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Romney’s Effective Tax Rate: Just 15 Percent?

January 17th, 2012 . by economistmom

Well, this is going to raise some voters’ eyebrows:

“What’s the effective rate I’ve been paying? It’s probably closer to the 15 percent rate than anything,” Romney, a GOP presidential candidate, said. “My last 10 years, I’ve — my income comes overwhelmingly from some investments made in the past, whether ordinary income or earned annually. I got a little bit of income from my book, but I gave that all away. And then I get speaker’s fees from time to time, but not very much.”

(The “not very much” in speaker’s fees is apparently more than $360,000, by the way.)

Besides being good negative gossip on Romney, though, perhaps it will be a teaching moment for all of us about tax policy more generally.  It underscores the fact that even the preferential rate on capital gains and dividend income, even though it seems more an issue about tax rates than tax base, is a big tax expenditure–a big way we “spend” money via the tax code.  Relative to a comprehensive income tax base where all forms of income are taxed at the same rate, the lower rates on capital gains and dividends result in well over $100 billion a year in lost revenue.  (See Table 17-3 in the revenue section of the analytical perspectives of last year’s budget and note that just the first three capital gains provisions add up to $135 billion for just fiscal year 2012.)  So besides the distributional implications that are already unsavory, there are the budgetary implications that should make us question whether these tax preferences are worth their cost.

So let the gossip and thoughtful conversations begin!

39 Responses to “Romney’s Effective Tax Rate: Just 15 Percent?”

  1. comment number 1 by: Becky

    Very interesting - I’m curious as to your thoughts on the Fair Tax?

  2. comment number 2 by: AMTbuff

    Relative to a comprehensive income tax base where all forms of income are taxed at the same rate, the lower rates on capital gains and dividends result in well over $100 billion a year in lost revenue.

    No. Taxable income in these categories is highly elastic. If you double the tax rate and the reported taxable income falls 50% there is no revenue gain.

    By analogy, suppose McDonald’s decides to reduce its extra large soft drink from $2 to $1. At the low price they sell 3 million per day. How much revenue has this price reduction cost McDonald’s? Using “tax expenditure” methodology, the “cost” of this price reduction is $3 million per day.

    In fact, the cost to McDonald’s is negative. Sales of drinks have more than doubled and the sale of other food items has increased as customers spend some of their drink savings on other items.

    Some might argue that it’s not fair to cut the price of only one item: Some customers don’t want a large drink, or any drink at all. However if the sale price is successful, it benefits other customers indirectly. McDonald’s has greater revenue and higher profits, allowing it to keep its overall prices lower than they would have been without the sale.

    As this analogy shows, tax expenditure estimates are deceptive. The actual revenue to be gained by removing a tax break will generally be much less, and it may not materialize at all.

    The purpose of tax expenditure analysis is political. That’s unobjectionable if the political agenda (for example, improved fairness) is revealed and if the revenue estimates are accurate. Neither is the case currently.

  3. comment number 3 by: SteveinCH

    I have a better idea. Let’s define as a tax subsidy all income of all types that isn’t taxed at 35%. Makes about as much sense as the point about cap gains taxes.

  4. comment number 4 by: Shadowfax

    I think a 15% capital gains and dividend income rate is OK for a retired person (67 and over) but not for others, who should be taxed like regular income.

    Only a tiny portion of the capital gains tax is paid by people who earn less than $100,000; we’re talking about wealthy folks who feel a significant bite from higher capital gains and dividend taxes.

  5. comment number 5 by: SteveinCH

    Yes Shadowfax, let’s advantage those people who already are getting almost all of the transfer payments we make as a nation. Excellent idea.

  6. comment number 6 by: Brooks

    I wish the lower cap gains rate weren’t called (by some) a “tax expenditure”. It muddies the waters and encourages those who mistakenly view any reduction in tax expenditures as a “tax increase”, meaning similar to a tax rate increase and not similar to a reduction in spending (for subsidies).

    As Steve rightly points out, by this very broad definition, all rates below the top rate in a progressive structure could be called “tax expenditure” subsidies.

    We are talking about a different rate for an entirely different form of income, and notably, a tax on income resulting from having invested money that had been previously earned and taxed (at some initial point). It is arguable that there should be no such “double taxation”. If we simply taxed income on labor, and there were no taxation of cap gains or dividends, would it occur to anyone to call the non-taxation a 100% “tax expenditure” “subsidy”?

    A lower tax rate for cap gains and dividends is a different animal vs. what I think are more appropriately labeled as “tax expenditures” — generally tax credits, deductions, exemptions/exclusions for buying or producing particular products or services.

