tax policy agenda of the political left contains the seeds of its own undoing. Sure, we can "pay for" new spending programs (the new stimulus act, Obamacare, whatever) by increasing taxes on the "wealthy" and "big corporations." But we're left treading water from a long-term budget perspective. Meanwhile, the Code gets more complex, and many businesses and individuals spend more time and money on non-productive tax planning and tax compliance activities.
The only way to finance the spending objectives of the political left and to tackle our long-term fiscal challenges is to increase taxes on everybody: rich, upper-middle class, middle class, lower-middle class, and poor. Maybe the left will convince voters and taxpayers that we should move in that direction. I wouldn't put money on that bet.
As I discussed yesterday, a dart-throwing monkey could put together a list of Obama's talking points for any given speech on tax policy. But, all fun aside, the posture of the U.S. political left on tax policy contains the seeds of its own undoing.
So what's the major flaw with the direction of Obama's tax policy?
The Obama administration and its cheerleaders generally believe that the solution to any budgetary issue is to "raise taxes on the wealthy" and to "close tax loopholes for greedy corporations." They make exceptions for favored industries and favored campaign donors, but they stay pretty consistent on message.
On the surface, this seems like good politics. If you convince 98% of the voting public that 2% of the voting public is not paying its "fair share," you can generate healthy majorities in favor of higher taxes on the 2%. At a minimum, you can use the Robin Hood card to get yourself elected or re-elected!
However, the political left harbors a desire to expand government and socialize the funding mechanism for various services (health care, green energy, affordable housing, etc.). The left's appetite for new programs requires new tax revenues. Mind you, we're not talking 'new tax revenues to reduce the trillion dollar budget deficit.' We're talking 'new tax revenues to pay for the President's new stimulus plan,' or 'new tax revenues to pay for Obamacare.'
Let me pause and note that politicians on the right have been complicit in the federal spending orgy that created our long-term budget crisis. However, the emergence of the Tea Party has created significant pressure on the right to end its complicity.
So the left needs new revenues, and it boldly declares class warfare on working professionals and their distant cousins in Martha's Vineyard and Sun Valley, the "millionaires and billionaires." In its thirst for revenues, it amends the Internal Revenue Code to create a series of "pay fors."
What do I mean by "pay for"? A "pay for" is a change to the Code that is projected to raise enough revenue to "pay for" a liberal spending objective. In recent years, Congress has enacted numerous "pay fors" without carefully weighing the consequences. One such folly was expanded 1099 reporting for small business (subsequently repealed). Another was the codification of the economic substance doctrine (which has left everyone, from the IRS to the tax practitioner community, scratching their heads).
Here's the thing about "pay fors." Tax policy driven by "pay fors" is no tax policy at all. "Pay fors" are a series of effectively random changes to the Code that are driven by political momentum to pay for a desired spending program. It is impossible to verify that the projected revenues from a given legislative change ever materialize.
And here's the other thing about "pay fors." When the political left closes a "loophole" to fund a new spending program, the revenues from that "loophole" are not available for deficit reduction. For example, President Obama would "pay for" the cost of his proposed stimulus act (ahem, "jobs plan") by raising taxes on the various bad apples described above (working professional married couples, millionaires and billionaires, oil and gas companies, private equity fund managers). However, if that proposal is enacted, we are still facing trillion dollar deficits as far as the eye can see. If the revenues of a new spending program are financed with a "pay for" that changes the existing tax rules, we're effectively trading water.
In this sense, the tax policy agenda of the political left contains the seeds of its own undoing. Sure, we can "pay for" new spending programs (the new stimulus act, Obamacare, whatever) by increasing taxes on the "wealthy" and "big corporations." But we're left treading water from a long-term budget perspective. Meanwhile, the Code gets more complex, and many businesses and individuals spend more time and money on non-productive tax planning and tax compliance activities.
The only way to finance the spending objectives of the political left and to tackle our long-term fiscal challenges is to increase taxes on everybody: rich, upper-middle class, middle class, lower-middle class, and poor. Maybe the left will convince voters and taxpayers that we should move in that direction. I wouldn't put money on that bet.
Tuesday, September 13, 2011
The Monkey, Millionaires and Billionaires
President Obama recently announced his latest stimulus proposal (ahem, "jobs plan"). To pay for the stimulus proposal, Obama went to the populist grab bag of tax "reforms," proposing tax increases oil and gas companies and on "millionaires and billionaires."
Oh, by the way, Obama defines "millionaires and billionaires" as "married couples earning $250,000" and "unmarried individuals earning $200,000." I still haven't thought of an easy way to describe this category of taxpayers, other than "working professionals." Apparently, in Obama's world, a working professional married couple that earns $250,000 is more similar to a billionaire than a working professional married couple that earns $249,999 or, for that matter, $149,999.
That's not my world, and probably not your world, but too much time in the Beltway scrambles all common sense. In any event, that topic is fodder for another post.
Obama tax policy would be infuriating if it were not so obvious that there is no policy behind the policy. Obama's solution to the nation's dysfunctional health care sector? Raise taxes on the "wealthy." Obama's solution to 9% unemployment? Raise taxes on the "wealthy." Obama's solution to the federal budget crisis? Raise taxes on the "wealthy."
