Tax Rascal

His Very Own Cross of Gold

Categories: Economy, Featured, Politics, Tax Policy
His Very Own Cross of Gold

Obama’s new deficit plan is as high on populist rhetoric as it is on taxes

The conservative’s dilemma

The American conservative has reached a certain crisis of conscience. With the American economy caught between a rock and a hard place, he must sail cautiously the dangerous waters of economic stalemate and double-dip recession fears, charting a delicate course between two equal and opposite dangers.

On the one side stands taxes, to which he is ideologically opposed, not so much because he objects to funding the government, but because he believes the government’s role should be a small one and because he fears the money, which he could put to work, will just be wasted. On the other side of the debate whirls the engorged federal deficit, an affront to the fiscal responsibility championed by any good conservative, which threatens to sink the entire ship of state.

That a day of reckoning is coming when the federal government will have to balance its books, or get a lot closer to it, no one will deny. And despite the obdurate and enduring opposition of Congressional Republicans to any tax increases on anyone ever, the reasonable conservative might ask himself if raising taxes, in the interest of getting the country’s fiscal house back in order, might not just be the right thing to do.

And then into these waters cannonballs a beleaguered President, spurned on by low approval ratings and a looming election, touting a whole new series of solutions to the nation’s economic woes, first a jobs act and now a plan to reduce the deficit by $3.6 trillion over the next ten years.

According to Obama’s plan these savings will come from a combination of entitlement cuts, war savings, and tax increases, the last of which will amount to $1.5 trillion. These increases are to include ending the Bush-era tax rates for individuals above the $200,000 income threshold and families above $250,000, as well as the intentionally vague ‘Buffet Rule’ which promises to institute some sort of minimum tax on millionaires to ensure they don’t pay less than your average middle-class family.

For his part, Obama is back on the campaign trail. The hopeless passivity that has seemed to dog his administration for the last several months is gone, replaced by strong proposals and a combative tone complete with a veto threat. Rhetorically he has dusted off the old Democratic hat of populist bluster, trumping up class warfare and economic victimhood in an attempt to fire up his base. At the heart of this political gambit is a new battle cry of fairness.

Mirror, mirror on the wall…

Mr. Obama has cast the debate in terms of fairness, stressing the need to make sure everyone pays their “fair share.” My colleague George Macalister presciently touched on the tip of this iceberg in a previous post on Warren Buffett’s initial calls for the federal government to stop coddling the super-rich. Since then, the topic of making the rich pay their fair share has come to dominate talk on reviving the economy and combating the deficit.

While deficit reduction might be the purported goal of these tax increases on the wealthy, the issue of fairness is being employed to justify them. In the speech outlining his plan for economic growth and deficit reduction, the President highlighted alleged sources of inequity in the tax system, saying,

Middle-class families shouldn’t pay higher taxes than millionaires and billionaires. That’s pretty straightforward. It’s hard to argue against that. Warren Buffet’s secretary shouldn’t pay a higher tax rate than Warren Buffett. There is no justification for it.

The reason it’s so “hard to argue against” Obama’s assertion that “middle-class families shouldn’t pay higher taxes than millionaires and billionaries” is because currently they don’t, both in terms of absolute amounts and rates. The problem with all this talk about fairness is that the rich already pay more in federal taxes than the lower brackets.

In fact, the U.S. has one of the most progressive tax systems in the world, and that’s according to the Paris-based Organization for Economic Co-operation and Development. In a 2008 study on inequality OECD researchers stated that in terms of household taxes the United States “has the most progressive tax system and collects the largest share of taxes from the richest 10% of the population.” How’s that for unfairness?

Let’s indulge in some statistics for a moment, statistics the President was happy to ignore when he implied that there exists a structural unfairness built into the American tax code. In the U.S., the top 1% of taxpayers account for 38% of federal income taxes, the top 5% for 58.7%, the top 10% for 69.9%. Let’s talk about tax rates too. Those making over $10 million pay an average rate of 26%, those over $200,000 a rate of 22.2%, those between $100,000 – $125,000 a rate of 9.9%, and those between $50,000 – $60,000 a rate of 6.3%. Are we seriously supposed to believe that this is the gross injustice of our tax system?

Obviously, fairness is subjective. There are some who would call an even more progressive system fair. And there are some, like Herman Cain and his 9-9-9 plan fresh off a victory in the Florida straw poll, who call a system with a flat tax rate for everyone fair. There is no way to define fairness and certainly no way to legislate it.

What is clear, however, is that many of President Obama’s specious claims are simply not supported by data. Furthermore almost everyone acknowledges that the measures he has suggested recently have almost no chance of passing in Congress. One suspects, then, that all this talk of fairness is nothing more than a red herring meant to set liberals salivating and send independents gallivanting off in the wrong direction, It is a largely political move calculated to convey the perception that he is doing something, anything on the economy and set up his Republican opponents, especially front-runner Mitt Romney (valued at something near $200 million) as defenders of the rich. And of course, let’s not forget Obama’s latent desire to “spread the wealth around,” a revelation brought to us by Joe the Plumber’s fifteen minutes of fame.

Capital, Capital!

