For last night's State of the Union Address, President Obama invited Warren Buffet's secretary, Debbie Bosanek, to sit in the First Lady's box during the speech and specifically promised in that speech to support tax changes in order to mend the injustice Buffet claims occurs allowing him to pay the lowest tax rate of anyone in his office, including his secretary. This line of attack is doubtless partly designed to pave the way millionaire Barrack Obama to make populist attacks on multi-millionaire Mitt Romney during the upcoming presidential campaign. Romney is, after all, very, very rich, and his income comes primarily from investments.
David Leonhardt at the NY Times asks both right-leaning economist Greg Mankiw and the left leaning Center on Budget and Policy Priorities to comment on this alleged tax injustice. Mankiw makes a fairly reasonable case that the reason capital gains are lower is that investment income is based on corporate profits and corporate profits have already been taxed. Companies would have more profits to pass on to investors (either as dividends or in the form of being worth more) if they didn't pay corporate taxes, and so the tax on investment income is set lower to avoid this "double taxation". Chuck Marr of the Center on Budget and Policy Priorities must know the facts aren't on his side, because instead of answering the question he provides a canned response about income inequality and how tax rates are lower than in the '70s. The column is worth a read.
However, there's another issue here which I think is worth pointing out. Progressives writing on this issue usually act as if billionaire investors such as Warren Buffet are all paying right around 15% (the capital gains rate) in taxes -- Buffet claims that he pays 17.4% -- and that "middle class Americans" are paying the top marginal income tax rate of 35%. However, that top marginal income tax rate only applies to taxable income (for 2011) in excess of $379,150 a year of which "middle class" families by any reasonable definition have exactly none. If you think in terms of gross income, a lot of middle class families probably fall in the 25% bracket, which is applied to married couples with a combined income of $69,000 – $139,350. Many others fall in the 15% bracket, which is applied to married couples with a combined income of $17,000 – $69,000.
Even that, however, is not the whole story. That tax rate is applied to your adjusted taxable income. If you have kids, a mortgage, medical expenses, 401k contributions, student loans, etc., your taxable income can be significantly lower than your gross income, plus you may qualify for tax credits which apply directly against your tax liability.
So, to take one concrete example, although our total household income falls neatly in the middle of that 25% bracket range, by the time we took all deductions and tax credits into account last year I ended up paying actual taxes equal to 5% of my gross income. This is pretty typical. According to Congressional Budget Office numbers, the average effective income tax rate for all American households was 8.7% in 2005. Those in the bottom 40% of households got more money back then they paid (they had negative effective income tax rates) and those in the top 10% paid an effective income tax rate of 15.9% and those in the top 1% paid 19.7%. Even if you look at total federal taxes (including both the highly regressive payroll taxes that fund Social Security and Medicare and the corporate income taxes which tend to his only the more wealthy), the total federal effective tax rate is progressive all the way up the income stack, with the bottom 20% paying 4.3% and the top 1% paying 31.4%
I don't doubt that Warren Buffet pays tax lawyers a lot of money to make sure that he doesn't pay more taxes than he has to, and as a result he may well manage to pay a lower effective tax rate as a member of the top 0.000001% than a member of the top 0.01% would, but to claim that he is paying a lower total effective federal tax rate than members of the middle class is, to put it bluntly: a lie.
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