Buffett Rule Hard to Follow
Making sure millionaires pay more tax than their secretary isn't as easy as it sounds.
Megan McArdle makes a strong case that President Obama’s proposed “Buffett Rule” is much less simple to implement than it sounds.
You cannot build a tax code on the principle that no millionaire, ever, should ever have an effective tax rate lower than their secretary. The tax code covers 300 million people. Rules written to cover that many people, in a complex economy where there are lots of different ways to make money, and some uncertainty as to what constitutes income, will not produce the same result that we would get if the economy were the size of a kindergarten class, and we had an omnipotent teacher charged with making the income distribution perfectly fair. (Though as you’ll recall, even in kindergarten class, there was frequently a lot of indignation about teacher decisions).Just to take one example, what about a millionaire who had a $750,000 capital loss last year, and $1 million in capital income this year. Since you’re allowed to offset past losses against future gains, even a millionaire with a 50% nominal effective tax rate on their capital gains would only pay $125,000 in taxes–50% of the difference between last year’s loss, and this year’s gain. If he pays his secretary decently, he’ll have a lower effective tax rate that she does.Likewise, unless you get rid of the tax-free status of muni bonds, Theresa Heinz-Kerry will continue to have the effective tax rate of a probationary janitor.Now, you could change the tax rules about capital losses and municipal bonds. But this would hurt a lot of people who aren’t millionaires, and dramatically increases the potential cost of investments with lumpy cash flows, as well as state and local infrastructure projects*.
Because the “Buffett Rule” is thus far a talking point or rule of thumb rather than a legislative proposal, we don’t know how the president intends to implement it.
Most speculation is around a Alternative Minimum Tax-like model that simply penalizes those who earn above a certain threshold by eliminating various deductions that they would otherwise be entitled to if it results in their tax burden being below a certain point. I’m not a fan of this sort of mechanism, which strikes me as punitive and lacking in transparency.
In the op-ed that started the conversation last month, Buffett himself made reference to the “carried interest rule,” which treats income earned by fund managers who get a share of profits rather than or in addition to their salary as if it were investment income rather than earned income. For people in the highest bracket, that’s a huge benefit: the money is taxed at a flat 15 percent rather than at the graduated rate, which tops out at 35 percent.
While there may be some plausible rationale for this, I can’t conjure it. For all practical purposes, money earned in this way is functionally earned income in the same way that a sales commission or performance bonus–which are taxed as ordinary income.
My amateur understanding of the matter is that we’re alone in treating carried interest as something special. I’m inclined to agree with Kevin Drum that it’s purely a result of successful lobbying by financial sector interests, who give an inordinate amount of money to candidates of both parties.
Changing this rule and similar ones would raise a substantial amount of additional revenue for the Treasury and do so almost entirely on the backs of very high earners. It’s something that should have bipartisan support.
For that matter, on a rule of thumb basis, the Buffett Rule is appealing. To the extent that the tax code is written in a way that it treats the sort of income that only the well-off can earn more favorably than salary income, we should look at it with a skeptical eye.
That doesn’t, however, mean that they should all be eliminated. For example, while it may be in some sense unfair that a wealthy heiress can park millions of dollars in tax-free bonds and, in a world where interest rates are something other than the near-zero they have been of late, make a lot of money for doing nothing, it’s nonetheless true that bonds are how localities pay for a lot of good projects. Providing favorable tax treatment on the interest is a powerful way to attract that much needed capital. The fact that rich fat cats disproportionately benefit doesn’t change that.
And an AMT-style millionaire’s penalty that effectively taxes these tax-free bonds would surely divert these to more lucrative investments.
The bottom line here is that crafting a tax policy that’s fair, efficient, and progressive is actually quite difficult. The Buffetts and Kerrys of the world have great accountants who will figure out how to exploit the loopholes of any system we devise.
This is the problem with trying to make public policy based on anecdotal cases. In a nation of 300 million people, there are always going to be outlier situations like the supposed story about Buffett and his secretary. Trying to craft tax policy based on those atypical situations is both difficult and, often, counterproductive
Megan shouldn’t really open w ith a straw man like the one below, if she wants to carry along almost-aligned readers:
The rule, whose details we have not seen, is probably not written to insure “no millionaire, ever, should ever have an effective tax rate lower than their secretary.” Lol, as if there is a place on the form to say “insert your secretary’s pay here.”