    All that said, from the little I know of “carried interest”, it seems inappropriate that private equity/hedge fund managers should be able to apply the lower rate to their income, given that it is not based on having invested their own money.

  7. comment number 7 by: Brooks

    Re: my comment:
    If we simply taxed income on labor, and there were no taxation of cap gains or dividends, would it occur to anyone to call the non-taxation a 100% “tax expenditure” “subsidy”?

    …or even a 35% “tax expenditure” “subsidy”?

  8. comment number 8 by: Arne

    The money that goes to pay the housekeeper and yardworkers also comes from money that has already been taxed. Should their wages go untaxed so we avoid this double taxation as well?

  9. comment number 9 by: Patrick R. Sullivan

    ‘…notably, a tax on income resulting from having invested money that had been previously earned and taxed (at some initial point). It is arguable that there should be no such “double taxation”.’

    Triple taxation actually, as the corporate income tax hits it (up to 35%) before it gets to the Romneys of the world personal tax returns.

    It’s amazing how this passes over the head of EconMom time and time again.

  10. comment number 10 by: Vivian Darkbloom

    “The money that goes to pay the housekeeper and yardworkers also comes from money that has already been taxed. Should their wages go untaxed so we avoid this double taxation as well?”

    Arne,

    You are usually better than this. Isn’t the issue here really *who* is subject to tax twice? Let me make it simple: If you own a business through a C corporation, doesn’t the incidence of the tax paid by the C corporation fall on the shareholder as much as it does on the dividend that company pays the same owner? Suppose that same owner decided instead to do business through an LLC. Has he just benefitted from a “tax expenditure” because he chose that form of business and was able to avoid entity-level tax? If anything, the 15 percent rate on dividends (and perhaps capital gains, but that is a more complicated story) should be treated as a *negative* tax expenditure. Is there any real difference other than form and tax consequences in these two examples? And, once that owner has cash in hand from a dividend or profit distribution, let’s suppose he uses that to pay his housekeeper. Do you see any difference at all between the double tax incurred by the business owner and the single tax incurred by the housekeeper?

    You could make a plausible argument that *some* of the incidence of the corporate tax is borne by employees (if these are different from the owner), but if the housekeeper is not an employee, your example is entirely off base.

    Your example would make sense to me if the yardworker or housekeeper did business through their personal C corporations. In that case, though, they would have gotten some very bad advice.

  11. comment number 11 by: Vivian Darkbloom

    Brooks and Steve,

    Regarding your respective comments, I can recommend that you read the JCT’s publication “A Reconsideration of Tax Expenditure Analysis” (2008). It contains a good summary of the history of tax expenditure analysis and recommends certain changes to tax expenditure analysis (that they have not yet implemented).

    http://www.jct.gov/publications.html?func=startdown&id=1196

    As to the issue of whether capital gains and the (reduced) tax on dividends are properly “tax expenditures” this basically goes back to Stanley Surrey’s original formulation that whether something is a “tax expenditure” should be based on a “normal tax” baseline. Much of this was based on Surrey’s own rather subjective determinations as to what a “normal tax” system should be. Here’s what the JCT said about his decision not to include corporate integration in a “normal” tax system:

    “He also included a separate corporate income tax in the baseline on the grounds that U.S. tax policy had accepted the concept, notwithstanding that strong arguments could be made that integrated taxation of corporations and shareholders would better implement the Haig-Simons definition. Numerous other structural issues were revealed only through his choices for the list of tax expenditures.”

    For this, and other things, Surrey was roundly criticized by Boris Bittker.

    Under the new JCT taxonomy, tax expenditures would be broken down into “Tax subsidies” (with further sub-categories) and “Tax Induced Structural Distortions”. Based on the JCT description of these items, it does not appear the reduced rates on CG and dividends would be considered “tax expenditures”. However, there is a third category called “Historical Continuity” that would list certain items (not specified) that would not fall under the main two, but would be included simply to provide the opportunity for “historical comparison”. It’s likely the CG and dividend issue would be dumped there (a wise political move).

    What the JCT also says, always, is that the list of “tax expenditures” is not meant to indicate whether a particular item constitutes good or bad tax policy.

  12. comment number 12 by: Arne

    “the issue here really *who* is subject to tax twice?”

    The corporation is not the same as the owner.

    The incidence of the tax is not really so simple. If the tax is truly dead weight it is one thing. If it is actually a cost of producing the good or service provided by the corporation then it falls on the consumer.

    If I had more dividend income I would have more incentive to believe double taxation to be an important factor, but my analysis is that it is not a first order effect.

  13. comment number 13 by: AMTbuff

    What the JCT also says, always, is that the list of “tax expenditures” is not meant to indicate whether a particular item constitutes good or bad tax policy.