Keep in mind, I'm a political independent and I support the notion that we should tax capital gains at the same rates as ordinary income. My problem is two-fold.
Number one, President Obama talks a big game about increased taxes on "millionaires and billionaires." But there aren't enough "millionaires and billionaires" to make a significant dent in any of his spending proposals. He is hiding behind class warfare rhetoric to make tax increases on working professionals seem like tax increases on the uber-rich. It's slimy behavior, regardless of the politics.
Number two, I want some policy debate around the idea that the "wealthy," including working professionals, are not paying enough tax. Let's slice and dice the distribution of income taxes at various income levels. Do we really want a society where half the population pays zero income taxes? (Yes, many are subject to payroll, and most are subject to sales taxes, but we're discussing income taxes.) Should the top 5% of taxpayers pay more taxes? The top 20%? The uber-wealthy in the top 0.1%? Let's have a national discussion about the numbers and whether different groups of taxpayers are paying their "fair share."
Instead, we get the same, tired proposals from the Obama administration. I suspect that President Obama has two large spinning wheels in a super-secret room in the White House (think 'Price is Right'). On one spinning wheel are a series of "stimulus" ideas: tax credits for this or that; infrastructure spending; cash grants to state governments. On the other spinning wheel are Obama's "tax policy" ideas: raise taxes on the "wealthy"; close "corporate loopholes" for multinational taxpayers that "send jobs overseas"; increase taxes on the "big oil and gas companies."
Before Obama decides to hit the road for the day, he assembles with his advisors in the super-secret room. His advisors trot out a monkey. Monkey seems to enjoy throwing darts at the spinning Price is Right wheels. Advisors spin the wheel. Monkey throws a few darts. Advisors track the landings and furiously scribble some notes. The darts plot out Obama's speaking agenda for the day. Obama slips into zen-like meditative trance as the Price is Right wheels turn and turn. Advisors break the trance with some fresh organic coffee ground by a Berkeley PhD. Monkey gets some fruit and tries to bite Berkeley PhD as a secret service handler leads him back to his monkey room for the day.
This is tax policy in the Obama administration.
Oh, by the way, Obama defines "millionaires and billionaires" as "married couples earning $250,000" and "unmarried individuals earning $200,000." I still haven't thought of an easy way to describe this category of taxpayers, other than "working professionals." Apparently, in Obama's world, a working professional married couple that earns $250,000 is more similar to a billionaire than a working professional married couple that earns $249,999 or, for that matter, $149,999.
That's not my world, and probably not your world, but too much time in the Beltway scrambles all common sense. In any event, that topic is fodder for another post.
Obama tax policy would be infuriating if it were not so obvious that there is no policy behind the policy. Obama's solution to the nation's dysfunctional health care sector? Raise taxes on the "wealthy." Obama's solution to 9% unemployment? Raise taxes on the "wealthy." Obama's solution to the federal budget crisis? Raise taxes on the "wealthy."
Keep in mind, I'm a political independent and I support the notion that we should tax capital gains at the same rates as ordinary income. My problem is two-fold.
Number one, President Obama talks a big game about increased taxes on "millionaires and billionaires." But there aren't enough "millionaires and billionaires" to make a significant dent in any of his spending proposals. He is hiding behind class warfare rhetoric to make tax increases on working professionals seem like tax increases on the uber-rich. It's slimy behavior, regardless of the politics.
Number two, I want some policy debate around the idea that the "wealthy," including working professionals, are not paying enough tax. Let's slice and dice the distribution of income taxes at various income levels. Do we really want a society where half the population pays zero income taxes? (Yes, many are subject to payroll, and most are subject to sales taxes, but we're discussing income taxes.) Should the top 5% of taxpayers pay more taxes? The top 20%? The uber-wealthy in the top 0.1%? Let's have a national discussion about the numbers and whether different groups of taxpayers are paying their "fair share."
Instead, we get the same, tired proposals from the Obama administration. I suspect that President Obama has two large spinning wheels in a super-secret room in the White House (think 'Price is Right'). On one spinning wheel are a series of "stimulus" ideas: tax credits for this or that; infrastructure spending; cash grants to state governments. On the other spinning wheel are Obama's "tax policy" ideas: raise taxes on the "wealthy"; close "corporate loopholes" for multinational taxpayers that "send jobs overseas"; increase taxes on the "big oil and gas companies."
Before Obama decides to hit the road for the day, he assembles with his advisors in the super-secret room. His advisors trot out a monkey. Monkey seems to enjoy throwing darts at the spinning Price is Right wheels. Advisors spin the wheel. Monkey throws a few darts. Advisors track the landings and furiously scribble some notes. The darts plot out Obama's speaking agenda for the day. Obama slips into zen-like meditative trance as the Price is Right wheels turn and turn. Advisors break the trance with some fresh organic coffee ground by a Berkeley PhD. Monkey gets some fruit and tries to bite Berkeley PhD as a secret service handler leads him back to his monkey room for the day.
This is tax policy in the Obama administration.
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