Exactly.
Whoops. If this rule does not move the top marginal rate, and only catches some number of people who skate under that rate, how is it “on the backs” of high earners, in anything other than your own “class warfare?”
(I think bottom line – we have a close in “loopholes” and the right-blogosphere has an underlying policy “you can never start with the rich.” It is “tax the poor first” as party policy. I mean, if that’s it, wear it.)
@john personna: I don’t mean it in any pejorative sense, simply that the burden would fall disproportionately on those earning a lot of money.
I use the term “class warfare” in a very narrow sense: demonizing high earners to score political points with those resentful of their success. There are plenty of rationales for progressive taxation, which I in the main support. But I’m very leery of political rhetoric aimed at making people feel entitled to take other people’s money away because they’ve been more successful.
McArdle blather aside, I would really like to see intelligent people open up a serious conversation about why wealth should continue to be privileged over work.
That’d be a great roundtable idea for the OTB contributors.
@john personna: BTW, I don’t think Megan is attacking a straw man. As noted in my post, the Buffett Rule is currently a talking point. So she’s attacking the talking point to show why, while it sounds good on the surface, it’s actually really complicated even at the level of rule of thumb.
@Rick Almeida: I’m not sure what “wealth being privileged over work” means. As I’ve noted many times, I’d prefer a system that taxes consumption, especially luxury consumption, over one that taxes income. But there are good reasons for treating interest on savings and stock dividends differently than wage income, because of the time value of money, then nature of risk, and the need to incentivize the injection of capital into the system.
@James Joyner:
I should note that we agree on core philosophy, apparently. That is that a progressive tax code is both fair and necessary. It looks like we pretty much have one, with just a regression at the very high end.
The “Buffett” rule is about correcting that regression.
The question for the week has been, do we support that idea? It is just the idea at this point, with details TBD.
From my perspective, the right-blogosphere has given us (as I’ve said) 1001 reasons not to support the idea, even before (possibly flawed) details emerge.
(And, the whole “let’s close the loopholes instead” thing has really seemed like a deflection, rather than a serious policy proposal. Heh. The only time we hear “maybe we should change ‘carried interest’ instead” is in this context. It sure as heck is not a pending House bill.)
James,
“It’s something that should have bipartisan support.”
Umm, why? Do you have any reason to believe raising taxes on the wealthy will get any non-trivial amount of Republican support?
Doug,
“This is the problem with trying to make public policy based on anecdotal cases. In a nation of 300 million people, there are always going to be outlier situations like the supposed story about Buffett and his secretary.”
After a decade plus of anecdotal cases (real or imaginary) driving efforts to eliminate the estate tax, I am not sympathetic at all.
“I use the term “class warfare” in a very narrow sense: demonizing high earners to score political points with those resentful of their success.”
Class warfare works in only one direction? What is the phrase that describes demonizing the poor as justification to gut the safety net (other than “business as usual”)?
@James Joyner: Your definition of class warfare is conveniently narrow. If calling the working poor “lucky duckies” because they don’t earn enough to pay federal income taxes isn’t class warfare, what is it?
(As an aside, some consider tax free muni bonds as a historical mistake. On the supply side, maybe muni debt should not be subsidized by federal preference. On the purchaser side, well it descends into the whole “unearned income”‘ versus “retirement accounts” mess. We have a skitzo attitude, essentially. Unearned income is bad, unless you do it in specific programs offered by the government-financial complex.)
@Moosebreath: “What is the phrase that describes demonizing the poor as justification to gut the safety net (other than “business as usual”)? ”
Libertarianism.
(James, many of our shared interests covered here)
JP doing yeoman’s work here, as usual.
Why, exactly, is closing a loophole bad? Oh, because that loophole impacts the rich, which is bad.
JP has it right: our tax system is designed to be progressive. Most of us agree w/this. At the top end, currently, it regresses some. Fixing this would be good, IMO, but all you I see is post after post ripping on Obama for trying.
@john personna: There are two separate issues at work here.
