Because most philosophies that frown on reproduction don't survive.

Wednesday, January 25, 2012

The Oft-Repeated Lie About Warren Buffet's Secretary's Tax Rate

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.


Foxfier said...

What drives me nuts is all the talk about him "paying less in taxes than his secretary."

The claim is he pays a lower percent, as best I understand-- not that fewer dollars leave his pocket than leave his secretary's!

Joseph M said...

Thanks for the clarifications, but I think the situation is still more complicated. In particular, focusing on income is just simply wrong when discussing wealth. Mr. Buffet's secretary almost certainly needs her income in order to live - she spends it, probably almost all of it, on living expenses. This is true of almost all income-earning people, from minimum-wage earners all the way up to professional athletes and entertainers who make millions in salaries per year - they (we) need our incomes in order to live our lives, and if our incomes dried up, we'd feel it immediately.

Not so the truly rich, such as Mr. Buffet. Income, even millions and millions of dollars in income, is but a tiny fraction of their wealth, and a controllable side effect of their economic activities. Mr. Buffet doesn't invest to produce income, even in theory. He never expects to realize those capital gains. As he points out ever day when he drives a 5 year old car down to the local diner for lunch, his material economic needs have been met many years and billions of dollars ago.

This, BTW, is not to pass a moral judgement - but it is to point to the factually different economic situation a truly rich person is in versus people who need a regular pay day to pay the bills.

The point: for Buffet to talk about income tax rates is utterly misleading. An income tax rate of 25% or 50% or even 95% would make no material difference on his life - if he even felt the pinch, he'd just move a few hundred million into tax-exempt Munis or some other more sophisticated instruments, or (he's almost certainly already done this) set up trusts to take care of all his basic needs in such a way that it no longer appears as income to anybody.

For the truly rich - for people who do not need income to sustain their lives - talking about increasing their income tax rate is simply immaterial.

Now, the income tax rate on high wage earners - who are the 'rich' in the classic 'soak the rich' discussions - that's another story. They - we? - are likely to care about our income tax rates, and are likely to take some sort of action if we feel them to be oppressive.

Bottom line: you will never soak the truly rich by means of taxes on income. You'll just ad friction and discouragement to somewhat better off working people. Buffet is not materially effected by income tax rates, and so risk nothing of his personal wealth by talking about raising them.

TrueBlue said...

The end of the conversation on these high income talking heads screaming how people like them don't pay their fair share goes like this: There is a line on your tax return paperwork giving you the option of writing a check to the IRS if you want to give them more money. They can preach about high income individuals having to pay more after they first do so willingly, without using the government to force everyone. If they think their tax percentage is too low, write a check for the difference or shut the heck up.

Anonymous said...

It's true, after all the deductions Americans pay very little, yet complain the loudest about their taxes. Nor will they tolerate cuts to anything, including the ridiculously bloated military.

Foxfier said...

Nor will they tolerate cuts to anything, including the ridiculously bloated military.


LOLIRL, as my generation says.

Amazing how expensive things get when you're picking up the check for a large chunk of the world....

Darwin said...


You know, for a minute there I lost faith, but the nice man in the dark suit took me into a back room and explained everything to me, and I now understand that I was so very wrong. I denounce all my past actions.


There are two ways to think about the bloated military: On the one hand, yes, we spend far more than anyone else. On the other, the fact that there is one country in the world with such an overwhelming military superiority has spared the world the sort of mass wars between equally matched powers that made the first half of the 20th century so catastrophic. Overall, I figure it's a better deal to spend money than lives.

Joseph M,

It's true, income taxes all relate to income, not wealth. I'm not sure that's entirely unjust since in order for someone do to anything with wealth he has to realize it as income at some point. One of the things about these people who are "super rich" because they own stocks or companies or land worth a lot of money is that in order for them to do anything with that wealth they need to sell the assets. Until they sell the assets, in a sense the wealth isn't "real" (as some of those dotcom millionaires discovered when their stocks suddenly went from $200 a share to $0.02.)

I don't agree with the idea, though, that because the wealthy are wealthy they don't notice how much they're taxed, or they aren't impacted with it. All other things aside, the fact that people like Warren Buffet spend so much money on tax accountants whose job it is to minimize their tax expenses suggests that they do notice the difference. And even if they don't use the money for personal consumption, how much of their income they "get to keep" controls how much more they have to invest in future ventures and thus shapes the business environment a lot.



TrueBlue said...

Given that China has increased their military budget from $9 billion to $62 billion since 2000, I don't have an issue with the military budget. They have a history of starting wars when their civil unrest reaches a certain level, and I don't want us or our allies to get caught with our pants down. Since Europe is a long way from China that means Japan, Korea, and The Phillipines.

Take out the discretionary spending for Iraq and Afghanistan and their budget is really not that big compared to everything else. I wouldn't go looking at how much we spend on the military vs other countries, I'd suggest looking at it from the perspective of percentage of the budget.

That said, there IS a decent amount of waste in the military (and the rest of the government agencies), end of year spending being an easy example. All of these government agencies are pushed to spend their entire budget for the year or risk getting that budget cut. This results in buying things like new chairs, to replace ones that are only a couple of years old and the new ones costing far more than your average middle class civilian would ever consider paying.

Then you have the waste that results from government contracts, most of which are not renegotiable as the price of goods decreases until the end of the originally signed contract. Many of those contracts while including on-site contractor support are for various pieces of hardware that the civilian sector pays a significant portion LESS for, simple because the system of lowest bidder the government uses to determine who gets a contract doesn't take into account current costs for items.

Have a friend of mine that actually got in trouble for negotiating down the price of several items for his office because he knew the true cost paid by private companies, but he isn't an authorized contract negotiator. His office ended up paying 15% under retail, and he got in trouble for it? Where is the logic there?

It's areas like that that need to be looked at across the board.