    That disclaimer is no more credible than the warning on Q-Tips that they are not intended for cleaning the ear canal.

    Tax expenditure analysis was invented to paint tax breaks as bad tax policy, to characterize tax expenditures as fully equivalent to poorly targeted spending programs.

  14. comment number 14 by: Brooks

    Thanks Vivian.

    I haven’t looked over that info yet (perhaps I have in the past — not sure), but (at risk of talking more when I should be reading) in my view, the whole purpose of applying the label “tax expenditures” is to characterize the tax provision as closer in nature to spending than to a reduction in tax rate (in terms of incentives, rewards and basis for those rewards, etc., as we’ve discussed at great length previously).

    So I speak mainly of tax credits, deductions, and exemptions/exclusions that reduce taxable income to which the relevant tax rates are applied.

    As a note, I realize, though, that it’s possible to tinker with tax rates themselves as part of economic policy to subsidize particular activities, industries, decisions, etc. Some particular industries could get their own separate corporate tax rate, or some professions their own individual tax rate on labor income. Such provisions would be in a gray area, but are arguably tax expenditures, because they deviate from tax rates applied to the broader categories of income to which they belong — corporate income and labor income (and the same would apply to investment income, perhaps broken out into cap gains vs. dividends, perhaps not). So insofar as there is a baseline to be applied, I’d say it should be the tax structure applied to each broad category of income.

  15. comment number 15 by: Vivian Darkbloom

    Arne,

    So, your solution would be to eliminate the corporate income tax? For both practical and theoretical reasons, I can agree that would be a better solution. Then, one could tax dividends and capital gains at the same rates as other types of income (with inflation indexing for CG). The reduced rate of tax on capital gains and dividends is actually a compromise that is intended to acheive more or less the same result.

  16. comment number 16 by: Vivian Darkbloom

    “All that said, from the little I know of “carried interest”, it seems inappropriate that private equity/hedge fund managers should be able to apply the lower rate to their income, given that it is not based on having invested their own money.”

    Brooks,

    The partnership tax issues surrounding “carried interest” are incredibly complex. Nevertheless, it is dismaying for me to see the issue so poorly covered in the media.

    The main problem I have with the media coverage is that they express the same idea you have in the comment above. However, keep in mind that a partnership is a contract among limited partners and the general partner. “Carried interest” does not manufacture a larger capital gain out of thin air. It basically constitutes an agreement among the partners that some (the general partner, generally) will enjoy a larger share of the capital gain realized by the partnership than that partner’s capital contribution would otherwise dicate. The media coverage *always* fails to mention that there are normally countervailing revenue effects from this arrangement. Simply put, the general partner may pay less tax, but the limited partners more through this arrangement.

    The problem as I see it is that this general principle does not apply when tax exempt persons (e.g. pension funds or endowment funds) are the limited partners because they don’t care if the income they get is characterized as CG or ordinary income and they also don’t care if they get a deduction for “compensation” paid to the general partner as “employee”. Tax exempts are as much to blame for this “arbitrage” as are the general partners. It should not surprise you that about 63 percent of the funds of these PE partnerships are contributed by tax exempt entities. And yet I never hear any call for Congress to terminate the Harvard Endowment Fund’s tax exempt status.

    One of the most comprehensive articles on this subject (and the one that likely kicked off this “controversy’ is this one: Victor Fleischer, “Two and Twenty: Taxing Partnership Profits in Private Equity Funds,”

    which you can find here:

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=892440

    Even there, the issue that I point out is neatly tucked into footnote 35 and then more or less dropped.

  17. comment number 17 by: Brooks

    Vivian,

    Is the bottom line that the cap gains rate is applied to what is, in effect, labor income (as is my impression) or not?

    Seems to me if one is not investing his own money (or if the share of returns is disproportionate to his share of investment, to, in effect, compensate for labor), then he is being compensated for labor, and should be taxed accordingly, not at the cap gains rate.

    Am I missing something that implies something substantially different from my impression? (Forgive me for not checking all the details — I first just want to know if I may be grossly wrong in my impression)

  18. comment number 18 by: Vivian Darkbloom

    Brooks,

    Assume we’ve got two partners , a general and a limited partner both of whom are subject to normal US tax. LP contributes 99 and GP contributes 1. But, LP agrees to allocate 20 percent of any CG to the GP (contrary to the normal 99:1 allocation but permitted under partnership tax rules—and of course contract law). The partnership invests that 100 and eventually sells the asset for 200 at 100 CG. 80 of that CG is allocated to the LP and 20 to the GP.

