Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

The Buffett Rule Is Unfair

Warren Buffett
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The Obama administration said over the weekend it would be incorporating a so-called “Buffett Rule” to tax millionaires more by denying certain tax deductions.

The rule is aimed at setting a new kind of alternative minimum tax on the wealthy, preventing top earners from using tax shelters to effectively pay lower tax rates.

It’s no doubt called the Buffett Rule because Warren Buffett has been at the forefront of arguing the tax structure unfairly taxes the very wealthy at lower rates than the non-wealthy. As far back as the summer of 2007, Buffett complained at a high-priced fundraiser for Hillary Clinton that “the 400 of us [here] pay a lower part of our income in taxes than our receptionists do, or our cleaning ladies, for that matter.”

Earlier this year, Buffett wrote an op-ed for the

Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.

(For a full history and discussion of Buffett’s agitation for higher taxes, read Ira Stoll’s article in Commentary.)

Buffett has a point—although it's not necessarily the one he thinks it is. It’s true that relative to his employees Buffett’s taxes seem to be too low. But it’s also true that relative to Buffett the employees’ taxes are too high. This is as much an argument for tax cuts as it is for tax hikes.

In any case, Buffett is actually understating the unfairness of the tax system in a way that is dramatically advantageous to him. The measure of Buffett’s ability to pay into the tax system is not his current income—it’s his overall wealth. Measured this way the unfairness of the tax system is even more unfair.

Let’s take a receptionist at Berkshire Hathaway . Assume she is single, 30 years old and makes $60,000 per year. Her federal income tax would amount to $9,675 at current rates. Federal payroll deductions would be around $4,600. State income taxes in Nebraska would be around $3,600 and another $3,600 paid on her behalf by her employer. (For now we’ll ignore property taxes, sales taxes and the temporary payroll tax deduction.) All told, she has somewhere in the neighborhood of $20,000 in annual tax liability. She has an effective tax rate of just 33 percent.

If she’s done very well for herself by saving and finding affordable ways to pay for education, she might have a net worth of, say, around $20,000. The median net income for her age bracket is closer to $11,000, but let’s just assume that working for Buffett encourages frugality and prudent investing. So she’s built up almost twice the net worth of her peers.

Notice that the taxes are equal to her net worth in our example. And we’re being very generous. Let’s say she’s actually got an even higher net worth, of $40,000—almost 400 percent higher than the median for her age cohort. Her tax burden in 50 percent of her net worth.

What’s Buffett’s? Well, Buffett has a net worth of $70 billion. He pays income tax and payroll taxes of about $7 million a year. His yearly income tax represents about 0.0001 percent of his net worth.

What happens if we dramatically raise Buffett’s taxes? Let’s say we tax him at an effective rate of 50 percent—which would mean that highest marginal rate would likely be at levels not seen since the Eisenhower administration. Even at these extreme levels—where Buffett would pay something like $17 million a year—Buffett’s tax would be just 0.0003 percent of his net worth.

No amount of jiggering with marginal rates or deductions will make the tax burden of Buffett even approximate the tax burden of his receptionist. The vast size of his wealth makes the tax burden irrelevant.

But not all the so-called wealthy are as immune to this type of thing.

Will Higher Taxes Curb the Deficit

Let’s take a household where both the husband and wife work. Assume they’ve got a combined income of $250,000 and two kids. Their federal income tax will be about $53,685. Payroll taxes amount to around $15,000. Their state income tax—let’s say they live in New York, which they’d likely do if they’re earning that much—is $17,125. City income tax takes another $9,516. Their total tax is $94,000—or an effective tax rate of 37.5 percent of their income (excluding sales and property taxes).

At that income bracket, they’d likely have around $1 million of net worth. This means they are being taxed at 9.4 percent of their net worth. Increase their effective tax rate just a few percentage points—which is part of Obama's other tax proposals—and they are paying a double-digit percentage of their net worth. Remember, Warren pays just a fraction of a percentage of his net worth in taxes.

This couple will see their life altered by higher taxes. Warren Buffett will not. Does that sound fair?

Hat Tip to Daily Speculations.

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