President Obama’s claims about fairness hinge largely on Warren Buffett, his proverbial secretary, and the capital gains tax. Mr. Buffett is in fact, taxed at an unusually low rate of 17.4%. His situation, however, is special. Though the third richest man in the world with an estimated worth of $47 billion, Buffet only pays himself an annual salary of $100,000. His share of Berkshire Hathaway is valued at $38 billion, but because he sits on it and doesn’t sell, he can take advantage of the low tax rate on long-term capital gains, which was reduced to 15% as part of the Bush tax cuts. This is why Buffett’s personal tax rate is so low. What has also gone largely unmentioned is the fact that dividends are paid out of corporate profits that have already been taxed. So Buffet’s earnings are really doubly taxed at rates of 35% at the corporate level and then again at 15% on his personal return. This puts the actual tax rate paid somewhere in the 25% range.

Let’s get something else straight. Many who favor President Obama’s new proposal have decried the loopholes that allow the rich to take advantage of ridiculously low tax rates. The capital gains tax, which taxes profit that results from investments in capital assets such as stocks, bonds, or real estate, is not a loophole. It is an intentional incentive for people to invest and build businesses, the sort of action that actually creates jobs in the long-term.

In the editorial that has largely sparked this whole controversy, Buffett makes the claim that a low capital gains tax does not in fact incentivize investment. Referring to previous decades when the capital gains tax was relatively high, Buffett wrote:

According to a theory I sometimes hear, I should have thrown a fit and refused to invest because of the elevated tax rates on capital gains and dividends. I didn’t refuse, nor did others. I have worked with investors for 60 years and I have yet to see anyone – not even when capital gains rates were 39.9 percent in 1976-77 – shy away from a sensible investment because of the tax rate on the potential gain.

This is a valid argument and really, I think, the debate the country should probably be having right now. The distribution of income taxes really is fair, even by the most progressive standards. If you are going to make an argument about unfairness, it should hinge primarily on this low rate. Even more important than fairness – at least in my opinion – is the question of economic efficacy. If Mr. Buffet is correct and the low rate does not in fact incentivize investment, raising the rate would strike a blow for both fairness and deficit reduction. In days of such economic stagnation, however, it would be best to think twice about raising the capital gains tax when there is a demonstrated correlation between low rates and capital formation, economic growth, and jobs creation.

But Mr. Obama is not just making an argument about the low capital gains rate. Going even further, he advocates rescinding the Bush-era tax rates for all those making more than $250,000. This decision is puzzling, because it will affect far more than the Warren Buffets of the country. In fact, it will disproportionately punish small businesses.

Small businesses typically file on the income tax level, as a sole proprietorship or S corporation, which means that they are essentially filing as an individual. 75% of small businesses file at individual rates, with 65% of joint filers with an income over $250,000 and 50% of single filers with an income over $200,000 earning business income. What all this means is that about half of those who are subject to Obama’s proposed tax increases are small businesses.

Admittedly, there is a lot of political grandstanding surrounding small businesses and the “Main Street” vs. “Wall Street” divide. Politics aside, however, small businesses are an essential driver of economic growth. They have generated 65% of net new jobs over the last 17 years. They annually account for 50% of non-farm GDP. And they employ $80 million workers, about half of the private sector. These small business owners are not sitting on $39 billion of Berkshire Hathaway shares. But in the crusade to equalize Warren Buffett’s tax rate with that of his secretary these are the people who will suffer.

I don’t think there are too many people who oppose removing loopholes in the tax code that unfairly benefit certain companies that expend massive amounts of money and employ armies of tax lawyers to avoid paying. Last year GE paid nothing in taxes thanks to write offs. Google paid a 2.4% tax rate, as opposed to the normal 35% rate. Goldman Sachs paid only $14 million on its billions of dollars in revenue. This is enough to inspire even the most staunch of tax opponents to take up the pitchfork. Fixing these loopholes is fairness. Slamming small business owners who already pay more is not.

The devil’s in the deficit

But what about the deficit? Have I forgotten about the other side of the equation? No I have not. No one is opposed to closing the deficit gap, and there is even many a conservative who would be willing to pay higher taxes, his “fair share,” to make that happen. But what he fears is that his money not be put toward fiscal responsibility. He fears it will just wind up getting wasted in another of the President Obama’s schemes to jump-start the economy.

It’s hard to justify paying more in taxes when a beneficiary of federal stimulus like Solyndra goes down the tube at a cost of $535 million to taxpayers. It’s hard to justify paying more in taxes when he watched the federal deficit jump from $460 billion in 2008 to $1.4 trillion in 2009, with only $100 billion of the difference coming from tax cuts. It’s hard to justify paying more in taxes when President Obama’s first term has given us the largest Keynesian stimulus in history with a price tag of at least $789 billion (by some estimates as much as $3.27 trillion) as well as a quasi-nationalization of ⅙ of the economy at an additional price of $1 trillion. This is hardly a reliable track record on fiscal responsibility.

An interesting statistic here is that $320 billion of the difference between the 2008 and 2009 deficits was the result of a loss in tax revenue due to the recession. This would suggest that combating the deficit would be made significantly easier by a healthy economy. The best way to close the deficit then is not really in taxing wealth more, but in creating more wealth to tax. As more people are employed and make more money, the government will naturally make more in the way of taxes, even if rates remain unchanged. Instead of funneling billions more dollars into stimulus packages and jobs acts, why not let American investors and small businesses keep their money and use it to create the wealth that’s going to improve the economy and help close the deficit. In such dangerous tax waters as these, the rational conservative would do well to steer clear.


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