    Assume, instead, that a “normal” course of action would be followed and LP had agreed instead to simply pay GP a contingent “management fee” of 19 on any gain (in addition to the 1 GP would earn on his own capital). LP has 99 of CG and GP has 1, plus 19 of ordinary income, taxed at ordinary rates. *But*, LP is allocated the deduction for GP’s “salary) which generally (this is a simplification) is deductible against ordinary income. So, it would really be a wash as far as Treasury is concerned. Generally, for every “salary” expense, someone else is getting a “salary” deduction.

    So, yes you *could* say, of course, that GP has *converted* his management fee into CG, but my point is that this is only half the story. The size of that CG pie remains the same. The different allocation comes at LP’s expense and that is what is ignored in the media coverage.

    There are a myriad of other ways in which parties who enjoy freedom of contract could come to the same financial result and the likelihood is that if Congress tries to “fix” the problem they will do exactly that. If the arrangement is at arm’s length and does not deprive the Treasury of income (because 1 partner pays more and the other less) then who cares?

    The problem with carried interest is that often the parties are *not* subject to the same US tax rules and therefore that this exchange of tax attributes *does* come at Treasury expense. As I noted, 63 percent of all private equity funds come from tax exempts. That, I think, is the arbitrage. If it were not for this arbitrage, parties acting at arm’s length and subject to the same tax rules would come to a different arrangement—the GP would simply get a higher management fee to compensate for the higher taxes he has to pay.

    I have previously suggested a possible “fix” to the issue by amending the law to preclude allocation of tax attributes to or from a party that is not subject to US tax. There is a good starting point in the Code for such a definition (Section 163(j).

    So, again, the media coverage on this is extremely incomplete and one-sided. It looks only at the general partner’s tax treatment (and gives him all the blame) and ignores the fact that GP’s favorable tax treatment often comes at the expense of others (at little or no cost to Treasury). The *real* problem is the tax arbitrage with tax exempts who are complicit. The media has not been hard enough on *that* industry for this problem, mostly out of ignorance, but for those who should know better out of partisan zeal. Tax exempts are trading their tax exempt benefits to others in return for lower fees and higher returns than they would otherwise get. That’s a classic tax benefit splitting negotiation.

  19. comment number 19 by: Brooks

    Vivian,

    Interesting. Thanks. It seems you have a very good point.

    But I’m not sure that it is necessarily a wash even in the case of GP and LP subject to the same tax rules, because the differential between the cap gains rate vs. the relevant marginal labor income rate (which I assume is generally 35%) is not the same as the differential between the cap gains rate and zero.

    Suppose $100 is in question.

    If that $100 were paid as management fee:
    (1) The LP would pay $15 less (vs. “carried interest” scenario), because cap gains would be $100 less, taxed at 15%
    (2) The GP would pay $20 more (vs. “carried interest” scenario), because he’d pay $35 rather than $15.
    Net effect would be $5 more for the Treasury.

    Correct?

    I would also guess that there are also other differences that are way over my head as far as tax accounting, even in this scenario of equal tax treatment.

  20. comment number 20 by: Vivian Darkbloom

    Brooks,

    It’s more complicated, of course, but in your simple example, your math is wrong because you forgot LP deducts mgt fee paid to GP:

    CG tax on $100 $15
    Deduction for $100 “salary” to GP -$35
    Net decrease -$20

    It’s a wash–increased salary to GP is also increased deduction for LP.

    I’m assuming the same marginal rate for both LP and GP.

  21. comment number 21 by: Brooks

    Vivian,

    You’re right that my math is wrong.

    Tell me if the following is what is going on.
    In the management fee scenario:

    1. LP has $100 more in cap gains. Pays $15 more in cap gains taxes.

    2. GP has $100 less in cap gains. Pays $15 less in cap gains taxes, so #1 and #2 is a wash

    3. What is the $100 management fee deducted from? The total cap gain that the LP pays taxes on, or from some other form of income? If it were deducted from the LP’s personal labor income, I can see why the LP would pay $35 less as you state. Is that the case?

    4. GP pays $35 more in labor income taxes, so #3 and #4 is a wash if answer to my question in #3 is “yes” (assuming same marginal rate on labor income for each person).

    Is that it?

  22. comment number 22 by: Brooks

    For my #3 above, I should have used “ordinary income” rather than “labor income”. The distinction I’m asking about is deduction from ordinary income vs. from investment income subject to cap gains tax rate.

