Taxing problems for the rich

Warren Buffett has a lot to answer for.

Not only has he created an army of copycat investors who like to sprout lines about catching gold in buckets, but now he’s gone and ruined it for rich people everywhere by suggesting that governments need to extract more tax from their down-trodden wealthy citizens.

And that’s exactly what’s happening.

The Greek parliament this week passed an emergency property tax in an effort to help bail out the country’s debt-ridden economy. The tax is based on the size of your property.

Alfredo Perez Rubalcaba, the Socialist candidate for Spain’s general election, is promising to whack the rich as part of his platform and in India Home Minister P. Chidambaram has also declared that the wealthy should be prepared to carry a higher tax burden.

In Australia we are about to hold a Tax Forum where the issue of personal tax rates are likely to be high on the agenda.

Ahead of next week’s government-sponsored event we’ve had charity group Uniting Care calling for super concessions to be cut for the wealthy while other bodies are likely to attack property taxes that are seen as helping the wealthy.

In the past week we’ve also seen the Australian Taxation Office form a new internal group to improve the way it targets the wealthy.

But the biggest action has taken place in the United States, where last week US president Barack Omama announced what he’s calling the Buffett rule after Buffett’s complaint — yes, he complained — that he paid less tax than his secretary.

“Any reform should follow another simple principle: Middle-class families shouldn’t pay higher taxes than millionaires and billionaires. That’s pretty straightforward,” Obarma said in a speech last week.

“It’s hard to argue against that. Warren Buffett’s secretary shouldn’t pay a higher tax rate than Warren Buffett. There is no justification for it. It is wrong that in the United States of America a teacher or a nurse or a construction worker who earns $50,000 should pay higher tax rates than somebody pulling in $50 million.”

When you hear it like that it is pretty hard to argue with, but that hasn’t stopped an army of critics doing just that.
Predictably, the Republican Party slammed the idea, with presidential hopeful Mitt Romney declaring “higher taxes mean fewer jobs – it’s as simple as that”.

A number of commentators have suggested that Obama and Buffett’s central premise —that the rich pay lower taxes than middle and lower class workers — is wrong. Some have also backed the Republican take that increasing taxes could stifle provide a disincentive for employers.

So who’s right? And could other governments seize on the Buffet/Obama theme and start taking aim at the wealthy? A bit of number crunching and some examination of tax regimes in other parts of the world is necessary.

Buffett, Obama and the numbers

Buffett’s original New York Times opinion piece, published in mid August, doesn’t actually mention his secretary. But it does say that Buffett’s tax burden was 17.4% of his taxable income, compared to an average tax rate of 36% in his office.

Exactly how those stats feed into Obama’s plan isn’t clear because Obama’s plan is extraordinarily vague at this stage. All the White House will say is that ”No household making over $US1 million annually should pay a smaller share of its income in taxes than middle class families pay.”

Other than the threshold of $US1 million a year there are no firm numbers to go on and certainly no detail on whether Obama plans to change America’s top tax rate, which is 35%.

That lack of detail has meant journalists and experts have attempted to fill the gap with their own stats, most of which have a similar message — Obama and Buffett are wrong.

On the Time website Stephen Gandel cites IRS data from 2008 (the latest ?gures) that show Americans who had income of a SUS1 million or more that year paid an average tax rate of 23.3% in terms of federal taxes, compared with the average American, who paid an average rate of 13.6%.

Washington Post reporter Glenn Kessler cites figures from the Congressional Budget Office released in 2009, covering 2006, which show the top 1% of American earners (minimum income of $US332,300) had an effective tax rate of 31.2%. Those with incomes of $US47,400 to $US71,20O had an effective tax rate of 17.6%.

But there is a wrinkle. While the top income tax rate is 35% capital gains tax paid on income from investments is just 15%, having fallen from 28% to 20% in 1997 and then to 15% under George W. Bush.
It is that very low capital gains tax rate that helps rich people like Buffett and the billionaire investors who clog the Forbes billionaire list to reduce their average tax rate so much – sometimes well below that of their secretaries, as is the case with Buffett.

Solving the problem

While Obama’s “Buffett rule” looks to be more of a political initiative than an economic one given the lack of detail, the problem their pair have identified remains — given the current state of the US economy (and indeed economies around the world) it does seem reasonable to rework the tax system to increase the burden borne by the wealthy.

But how to do it?

Obama’s plan suggests two methods – increasing income tax rates or increasing the capital gains tax rate. There are pros and cons for both.

There would appear to be room to increase capital gains tax, although some, such as media baron Steve Forbes, have argued strongly against it, arguing that it could discourage investment and risk taking.

”The fact of the matter is … you punish people who take risks – remember, most new ventures lose money,” he said in an interview last week.

But Warren Buffett is one who has pushed for the capital gains tax rate to rise and rubbished those suggestions.

”l have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9% in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain,” he wrote in his New York Times piece.

“People invest to make money and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then – lower tax rates and far lower job creation.”

The other option is to increase income tax rates. They could be allowed to rise naturally if temporary cuts made by George W. Bush are allowed to expire -these were supposedly designed to stimulate business and job creation, so it is hard to mount an argument that they have worked.

But several millionaires who lack the billions of Buffett have attacked that suggestion.

A story on CNNMOney quotes Leigh Bortins, owner of a business selling home-schooling education curriculums and providing seminars for families.

She makes profits of $1-2 million a year, so would likely be hit by Obama’s “Buffett rule”.

But because of her structure she pays tax at personal rates and argues that higher income taxes would hurt her ability to employ more workers.

According to Steve Forbes the answer is a flat income tax rate accompanied by the abolition of all tax deductions.

The wealthy agree – according to research by US firm Spectrum Group 44% of those making a $1 million or more a year support a flat tax while just 24% pay a graduated tax rate that would mean those who earn more pay more.

The rich would say that, you might say. But there is at least some evidence to say that increasing top tax rates isn’t the panacea that some suggest.

In Britain the former Labor government’s decision to raise taxes for those earning more than £150,000 to 50% in the wake of the GFC appears to have mixed results.

While the initiative was supposed to raise £7 billion, research by the Institute for Fiscal Studies claims it may be costing the British Treasury up to £500 million a year, because the wealthy have increased their use of legal tax avoidance measures.

A taxing question

The conclusion of all this is painfully obvious. Setting up a tax system that ensures the wealthy pay their fair share (or in the case of the US, at least their fare share) and also encourages entrepreneurship and risk taking isn’t as easy it appears.

But in the final wash-up you do sense that the Buffett viewpoint is going to win out.

Governments in the developed world face such financial pressures that it appears inevitable that the wealthy will be asked to carry a bigger tax burden.

They won’t like it of course, but I do wonder if Buffett isn’t right. Do wealthy entrepreneurs really shy away from opportunities because of tax?