Warren Buffett famously found in 2007 that his own marginal tax rate was below 20% while the average of his employees exceeded 30% – and that is still true. For some ultra-rich Americans, their tax rate is well below 20% today, while 18.5 million ordinary Americans face a tax rate of nearly 40%.
All of this continues amid all of the changes in US tax policy proposed by President Joe Biden – a persistent violation of what the White House Obama called the “Buffett Rule” in 2012 – that those who make millions shouldn’t get a lower rate should pay than those who make thousands.
Buffett, a centrist, suggested a simple solution: an annual income tax with no gaps of 30% on incomes between $ 1 million and $ 10 million and 35% on incomes above. Buffett’s target for such taxes is clearly the ultra rich, people like him, from hedge fund managers and celebrity CEOs to top athletes and entertainers. This simple suggestion has yet to be implemented – and Biden is not proposing it.
Senator Elizabeth Warren (D-Mass.), A progressive partisan, has proposed an annual property tax of 2% for the $ 50 million cohort and 3% for the billionaires. While this is bold and novel compared to America’s traditional income tax, it wouldn’t raise angry fairness objections in the vast majority of Americans. Even some billionaires support it. But Biden doesn’t suggest it.
Instead, Biden suggests increasing the highest personal rate for annual income over $ 400,000 from 37% to 39.6%. This threshold is well below any idea of the ultra-rich. Additionally, it’s below $ 440,000, a current breakpoint for higher capital recovery rates. $ 500,000, a number Buffett mentioned when supporting Obama’s reversal of Bush’s tax cuts; or $ 540,000 including the top 1%.
Why did Biden abandon the simple targeted approaches of Buffett and Sen. Warren? Billionaires and other ultra-rich people are powerful, albeit a minority, and taxes like Buffett or Warren would be unstoppable without loopholes. Biden’s political calculation is to portray such proposals as extreme, which makes his proposal appear moderate. Under this ruse, the ultra-rich win while millions of ordinary people lose.
Another lingering flaw in federal tax legislation that the Biden Plan continues is the ignoring of large regional differences in the cost of living. In addition, a single national tax rate ignores the different levels of state and local taxes across the country. This is a particularly damaging oversight after the Trump tax law amendments revoked their longstanding federal tax deductibility. The Biden plan does not address such shortcomings.
Part of the reason the elite pays less than ordinary Americans is because of the many loopholes politicians fill in tax laws. The most notorious of these concerns the income of hedge fund managers. They work hard to provide financial services to their customers for a fee. But instead of treating these fees as ordinary income that is now taxable at up to 37%, they magically explain that these fees are actually capital gains (so-called “interest income”). Such capital gains have been treated at lower rates for 100 years, now around 20% for high earners.
Buffett has strongly advocated the elimination of interest income, which converts labor into capital for tax purposes. The Biden Plan again shies away from facing this extremely rich trick. Instead, the Biden Plan would reduce the incentives to do so by applying the same 39.6% rate to both ordinary income and capital gains for anyone reporting income greater than $ 1 million. This may sound good on paper, but it will only partially hit the heart – not the ultra rich – but the upper middle class: Many savers considering selling stocks to buy a bigger house face double the tax burden .
Biden’s blunt proposal overlooks the many reasons why US capital gains and revenues have been treated differently for the most part over the past century. For example, capital gains are fully taxed, while capital losses are not fully tax deductible. Capital gains are not adjusted for inflation to reflect their real value, but rather on nominal price increases, and capital gains received by shareholders have already been taxed once on the profits of the issuing company with which they were earned.
Biden’s alignment of capital gains and income appears to be aimed at reducing the incentives the elite have to classify their income as capital gains. But while this clearly makes sense with carried over interest earned by a small minority of powerful hedge fund managers, it makes no sense to the millions of Americans who both work and invest. For fund managers, they may not welcome such a reform, but by avoiding being addressed directly, they preserve other loopholes.
One final perversion brings us to an investment hour. Any capital gains tax, especially a higher one, increases the value of a buy-and-hold investment philosophy. While Buffett generally pursues and supports a superior investment strategy, there are times when even the most patient investor makes a rational decision to sell an investment. A high capital gain rate, on the other hand, is a major deterrent.
Politicians across the aisle have recognized Buffett’s practical wisdom when it comes to tax policy. After all these years, they should finally act on it.
Lawrence A. Cunningham is a professor at George Washington University, longtime Berkshire Hathaway shareholder, and editor of The Essays of Warren Buffett: Lessons for Corporate America since 1997. For updates, including an invitation to its exclusive webinar during Berkshire Hathaway’s 2021 Annual Meeting, sign up here.
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