  23. comment number 23 by: Vivian Darkbloom

    Brooks, you asked for an explanation. This is probably more than you bargained for:

    You might find it easier to look at it the other way around (at least I do). That is, the starting point is that there is no “carried interest” and then that there is. Let’s assume for simple math that the LP has 100% of the capital. Let’s further assume LP agrees to pay GP a management *fee* equal to 20 percent of any net gain and that the ultimate capital gain is $100. I’m assuming that the LP’s are not tax exempt and are wealthy individuals. Without the carried interest, it would look like this:

    LP gets $100 CG taxed at max 15% (we assume its long-term)

    GP gets $20 management fee taxed at max 35%

    LP also gets allocated the deduction for the management fee of $20 in accordance with their percentage of capital (100%°) .

    As to the nature of the deduction, you ask a very good question to which my best answer is “it depends”. The nature and benefit of the deduction depends on how the compensation arrangement is set up, whether the partnership is considered “engaged in a trade or business” and also on the tax attributes of the partner who gets allocated the deduction.

    I think there are two general possibilities:

    First, partnership is engaged in a trade or business due to GP’s activities (and by attribution, LP’s are, too). The fee paid to the GP should be treated as ordinary compensation and deductible by the LP’s as an ordinary and necessary business expense under section 162. Thus, there are no real restrictions on deducting this expense and it is deducted against marginal income at marginal rates.

    A second possibility would be that the partnership is not considered engaged in a trade or business and the expenses are considered as “other expenses” related to “portfolio income”. Compensation to the GP would be treated as a miscellaneous itemized deduction subject to the 2 percent AGI floor, AMT rules, etc, but otherwise deductible at marginal rates.

    Clearly the former is the more beneficial tax treatment for the LP’s and is consistent with Fleisher’s article (footnote 35 and discussion around that). Also, a more recent article by Howard E. Abrams (Taxation of Carried Interests: The Reform That Did Not Happen ) had this to say on the general issue:

    “When an allocation and distribution are recharacterized as compensation under Section 707(a)(2), the partnership-level capital gain is not eliminated. Rather, it is allocated among the partners, who are then treated as paying compensation to the service partner.
    To the extent such payments constitute ordinary and necessary business expenses, an offsetting deduction will arise. In many cases, all partners will be in the same marginal tax bracket, and so the effect of recharacterization will be to shift income among the partners but will not change the net income they report in the aggregate. If, however, some of the partners are exempt organizations or foreign taxpayers not generally subject to U.S. taxation, recharacterization will have significant fiscal impact.”

    http://www.luc.edu/law/activities/publications/lljdocs/vol40_no2/abrams_taxation.pdf

    (Note that if a foreign partner is considered engaged in a US trade or business through the partnership, that partner is liable to US tax on income from that business).

    The bottom line, I think, is that if the carried interest possibility did not exist, these partnerships would arrange their affairs so that the income received by GP with respect to a “contingent fee” would generally be “matched” by a corresponding deduction by the LP’s at the same marginal rate.

    Therefore, when there are taxable LP’s subject to the same tax regime as the general partner, the advantages of this carried interest “trade off” are severely restricted, if not eliminated, but the extent to which this is the case depends on a variety of factors as noted above.

    As I mentioned, most private equity funds come from tax exempt partners. This is no accident. The general media ignore the problem and even the academic writers mention it and then focus all their attention on the PE general partners. Also, contrary to the impression given in the general media, not all private equity arrangements follow the “2 plus 20” formula. Per the JCT, about half private equity income was subject to the “carried interest” rule in the period ending 2007. I strongly suspect that in those cases in which the technique is used tax exempts are involved. If tax exempts are not involved, the likelihood is much lower because, as noted above, the tax interests of the LP’s and the GP’s are not perfectly aligned and there is therefore a different negotiation paradigm than when tax exempts are involved.

    My point is not that there is no problem with “carried interest”. In fact, I have previously written here that it can be legitimately called a “loophole” when the arbitrage is among tax exempt partners and taxable partners. My main point is that the general media and the pubic like simple explanations and this is one very good example. Every problem and every crisis has to have one cause and one villain. In the absence of specific knowledge, mere opinions, particularly partisan opinions, take over. The general media has said nary a negative word about the Harvard Endowment Fund or union pension funds even though they often negotiate sharing their tax exempt benefits with others (for even additional benefit to themselves). Whenever I read something in the general media that I happen to have been witness to or have particular experience with I’m always shocked at how misleading or even flatly incorrect that coverage is. I suppose this has always been so, but now that our “experts” are so preoccupied with blogging and tweeting, and this is the only thing the general public is consuming, I’m starting to wonder if the internet might even be making that general problem worse than it previously was.

  24. comment number 24 by: B Davis

    SteveinCH wrote:

    The mistake Buffett is making is using AGI as the measure of income, as one would working off of the 1040 form. But the 1040 form doesn’t include payroll taxes. If Buffett is contending that his employees had an average income tax liability versus AGI of 32.9%, he must pay him employees a whole lot of money. The top marginal rate as a percentage of AGI is 35%. Getting the weighted average to 32.9 is almost mathematically impossible.