First, most of us were simply unfamiliar with the “carried interest” business. My incorrect understanding was that it was simply a matter of people being paid with stocks (as in the glory days of dot.com) and earnings from them being treated as investment income.
Second, much of both parties have been captured by the financial sector for reasons Drum outlines in the linked piece.
Third, but relatedly, my party has been captured by the Grover Norquist “taxes can never be raised, even by eliminating loopholes we all agree are stupid” ideology. This aspect of Norquistism is relatively new and fundamentally different from the “cutting taxes is always good” philosophy that’s been with us since at least Ronald Reagan.
Simply removing the cap on the Social Security tax would go a long way towards bringing back fairness to our tax code.
@James Joyner: The Buffett editorial talked about his situation and how he as an investor was gaming things, but he also was writing about the seperate issue of 88 out of the 400 wealthiest Americans report “no income.”
The last I looked many CEOs at publicly – traded companies receive no wages, but do receive restricted stock or stock options. Restricted stock is not reported to the IRS until the restrictions are lifted or an election is made. Stock options require some sort of vesting event I believe. These are not purely tax avoidance measures, they are intended to promote alignement of excutive interest with the shareholder, while avoiding problems of insider trading.
Many are treating capital venture as a sure thing. It is not. As James touch on in his main post, sometimes people lose and lose big. Liberals though will only mention when they make big profits. Liberals also leave out things that don’t support their agenda for example profits of a company are tax once already before they even make it out as dividends.
If demonizing one class and pitting other classes against that class isn’t promoting class warfare then what is?
To help out here is the definition of class warfare. It refers to a class conflict, or tensions between members of different social classes.
Promoting it would be promoting class conflict or promoting tension between members of different social classes.
Can regular Americans who lose their jobs use their lost income to offset future income (if they can find another job)?
Or is this just a privilege accorded to unearned income?
my addition is emphasized.
this back and forth is why we are where we are with the tax code. perhaps a reset is needed. i don’t see that ever happening though given the inability of the so-called republicans to negotiate and compromise on anything…even the things they actually agree with.
@PD Shaw:
No. This did not relate to his investment earnings. This related to his management share.
Note that last sentence.
I guess “carried interest” is using the word “interest” in the old sense. You can have an “interest” in an outcome based on investment, or based on services rendered.
Now, separately there are questions of investment, and capital gains, and how to manage them, but remember that any “Buffett rule” is relating right back to Buffett’s carried interest.
@Wayne:
Managers earning “carried interest” do not have capital at risk for that “interest.”
They may have capital holdings, but they are treated separately in the tax code.
@Doug Mataconis:
If you use singular or isolated anecdotal cases than it’s cherry picking. However, if you used samples, here and there, like they do in polling, then it can be representative. Buffett, using his own secretary, though, is hardly an example of a representative sample to be used in the creation of such a broad fiscal policy, effecting a larger swath of people.
@john personna:
I don’t know where you get your info from, however, the republican party line that I read is that they want the tax flattened to merely include those who pay no income tax at all, not to tax any one class ‘higher.’
When a person pays not one cent in income tax, why should they care how much higher the tax rate is on others? It ‘s lopsided to create a policy where a 100% of the people can register an opinion and/or vote for something, when it adversely effects and changes the lives of a little over half of them, leaving the rest of them to lose nothing and most likely benefit more from it.
Productive workers are not sheep. Eventually, many will tire of being the designated charitable organization, who is spoken poorly of by those who are on the receiving end of his labors. It becomes a lose-for-one and win-for-the-other society, which does not function well over the long haul.
If demonizing one class and pitting other classes against that class isn’t promoting class warfare then what is?
So demonization of the poor (welfare queens, lucky duckies, parasites, etc) and various other undesireables (“union thugs”) isn’t class warfare. That’s just truthtelling.
When the Left shoots back (rather tamely, in comparison), it’s time to clutch your pearls, eh?
In this world there is always a need for a scapegoat — someone or something in which blame can be readily attached. For the democrats, it’s the republicans/libertarians. For the republicans it’s the democrats/socialists. For poor and rich people, it’s each other. For children, it’s their parents. For parents, it’s oftentimes their children or other family relatives. And on and on it goes.
