Warren Buffett Is Right, the Wall Street Journal Is Wrong

Warren Buffett, the billionaire investor and CEO of Berkshire Hathaway, called for higher taxes for millionaires in a widely-noted op-ed this week. As expected, the Wall Street Journal reacted with a variety of misleading counter-arguments. We conclude that:

1. Buffett is correct that the tax breaks that benefit the wealthy investor class, like the capital gains and dividends preferences, are unfair.

2. The Wall Street Journal’s arguments that these types of investment income are double-taxed are incorrect.

3. Contrary to what the Journal claims, President Obama’s tax plan is in keeping with Buffett’s call for higher taxes on millionaires.

Billionaire Investor Is Right to Call for Higher Taxes for the Rich and End of Breaks for Investment Income

Buffett points out that middle-class Americans are being asked to “sacrifice” as Congress and the new twelve-member “super committee” search for ways to reduce the budget deficit, but millionaires have not been asked to sacrifice anything. He argues that the super committee should ask millionaires to pay at higher rates than they pay today and should also end or reduce special tax preferences for investment income, which makes up most of the income of millionaires.

Citizens for Tax Justice has long made the case that these tax preferences — the special low income tax rates for capital gains and stock dividends, should be repealed entirely.

CTJ offers the example of an heiress who owns so much stock and other assets that she does not have to work. She receives stock dividends, and when she sells assets (through her broker, of course) for more than their original purchase price, she enjoys the profit, which is called a capital gain. On these two types of income, she only pays a tax rate of 15 percent.

Now consider a receptionist who works at the brokerage firm that handles some of the heiress’s dealings. Let’s say this receptionist earns $50,000 a year. Unlike the heiress, his income comes in the form of wages, because, alas, he has to work for a living. His wages are taxed at progressive rates, and a portion of his income is actually taxed at 25 percent. (In other words, he faces a marginal rate of 25 percent, meaning each additional dollar he earns is taxed at that amount).

On top of that, he also pays the federal payroll tax of around 15 percent. (Technically he pays only half of the payroll tax and his employer pays the other half, but economists generally agree that it’s all ultimately borne by the employee.) So he pays taxes on his income at a higher rate than the heiress who lives off her wealth.

What make this situation even worse are the various loopholes that allow wealthy individuals to receive these tax breaks for income that is not really even capital gains or dividends. As Buffett explains, fund managers use the “carried interest” loophole to have their compensation treated as capital gains and taxed at the low 15 percent rate, while the “60/40 rule” benefits traders who “own stock index futures for 10 minutes and have 60 percent of their gain taxed at 15 percent, as if they’d been long-term investors.”

CTJ has found that if Congress simply repealed the preference for capital gains entirely, three fourths of the tax increase would be borne by the richest one percent of taxpayers. (See page 19 of this report for estimates.) The tax preference for dividends expires at the end of 2012 if Congress does not extend it.

The Myth of Double-Taxed Investment Income

The Wall Street Journal starts with the following complaint about Buffett’s argument that his capital gains and dividend income is insufficiently taxed:

“What he doesn’t say is that much of his income was already taxed once as corporate income, which is assessed at a 35% rate (less deductions). The 15% levy on capital gains and dividends to individuals is thus a double tax that takes the overall tax rate on that corporate income closer to 45%.”

Anti-tax ideologues often claim that corporate profits are taxed twice, once under the corporate income tax and then again under the personal income tax when the shareholders receive them in the form of capital gains and dividends. There are several fatal flaws in this argument:

First, many corporate profits are not taxed, as GE, Verizon, Boeing, and many other corporations have demonstrated.

Second, two thirds of those dividends are actually paid to tax-exempt entities like pension funds or university endowments.

Third, a capital gain from selling a corporate stock is not necessarily a form of corporate profit. If stock value rises based on some expectation of a future increase in profits (which a drug company might enjoy after the FDA approves a new product, for example) that does not have anything to do with profits that the company has already received or paid taxes on.

In any case, the capital gains earned outside of tax-exempt plans are not taxed until shareholders sell their corporate stock at a profit, meaning those gains can be deferred indefinitely. Even when shareholders do report capital gains they often offset them with capital losses.

If one applies the logic of the “double-tax” argument more broadly, one would have to conclude that the wage and salary income of ordinary Americans is subject to several forms of taxes that wealthy investors don’t worry much about. For most Americans, income consists entirely of wages and all of it is subject to Social Security taxes and much or most of it is subject to the federal income tax. Then when people spend their income, a great deal of their purchases are subject to sales taxes.

Somehow the Wall Street Journal and its devotees only express concern over taxing income multiple times when wealthy investors are involved.

Ending Tax Cuts for Income Over $250,000 Actually Targets Millionaires

The Wall Street Journal also complains that, “Like Mr. Obama, Mr. Buffett speaks about raising taxes only on the rich. But somehow he ignores that the President’s tax increase starts at $200,000 for individuals and $250,000 for couples.”

But President Obama’s plan does target millionaires. A recent report from Citizens for Tax Justice explains that if enacted in 2011, 84 percent of the revenue savings from Obama’s income tax plan would come from people who make more than $1 million annually.

What is often not understood is that Obama’s plan would leave in place the Bush income tax reductions for the first $250,000 of adjusted gross income (AGI) for all married couples (and the first $200,000 for all unmarried taxpayers).

A married couple with adjusted gross income of $250,001 would pay higher taxes on at most one dollar, and face a tax hike of only 3 cents at most. But even that tiny tax hike would be extremely rare, since almost all couples at that income level itemize deductions. Typically, couples would have to make more than $295,000 before they lost any of their Bush income tax cuts.

Married taxpayers with incomes between $250,000 and $300,000 would lose just one percent of their Bush income tax cuts, on average, under President Obama’s plan.

The Wall Street Journal calls taxpayers with AGI in excess of $250,000/$200,000 “middle-class.” CTJ estimates that in 2013, when the Bush tax cuts are scheduled to expire, only 2.6 percent of taxpayers will have adjusted gross income in excess of the $250,000/$200,000 threshold.

This shows that President Obama is asking too few, rather than too many, Americans to pay higher taxes than they do today. 

Photos via The White House Creative Commons Attribution License 2.0