    You actually wrote this in the thread on Bruce’s New Book but it is related to this topic. Anyhow, I was curious in this question and posted a blog about it at this link. As you can see, Buffett clearly states that he is using taxable income and, by that method, his numbers are perfectly reasonable. You can comment on the blog there or here.

  25. comment number 25 by: SteveinCH

    Fine, I’ll amend my statement. Buffett’s approach was intended to mislead or to be irrelevant. In all the writings on tax incidence, you will never find another example of using taxable income in the denominator of an effective tax rate conversation.

    Thanks for doing the math on TI and making the point. I’ll continue to argue that using AGI or total income yields a different result and thus using TI to make the point was done for exactly that reason, to make the point you wanted to make.

  26. comment number 26 by: Arne

    “So, your solution would be to eliminate the corporate income tax? ”

    Corporate taxes (2009) make up 15 percent of federal revenue (excluing employment taxes). Capital gains and dividends make up 5 to 12 (1990 to 2005) percent of taxable income.

    After my knee-jerk negative response and actually looking up numbers, I would agree that my solution wrt corporate income would be to elimnate the existing corporate income tax and eliminate the preferential treatments for dividends and capital gains. The hole would need to be filled - higher rates? Perhaps a VAT would be more in line with having taxes fall as a function of the services provided. Corporate dependence on government is more than how much profit it makes, but it is also more than an aggregation of the people it pays salaries and dividends to.

  27. comment number 27 by: Brooks

    Thanks Vivian. I haven’t had a chance yet to read through your reply but thanks for taking the time to write it.

  28. comment number 28 by: B Davis

    SteveinCH wrote:

    Fine, I’ll amend my statement. Buffett’s approach was intended to mislead or to be irrelevant. In all the writings on tax incidence, you will never find another example of using taxable income in the denominator of an effective tax rate conversation.

    If that is the case, then effective tax rates should not be used to compare the equity of taxes. Suppose that person A has an AGI of $100,000, gives $90,000 to charity and pays the other $10,000 in taxes. Then suppose that person B also has an AGI of $100,000 but gives nothing to charity and pays $20,000 in taxes. Person A is paying 100% of taxable income to person B’s 20% but is paying 10% of AGI to person B’s 20%. By your logic, person B is paying a higher tax rate despite the fact that he is left with $80,000 and person A is left with nothing. Deductions are a separate issue. If they are unjust or inequitable, then they should be changed. But they should not be used to compare the equity of taxes.

  29. comment number 29 by: Arne

    “By your logic, person B is paying a higher tax rate ”
    Absent AMT, B’s taxable income is $10K and B’s tax would be zero. You are misrepresenting Steve’s logic. In this case the logic is simply that using $90K and $10K as the incomes to compare is not the best choice.

  30. comment number 30 by: SteveinCH

    Ummmm….if person A has taxable income of $10,000, he won’t be paying $10,000 in taxes unless we have a flat tax of 100%.

    You’re confusing how the taxes are calculated with how effective tax rates are calculated. Tell you what, let’s use real numbers. Let’s use the IRS calculator with individual filing singly and do the math.

    Person A has taxable income of $10,000. Person B has taxable income of $80,000. Person A owes taxes of $1079. Person B owes taxes of $16131. So even calculating by TI, person B’s tax rate is 20% and person A’s is 11%. That’s before you get to thinking about the fact that charitable contributions are voluntary.

    Deductions are the issue that gets you to taxable income in the first place. I agree that they should not be used in calculations of tax equity which is why one uses AGI, GI to CI (comprehensive income) in the denominator.

  31. comment number 31 by: SteveinCH

    To add, Buffett isn’t using AGI, he’s actually using taxable income which is an even more bizarre choice.

  32. comment number 32 by: B Davis

    SteveinCH wrote:

    Ummmm…if person A has taxable income of $10,000, he won’t be paying $10,000 in taxes unless we have a flat tax of 100%.

    You mean to say that we don’t have an upper marginal rate of 100 percent? The rich are getting off easy! :) Of course, I know the current rates. I used them to calculate all of the examples at this link. I gave that last extreme example to show that effective tax does not properly measure tax equity or “fairness” under every situation. Although persons A and B would be paying effective tax rates of 10% and 20% respectively, such a tax would be seen as “unfair” to person A and would never be implemented.

    You’re confusing how the taxes are calculated with how effective tax rates are calculated. Tell you what, let’s use real numbers. Let’s use the IRS calculator with individual filing singly and do the math.

