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Thursday, September 22, 2011

The Tax-the-Rich Truth Squad

Obama: wrong, wrong, and wrong.

President Obama has unveiled his so-called deficit reduction plan.  Besides spending cuts that aren’t really cuts, he has proposed ending the Bush-era tax cuts for individuals making $200,000 (couples $250,000) or more and an additional surtax on those earning a million or more.  The President’s argument for the surtax is that no millionaire should pay a lower tax rate than his or her secretary. (Obama calls this the “Buffett Rule” for reasons to be explained below.)  This is part of a more general claim that the rich need to “pay their fair share.” He denies this is “class warfare,” but only “simple math.”  By taxing the rich, he says, we can raise sufficient revenue to significantly reduce the deficit and debt.

Let’s put the “Tax-the-Rich Truth Squad” on the case and see how Obama’s claims hold up.  We’ll start with the claim that millionaires pay lower rates than their secretaries. This debate started when legendary investor Warren Buffett claimed that the rate he paid on his income last year — 17.4 percent — was about half what his secretary paid.

Defining “Income”

Part of the problem here is in how you define “income” and the relevant “rate.”  Buffett pays himself a very low salary, but earns a great deal of income in capital gains from his speculative activity.  Those gains are indeed taxed at a lower rate — 15 percent — than his secretary’s top rate of 30 percent or more.  The reason the capital-gains rate is so low is that those gains are taxed first at the corporate level — at  35 percent — before being taxed again as Buffett’s income at 15 percent.  In addition, it’s not clear what Buffett included in his secretary’s taxes and income.

In any case, we have aggregate data on the relationship between income and average tax rates.  According to the Tax Foundation, 2008 IRS data show that the top 1 percent of taxpayers paid an average 23.27 percent of their income, with the top 5 percent paying 20.7 percent; top 10 percent, 18.71 percent; top 25 percent, 15.68 percent, and top 50 percent, 13.65 percent.

The bottom 50 percent paid an average 2.59 percent.  So either Warren Buffett is an outlier because so much of his income is from capital gains (which appears to be the case) or he has a terrific accountant whom his secretary should hire.  We might agree that taxes should be lower for everyone, but to claim that the system is regressive, as Buffett and Obama do, is simply wrong.  The Truth Squad says:  “FALSE!”

What about paying “their fair share?”  Defining “fair” and “share” is tricky and subjective of course, but consider this from that same Tax Foundation report: In 2008 the top 1 percent earned 20 percent of all income but paid 38 percent of all total income tax receipts.  The top 10 percent earned 46 percent of all income and paid 70 percent of total taxes.  Seems like more than their fair share.

Percentage of Total Income

Suppose instead we think “fair share” means that people should pay the percentage of total tax receipts that corresponds to their income’s percentage of total income. We can sort of compute this for Warren Buffett.  He paid about $6.9 million in taxes last year, a rate of 17.4 percent. If you do the math, that means he reported about $39 million in income. Total 2010 national personal income (wages/salaries minus transfer payments) was about $6 trillion. So Buffett’s income was about 0.00065 percent of total income. Total income taxes paid by Americans in 2010 was about $900 billion.

Nine-hundred billion multiplied by 0.00065 percent is $5.85 million, hence, Buffett’s “fair share.” Except Buffet paid $6.9 million.  So by that standard, Warren Buffett is overtaxed!  Yes “fair share” is subjective, but these data are strong enough for the Truth Squad to declare: “FALSE!”

Not Enough Money

Finally, would taxing the rich help close the deficit?  The 2009 data show that the slightly more than 250,000 households making more than $1 million earned a total income of $727 billion.  A 10 percent surtax would generate at most about $73 billion, which amounts to a whole 2 percent of federal spending.  This also assumes the rich take no actions to avoid that additional tax.  Taxing millionaires will help the deficit?  The Truth Squad once again says, “FALSE!”

In the end all that’s left of the argument for taxing the rich more heavily is pure demagoguery and a desire to avoid the real solution: reducing the size and cost of government.  The danger here is that in emulating FDR’s Depression-era attacks on “economic royalists,” Obama will repeat FDR’s results: entrepreneurs and investors sitting on the sidelines, afraid to innovate, invest, and take risks lest their hard-earned income be confiscated. Engaging in fact-free class warfare is the last thing we need when private investment continues to lag, keeping the economy in the doldrums and too many people unemployed.

  • Steven Horwitz was the Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University, where he was also Director of the Institute for the Study of Political Economy. He is the author of Austrian Economics: An Introduction.