Don Roach: The Buffett Rule is Really the Buffet Rule

Wednesday, February 29, 2012

Don Roach, GoLocalProv MINDSETTER™

 

Rhode Island’s own Sheldon Whitehouse has introduced legislation to implement the Buffett Rule. For those of you that don’t know what that it is: The Buffett Rule is a tax proposal made by President Barack Obama in September 2011. It is a plan to increase the effective tax rate for U.S. citizens with an annual income of $1 million or higher.

Warren Buffett complained that his effective tax rate was lower than that of his secretary and he didn’t think that was fair. Buffett recently spoke in favor of the Whitehouse’s proposed legislation saying, “I’m delighted to be identified as a supporter of S. 2059… I have no problem endorsing any large step in the direction of greater fairness in the Tax Code. … Thanks for what you are doing for our country.”

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Capital Gains Taxes – An example

The alleged unfairness Buffett is referencing is the lower tax rate for capital gains versus the tax rate for earned income. Think of it like this, you are taxed at a higher rate for wages earned at your place of employment versus earnings through investment. People tend to call the latter passive income with your money working for you rather than you working for your money. In terms of investing, this is one of the rules financial planners tell young adults entering the workforce – pay yourself first. The thinking goes that you always will have to pay ‘the man’ or in this case the government, but you should always invest in yourself. Why? Because if you don’t, who will? And when you are unable to work how will you survive?

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In theory, capital gains tax, in my opinion, acts as a double tax. We’ll save that conversation for another day though and for now let’s look at how capital gains tax works in general. Let’s say one year Buffett earned $1 million through his work. He didn’t spend it all and saved a portion of it. The IRS taxed him on all of it at the time he earned it. Thankfully, he had some leftover and decided to invest in that portion ($200k). The following year, his $200k earned a 10% return and he had a total of $220k to reinvest the following year. The IRS taxes him on the $20k income he earned through his investment. The tax rate on the $20k is less than the tax rate on the original $1 million Buffett earned, as the example goes.

Whitehouse wants more of your money

Whitehouse and Buffett want to increase the tax rate on capital gains making it simpler. Whitehouse recently said:

The structure of our bill is simple: if your total income—capital gains included—is over $1 million, you calculate your taxes under the regular system. If your effective rate turns out to be greater than 30%, you pay that rate—the same rate you would pay without the bill. If, on the other hand, your effective tax rate is under 30%—like Warren Buffett’s 11%—you would pay the Fair Share Tax. [...]

This bill would simplify taxes; discourage exotic tax dodges; reduce the deficit; and bring fairness and common sense to our tax system. There are lots of advantages that come with an enormous income, and that’s great because America thrives on capitalism and we all love success; but paying a lower tax rate than regular working families should not be one of those advantages.

What’s fascinating about Whitehouse’s logic is that he’s ok with people paying more than the 30% threshold but not paying less. That’s craziness! Make no mistake the tax code is a minefield that keeps CPA’s everywhere gainfully employed and the rich are most able to pay for their services and take advantage of the rules. However, lower income earners have lower tax rates that offset the loopholes needed by higher income earners. Also, in gross dollars higher income earners pay much more than you, me, and our neighbor down the street.

Buffett probably pays more in tax than the average worker makes in a year. In fact, the government wants more Warrant Buffett’s because even if capital gains is taxed at a lower rate the gross dollars collected is far and away greater than lower income earners.

It seems that Whitehouse and supporters of his bill are looking to make a buffet out of the income of rich people and call it a fair tax plan. They’d like a whole lot of their earned income, with a side of their investment income, and the ability to come back for seconds, thirds, and that final trip you know you’re going to feel in the morning. I wonder what’s for dessert.

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The answer is reducing spending, not increasing taxes

Whitehouse’s thinking is out of step with the financial issues we’re facing and Buffett’s offer, while commendable, will not solve our economic problems. As rich as Buffett is, he cannot singlehandedly bridge the government’s budget deficit. And even if he did today, the systemic problems within government spending won’t be solved by a one-time injection of funds. Instead, there needs to be a policy shift.

Whitehouse’s proposed shift is to increase the government’s revenues by increasing taxes. That’s one way to attack the problem, but any good businessman knows that you need to address expenditures or your revenue increased will be offset by increased spending. Obama and Bush before him haven’t demonstrated an ability to reduce government spending and that is the KEY issue facing our government. Spending must be reduced and we need to find an equilibrium wherein we are spending within our means. Anyone telling you that’s not the main issue has their head in the sand.

And unlike Home Town Buffet on Route 2 in Warwick, even the pockets of the very rich can and will run dry if tax plans like Whitehouse’s are implemented. And what’s fair about that?

Don Roach is a member of the RI Young Republicans. Comments and questions can be directed at [email protected].

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