However, often, with responsibility so easily disposed of in another person’s back yard, we rarely go to ourselves, to see what parts we own which either contribute to the success or failures in our own lives. If more people did that, I think there would be far less redistribution of blame going sideways, as so often seems the case.
Does anyone find this line of defense particularly ironic or is it just me? First o all this is a fundamental aspect of our system of government — or at least that 100% of the of-age people can vote for someone who will vote on these matters.
But beyond that, it seems to me to be a classic example of what social conservatives have been doing for years (Jan, I know that you don’t consider yourself one of them).
But beyond all the talking points, Jan, how do you stand on closing the “carried interest” loophole at the center of some of this debate? It seems that many critics quickly skip over that issue as something that makes policy sense.
@ponce: As someone who earns over the maximum and caps out of Social Security every year, I don’t have a problem with raising the cap and paying on every penny of earned income I have. I already do with the Medicare tax. However, if I’m going to pay more in, I should get more out in the end. Under current law, the monthly benefit is capped, which has been the rationale for capping the amount of income subject to Social Security withholding.
As long as I pay in more, do you support removing the benefits cap? If not, why?
@Rob in CT:
Don’t forget that those “lucky duckies” and “welfare queens” are dependent of those with money. Without the money of those that have it, who pay it into the federal coffers in the form of taxes, the government wouldn’t have funds to disburse to those less fortunate. If someone is putting a roof over my head and food on my table, I’m not going to bitch that they should do more. Instead, I’d be grateful for what I did get.
@mattb: @mattb:
I have never heard of the “carried interest” loophole until recently, so really don’t have anything to comment on about it. However, loopholes, in general, merit scrutiny, in closing which would not only generate more revenue, but also simplify the way taxes are calculated. I think there is quite a bit of support for this on all sides of the pollitical spectrum.
@Moderate Mom:
This reminds me of a news segment I saw dealing with food stamp recipients. There was a video of two people, man and woman who were at least 350 pounds a piece, pushing a shopping cart full of groceries purchased with food stamps. They were smiling, and obviously well fed, their major concerns about getting these food subsidies being that they needed more, because what they had wouldn’t last long.
This was network news, CBS, doing the piece, with so much irony on display.
@Moderate Mom:
Good questions!
As long as some/most of the extra money goes towards…solidifying Social Security, why not?
On a side note, if Obama and Congress do nothing, the capital gains tax will be increasing from 15% to 20% soon anyways…
@jan:
OK, wait for it …
So how many posts did you make attacking Buffett, the Buffett Rule, and “class warfare,” without understanding what he was talking about?
How many posts did your fellows make?
@Moderate Mom:
Say someone exactly like you in every way had the same career and withholding path, until a tree fell on her, and she had to start collecting the disability.
Should she (you in a parallel universe) only get what she paid in, or are you willing to share?
@jan:
The “why do fat people need more foodstamps” is a big simplification of a rather huge socioeconomic issue. I’m happy to admit that there is food stamp fraud going on. That said, it’s also true that the market is saturated with low-cost processed, sugary foods. The fact is that in most urban centers, eating healthy costs a lot. At least in our area, most of the supermarkets have left the highest areas of poverty and been replaced by corner stores which don’t carry things like fresh produce.
That said, I do see a lot of people using WIC/Foodstamps at our local public markets. So there are many people that are in the program and able (and willing) to avail themselves of those programs.
Which gets to a bit of a difference in ideology. Liberally minded people are often more concerned with how to increase the availability of these resources, I then to think that Conservatives focus more on the issue of willingness (and typically link moral judgements to it without seriously wrestling with the issues of availability).
@john personna:
John, totally agree with the fallen tree point. That said, one aspect of fixing SS in my mind is to switch it from the image of the program as money deducted and kept in trust for you to that of being a form of social insurance.
BTW those concerned about SS cheats or dubious claims have most likely never been to SS court. Its pretty incredible how hard it is in many cases to receive benefits before retirement (and I’m not suggesting that is necessarily a bad thing).