    Person A has taxable income of $10,000. Person B has taxable income of $80,000. Person A owes taxes of $1079. Person B owes taxes of $16131. So even calculating by TI, person B’s tax rate is 20% and person A’s is 11%. That’s before you get to thinking about the fact that charitable contributions are voluntary.

    And then suppose Person C has a taxable income of $100,000, all from long-term capital gains. He will pay $15000 in taxes for a tax rate of 15%, less than Person B who made $20,000 less in income. That’s the whole crux of the argument that Buffett is making. Should long-term capital gains and dividends be taxed at a much lower rate without limit?

    To add, Buffett isn’t using AGI, he’s actually using taxable income which is an even more bizarre choice.

    I could say that it’s bizarre that someone would insist that AGI is the only proper measure of income equality despite all of the seeming cases of inequality that it misses. But then I don’t think it’s useful to use the word “bizarre” for the opinions of those who one disagree with. At least, not if one is truly trying to have a productive conversation.

  33. comment number 33 by: SteveinCH

    Of course but you are ignoring the pass through corporate taxes that accrue to Buffett. That is why his argument is bizarre. Pretty much every tax analyst I’ve ever seen uses either GI or comprehensive income in the denominator and total taxes (including imputed taxes and employers portion of FICA) in the numerator.

    Of course it’s possible to choose a different methodology but one should specify when one is doing so and make an argument for the non-standard methodology.

    To your specific example, person C is responsible for (on average) about 20% (effective rate) in corporate taxes which is how one would make an apples to apples comparison.

  34. comment number 34 by: Vivian Darkbloom

    “Should long-term capital gains and dividends be taxed at a much lower rate without limit?”

    Actually, the point is that capital gains are taxed at a *higher* rate, without limit when one properly considers the corporate income tax underlying those gains (and dividends). The combined corporate and CG tax already exceeds the marginal 35 percent tax rate.

    But, I would agree (see exchange above with Arne) that the lack of integration of corporate/individual taxes is a problem. If you are concerned about progressivity on a case-by-case basis, you should be all for eliminating the corporate income tax and treating all corporations as flow-thru’s. In this respect, it would make the allocation of tax burdens on a case-by-case basis *more progressive* and, in particular, more fair to workers.

    Currently, the only “income taxes” lower income tax households have the burden of is the corporate income tax. You can argue labor bears a portion of the tax rather than “capital” but this simply means that lower and medium wage earners typically bear both and thus, their pro rata share of corporate income tax is 100 percent.

    Consider Worker A who has $40,000 of taxable wages and $40,000 of deferred savings (IRA 401(k), IRA, etc. and perhaps employer provided pension) and $10,000 of taxable savings, all of which is invested in corporate stock. That worker currently bears the full burden of the corporate income tax at a rate that far exceeds his marginal income tax rate. Eliminating the corporate income tax by treating corporations as flow-thru’s would reduce his tax burden, perhaps allow him to earn higher wages, build up pension balances quicker and encourage him to save more. All these things are desirable, I presume, from a progressive standpoint. And yet, progressives seem against lowering the corporate income tax, much less eliminating it.

    And, if all corporations were treated as flow-thru’s for US tax purposes, that would eliminate another key concern of progressives—the existing deferral of US tax for non-Subpart F, non-PFIC, non-FPHC income of foreign corporations owned by US shareholders. Income would flow through to US resident shareholders and taxed immediately, subject to foreign tax credits. Index capital gains for inflation, but everyone would be taxed at progressive ordinary tax rates. That would make investing in the US or abroad pretty much tax neutral.

    There are practical problems with this, but with work it could probably be effected. REIT’s, RIC’s, mutual funds and publicly traded master limited partnerships such as Kinder Morgan actually work in more or less flow-thru fashion.

    Why don’t progressives take the lead on this?

  35. comment number 35 by: Vivian Darkbloom

    David Rubenstein, co-founder of the Carlyle Group, believed to be the largest private equity fund in the world, recently gave an interview to Fareed Zakaria on CNN. Here’s what Rubenstein had to say in response to a questions about Private Equity Fund manager earnings and “carried interest”:

    “And, most importantly, the money that I make, or my partners make, is perfectly aligned with our investors. If our investors make a lot of money, then we will make money. We typically get 20 percent of the profits. So if the pension funds that invest with us are doing very well, yes, we will do well. And because we’re doing well, I’m fortunate to be able to give away the bulk of my money.”

    Notice that he referred to pension funds, but he doesn’t connect the dots between their exempt status and his capital gains. Talk about interests being “perfectly aligned”?

    http://podcasts.cnn.net/cnn/services/podcasting/audio/fareedzakariagps/gps0122.mp3 (at about minute 9)

  36. comment number 36 by: Arne

    “when one properly considers the corporate income tax underlying those gains”
    “Why don’t progressives take the lead on this?”

