Is the ‘Buffett rule’ pie in the sky?

2011-09-24 14:36

Turning the “Buffett rule” proposed this week by President Barack Obama from a political concept into a real-world tax policy aimed at the highest-earning US households will prove logistically and mathematically difficult.

The concept, named after billionaire investor Warren Buffett, would require Americans earning more than $1 million (R7.6 million) a year to pay at least the same tax rate as middle-class households.

Constructing such a rule would be tricky because high earners aren’t the only taxpayers benefiting from breaks. Many middle­income families use deductions, credits and exemptions to drive their rates below the 17.4% that Buffett says he pays.

For now, the Buffett rule is less of a concrete legislative proposal and more of a political talking point that has elicited Republican cries of “class warfare”.

Democrats defended the idea and urged Congress to adopt it in designing a new tax system.

Said US Treasury secretary ­Timothy Geithner: “We’re not ­going to give Congress a detailed proposal for how to meet that principle because we think there are a bunch of different ways to do that.”

Charles Schumer of New York, the third-ranking Democrat in the Senate, said the proposal would have broad support in his party and would be a “game-changer” in the tax debate.

“It really works well as a defining principle, but I think it works even better as an actual piece of ­legislation,” said Schumer, a ­member of the tax-writing Finance Committee.

“Let’s draft the language and get it scored. Let’s put it on the floor and let’s have a vote.”

It’s not known how much money the proposal would raise if applied to the current tax code or how many people would be affected.

Senate majority leader Harry Reid, a Nevada Democrat, said this week that 22?000 Americans had incomes exceeding $1 million and paid less than 15% of their income in taxes.

Said Obama: “Middle-class ­families shouldn’t pay higher taxes than millionaires and billionaires. Warren Buffett’s secretary shouldn’t pay a higher tax rate than ­Warren Buffett. There is no justification for it.”

The example that Obama gave during his speech illustrated the difficulty of applying the Buffett principle in practice.
He said a teacher earning $50 000 shouldn’t pay a higher tax rate than an investor making $50 million.

But Obama’s example isn’t as straightforward as it appears.

Under current law, that teacher would have a maximum taxable ­income of $40 500 after subtracting the standard deduction and personal exemption.

The teacher’s federal income tax would be $6 250 or 12.5% of the $50 000 income.

The teacher’s tax rate, though, would be higher if payroll taxes were included. This year, employees at that income level pay 6.65% of their wages and employers pay 8.65%.

The middle-income tax rate would be lower if the teacher took advantage of the specific breaks available to middle-income taxpayers: those for retirement savings contributions and healthcare flexible spending arrangements, and deductions for student loan interest and out-of-pocket expenses of educators.

The tax rate would be even lower if the teacher were married or had children, which would allow for a larger standard deduction, personal exemptions and child tax credit.

A married couple with two ­children can earn as much as $45 776 without paying income taxes this year, according to the Tax Policy Centre, a nonpartisan Washington research group.

As a result of those complexities, legislators trying to write a Buffett rule would have to make some choices about how to define a ­middle-income family’s earnings and tax rate.

They also face complicated arithmetic for higher-income taxpayers. Assuming the millionaire investor received all income from long-term capital gains and dividends, the tax rate would be 15%, the preferential rate for investment income.

That rate could be much lower if the investor took itemised deductions for state and local taxes, mortgage interest and charitable contributions.

It would be higher if the investor also had some wage income, which would be subject to a 35% top rate and at least some payroll taxes.

Writing a Buffett rule into law would require defining income and setting a minimum rate for it, said Roberton Williams, a fellow affiliated with the Tax Policy Centre.

“Every time you set up ­something like this, you’re opening the door for the tax lawyers to come in and get around the ­attempt to raise revenues,” Williams said.

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