@john personna:
So, no one can disagree (‘attack” is your added dramatic wording) with Warren’s Buffett’s position of taxing the rich, the Buffett Rule, named after said man (who is protesting the billion dollars the IRS says is owned them), or class warfare unless they thoroughly understand the ‘Carried Interest’ loophole???
Get real!
@jan:
Exactly. It was actually a sad cycle in blogdom when so many spilt so many characters on the webs, attacking Buffett, without understanding him.
@mattb:
The 350 pound people carting off groceries paid for by food stamps example was brought up as symbolic irony of the government’s lack of oversight in it’s intervention in people’s life.
On one hand we have Michelle Obama out there curbing obesity problems with various government food regulations in the offering. Then we have government, in the other corner, doing their public service announcements encouraging people to get on food stamps. Put them together and we have two obese people, wishing they had more food stamps given out by the government, to aid and abet their appetite for too much food.
It is a circular observation, which tends to conclude that sometimes it would be far better if the government just stayed out of micromanaging people’s lives.
I also am aware that in the demographics of the poor, there is a higher propensity to go for cheaper, higher carb foods and fast foods. However, I don’t think you can always validate behavior by lack of easy access or finances, as there are also people in that same demographics who seem to escape the pack, finding and eating healthy foods that are within their fiscal means.
With all the box and bargain stores available, like Fresh & Easy, Costco, even 99 cent stores carries cheap fresh food these days (my husband goes there), the excuses seem to dwindle, if one just goes to a little effort to find these sources.
@jan: What Jan is trying to say is that the law, in its infinite majesty, equally forbids both the rich and the poor to sleep on the sidewalk.
@jan: You were the one who was saying that we should embrace experts who “know” what they are talking about. It seems fair to expect that you should hold yourself to the same standard.
The “Buffett Rule” (and the editorial) were largely based around the Carried Interest loophole. And admittedly its complex and taken a number of people sometime to wrap their heads around it (and in the process has changed some viewpoints). But rather than trying to do that work, you charge in and immediately dismiss the concept.
Frankly. that’s been the problem with a number of you opinions on topics that have a basis in actual fact. You copy and paste articles without really understanding them and then don’t respond when we point out the articles don’t say what you say, you often punch of the discussion.
Which doesn’t really make it a discussion in the first place — there typically has to be listening on both sides for that to take place. I fully admit that my opinions change and I’m happy to admit when I’m wrong.
But the one thing I really try not to be is willfully ignorant. It would be great if other people tried to apply the same rule before they posted on a topic.
@jan: What Jan is trying to say here is that since some people on food stamps get fat, it’s much better that the government let them all starve to death.
Ok now its like you’re just trying to annoy me.
1. My point wasn’t an issue of too much food. It was a general lack of access to healthy food.
2. You’ve managed to take two anecdotal examples and use them to tar and feather an entire class of people. You conviently miss my mentioning of all the people I have seen usinbg food stamps to buiy healthy food at the public market (oh and by the way in doing so helping to sustain smaller scale agreculture here in western NY — I know a lot of farmers who are very happy that those people are getting the assistance.
3. Further, you’re taking up the tired trope that the government should advertise the programs that it puts out to help people (and of course from there it’s an easy hop, skip, an jump to Obama — that marxist — WANTS people to become more dependent on the government). Of course this asinine position misses the fact that due to the present economic state, more and more people do need help with food. And many of those people are the very ones who have been paying into the system for quite some time. So why shouldn’t the government reach out to them?
Jan, you claim not to listen to Rush. But I cannot fathom that you are not listening to some local rightwing radio (or perhaps its just the purely partisan sites that appear to be all that you read). But the fact is that you’re really good at recycling talking points rather than critically and honestly thinking about them.
@jan:
I was careful in my post NOT to remove some level of personal responsibility. It has to b there.
Too bad you are not fundamentally honest enough to ask yourself why a vast majority of people are not able to escape those scenarios. As I said, conservatives like you use personal responsibility to make fundamental moral judgements.
Why not just come out and say that those people are weak and their misery/poverty/problems are all their own faults. Because it’s clearly what you appear to be advocating.
Likewise your success is due to the fact that you’re a hard worker and a good person right? Because this is America where our exceptionalism is based on the fact that good people always prosper (unless of course they’re democrats and then they were promoted above their position or got there due to affirmative action).