    I think that the problem is in your model. Treating the tax incidence as wholly on the stockholders is easy (and easy can be useful), but that does not make it proper. Without a government of laws our corporate entities would literally not exist. I am convinced that (some) government programs help corporations by aiding in the creation of a higher class of workers and consumers. Thus, paying for government is a cost of business and falls into the price of the good or service.

    This is not a very useful model because I cannot assign numbers, but it is consistant with some combination of lower corporate income taxes in combination with a tax paid at the corporate level that does not depend on profit such as a VAT.

    Of course, any change based on convincing people with data requires that you can get them to look at the data.

  37. comment number 37 by: Jim Glass

    That’s the whole crux of the argument that Buffett is making. Should long-term capital gains and dividends be taxed at a much lower rate without limit?

    They *should* be taxed at a 0% rate without limit as long as they are reinvested and not consumed.

    The whole emotional background justification behind the “tax high income more” urge is the assumption that income = welfare.

    This is a weak assumption contradicted by fact on countless occassions. I could give examples that run down my arm and up yours. Also, as with many emotional arguments, it doesn’t consider systemic consequences.

    Welfare corresponds *far* more closely to consumption than income — and the picture of the consumption distribution is *far more even* than the income distribution, with a much smaller gap from top to bottom, and the difference from top to bottom having not at all growin as that of the income distribution has.

    Economists at least, who know about consumption distribution, but go on and on and on about income distribution without ever even mentioning the consumption distribution are, at the least, disingenuous (though I often prefer to think of them as being dishonest).

    And of, course, the systemic consequences of taxing consumption instead of income are far preferable economically, regarding the feeback effects for everybody else.

    If Warren Buffett reinvests all his income rather than consuming it, so that he spends less on food, housing, transport, entertainment and all the rest than I do, massively increasing the capital stock of the nation as a result, then he *should* pay less tax than me — and because he’s reduced his level of material welfare to below mine to do it, I’d have no problem with it at all.

  38. comment number 38 by: Vivian Darkbloom

    “Welfare corresponds *far* more closely to consumption than income — and the picture of the consumption distribution is *far more even* than the income distribution, with a much smaller gap from top to bottom, and the difference from top to bottom having not at all growin as that of the income distribution has.”

    I agree with Jim as far as it goes, but I don’t think it goes far enough.

    Of course, this depends entirely on the definitions one assigns to “welfare” and “income” respectively. I’m sure that Warren derives great personal satisfaction from simply being one of the richest persons on the planet and the security, power and influence that goes with that. In this respect, Warren’s wealth is an never-ending supply of non-taxable “welfare” that he consumes on a daily basis.

    The income tax rate does not really have much significance for Warren. He can indefinitely delay his realization of “income” and the tax on what “income” he does realize can be offset by his charitable deductions. You can raise the tax rate to 90 percent and Warren wouldn’t mind so long as he gets a deduction for those contributions to the Gates foundation valued at 90 cents on the dollar in tax savings. If you really want to get Warren’s attention, you would eliminate the charitable deduction for income, gift and estate tax purposes (or tax those charities on receipt).

    This, of course, raises the issue as to what “consumption” is. Should Warren be considered to “consume” his wealth when he decides to give it away? Or to “consume” it when he bequeaths it to charity or to his kids? Conversely, should those charities be considered to have taxable “income” when Warren gives them his billions? Or his kids, when Warren gives them only his millions?

    A “consumption” system of taxation makes a great deal of theoretical and practical sense to me, but not without some modifications. Some argue that a “life-cycle endowment” approach should be taken in regards to taxation. In other words, the net present value of the taxation of each person’s lifetime “endowment” should be the same regardless of at which point in time they choose to “consume” it. The best way to approach that would be to make gifts and inheritances taxable to recipients (including “not-for-profit” organizations) That’s it. Then combine this with a personal consumption tax.

    It seems both logical and fair to me that Warren’s children should be considered to derive taxable “income” from whatever Warren chooses to leave them and then that they should be taxed at the same rate as I am on whatever is left that they choose to “consume”. They would still be entitled to consider themselves “lucky” and, in that respect Warren made a valid observation: his children did not become his children through any particular effort of their own.

  39. comment number 39 by: AMTbuff

    I’m sure that Warren derives great personal satisfaction from simply being one of the richest persons on the planet and the security, power and influence that goes with that. In this respect, Warren’s wealth is an never-ending supply of non-taxable “welfare” that he consumes on a daily basis.

    Should Hollywood stars and ex-Presidents be taxed on their imputed “status” income? Inquiring minds want to know!