God I hope that karma never comes around for you.
@mattb:
No, I think people have a better chance of making better innate decisions for themselves if they are not enabled too much, at the get go.
What you unintentionally do, is to start out thinking people don’t have the capacity to make good decisions. Consequently, you think more individuals need outside help to survive. And, where we differ is that I first want to give people “the benefit of the doubt,’ that they have better judgment if given at least half a chance to express it.
It’s the same as parenting. If you helicopter over a child, over-think what is best for him/her all the time, they never develop skills or even confidence that they can live life without you.
Poverty, all unto itself, does not necessarily make people weak and/or miserable. Just like being rich and successful does not guarantee one strength and/or happiness.
When one really delves into these rich/poor discussions, it seems to me that it is the social progressives who have more misplaced judgment, regarding what other people are or are not capable of achieving. An avalanche of pity can be just as much a disservice to those in need as someone being too hard-nosed and closed-minded. It’s all about finding an unbiased balance in assisting others, lifting people up and out, rather than keeping them down and bound by too much help.
LTCG used to be a preference item for AMT. If it’s restored, then we’ll have the rule. Simple enough, McCardle’s attempts to conjure complexlity out of thin air notwithstanding. She’s right that there will be situations where someone may pay less due to NOLs or capital loss carryforwards, but I don’t think the goal of the Buffett rule (I hate that phrase; we need something better and less trademark-ish sounding) is to eliminate things like NOLs or capital loss carryforwards.
It’s not terribly dissimilar, actually. To analogize, carried interest is where the company pays you in stock, you get to value it at zero for tax purposes when you get the stock, and then all future income from the stock is qualified dividends taxed at 15%. The real issue here is how we value that initial transfer of stock. Saying it’s zero is ridiculous on its face (I’ll happily buy someone’s carried interest for a buck, but I don’t think they’ll take me up on that offer), so the tricky bit is how to value a piece of investment property for which no market exists and is therefore hard to value.
@jan:
I don’t disagree with this at all. And again, I’m not advocating for vacating all personal responsibility. What I take issue with is the following (mostly) strawman:
Surely some have… but the problem is that they are mirrored by people like you on the conservative side who uncritically repeat ditty’s like this:
Which on the surface is entirely true. But it gets used as a balm to prevent you having to seriously consider the next point that while poverty does not necessarily make people weak or miserable… it does tend to place them in a social position where they do not have access to the same tools for success that people who belong to middle and upper middle classes have.
Of course to admit the second half of that would be to seriously address wide reaching and systemic inequalities within our system. And from listening to and discussions with a lot of conservatives, I have yet to see ANY interest in that discussion.
Hence for example… white conservatives who say “my family came to the US after the Civil War and had no part in slavery, so why should be blamed for racial inequalities? Especially since my family came over here poor…”
This point fails to recognize the historic, post slavery, privileges that came with being white (and while better, to a large degree, still exist). It also imagines that we all start with nothing. It’s Weber’s Protestant Ethic over and over again (and the spirit of American Capitalism).
Again, does that vacate personal responsibility? Hell no. But it needs to be seriously acknowledged and wrestled with in order to have a serious debate.
My continuing problem with your posts Jan — such as the ones I critiqued above — is that while you claim to be (maybe even think that you are) open to “these ideas” your posts continually dismiss them with little “just so ironies” that not only ignore real facts (that shake your position) but reinforce the very beliefs that you claim not to be taking.
Perhaps your just ignorant of what you’re doing. But given the amount of times that people have offered real criticism and you’ve ignored it (or not responded to it) I’m beginning to think you are simply willfully ignorant and you chose to ignore anything that might upset your ideological pure little house of cards.
No, you need poverty and cold weather.
“Since you’re allowed to offset past losses against future gains”
So there is less risk and more reward (The rich stay rich and the poor stay poor)…….did you really think the 3rd richest man in the world was looking out for us little guys? Or is he just trying to keep his wealth…..so what about a capitol gains tax for gains over $100,000? Oh thats right, buffet makes most of his money through capital gains….so obviously that would be off the table. Sounds to me like a Buffet sceme to go from the third richest to second or first richest if you ask me…