Fairness, the Buffet Rule and Capital Gains Taxation

Eliot Spitzer has a post on fairness and the capital gains tax code at Slate: “So is the call for a ‘Romney rule’ mandating that capital gains be treated as ordinary income, and so be subject to the same top marginal rate of 35 percent that applies to ordinary income, rather than the current top rate of 15 percent.  But we shouldn’t raise the capital gains tax just because it’s a popular idea. The rate should rise for philosophical, economic, and political reasons.”

There’s one way of approaching fairness in the tax rate that involves two dimensions, and capital gains violates both of them.  That approach has a vertical and horizontal approach to fairness.  There’s vertical equity – where those with more pay more – and there’s horizontal equity, where people who are the same should be taxed the same.  (Whether these are necessarily two principles of equity or one is a debate for another day.) That capital gains are taxed less than income violates both.

Everyone understands that Warren Buffet paying less of a rate than his secretary, who makes much less money than he does, is unfair.  That’s the vertical relationship.

But let’s also consider the horizontal one.  Let’s imagine Warren Buffet’s gardener, and let’s make up that he makes $8 an hour.  Warren Buffet made roughly $63 million dollars last year.  Now let’s picture that the gardener, who has all kinds of cool incentives to make lots of money since he gets to see Warren Buffet’s example, also wants to make $63 million dollars in a year.

At $8/hour, it takes him 7.875 million hours of work to pull that off in a year.  Technically it takes him working 900 years to make that kind of money – but he’s capable of doing it in one year because he is really tugging at those bootstraps.

Now what’s his tax rate when he makes $63 million?  It isn’t 15% – it is much higher.  Even though they make the same money, the person who makes it from labor pays a much higher tax rate.

There are reasons to violate horizontal equity – we give people with children a tax break over those without children, even if they make the same income, because we value that as a society and want to invest in young people, for example.  But what’s the reason to give Buffet a break over his multi-millionaire gardener?  That is also as unfair as the Buffet secretary example – and why it is important that income is taxed as income is taxed as income.

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29 Responses to Fairness, the Buffet Rule and Capital Gains Taxation

  1. Jackson says:

    Another way of saying ‘vertical’ equity is progressivity (i.e., that higher marginal amounts are taxed at higher rates). CG rates do violate progressivity but the winning argument against them really seems to be that different forms of income shouldn’t be treated be differently (at least not for a very good reason). In addition, CG rates add complexity to the Code and keep tax lawyers in business, which is another strike against them.

    But don’t forget the point in the Times today: horizontal equity on capital gains is violated in two ways, first that they are taxed at a lower rate and second that they are taxed only upon a realization event. Wage earners have no such “realization” option. In fact, you can’t even tell your employer to “pay me next year with interest” (see: Section 457A and offshore hedge fund manager comp deferrals).

    • agrajag says:

      Indeed, and the power to defer tax infinitely by choosing not to realize is HUGE. Imagine if I could ask my employer to pay me only what I need to live, and invest the rest, while paying taxes only on the portion paid to me. My marginal tax-rate is 35%, and I currently save about $25K/year, so I’d save 35% of 25K on this alone, or $8000/year.

      Or, I could even ask my employer to pay me -nothing- but instead invest every cent of my gross, zero taxes paid. When I need money to live from, I’ll just go to the bank and borrow, with the investments as collateral, this too results in zero taxes.

      I could work, earn millions, spend millions, and pay zero taxes.

      You can’t do this if your income is wages. But if it’s capital gains, you can.

      And that’s grossly unfair.

  2. Tom says:

    “Everyone understands that Warren Buffet paying less of a rate than his secretary, who makes much less money than he does, is unfair.” Not everyone understands it, they think that calling it unfair is passing judgment on those who have been blessed or successful, that it is vilifying those who pay the lion’s share, that it is covetous and greedy.

  3. Garrett Wollman says:

    Seems to me the right argument against tax policies that favor investment income (of all kinds, not just capital gains) should be even more obvious: those who are well off have the ability to influence (in many cases, determine) how their income is recognized, while those of us who are not rich generally have little control. Inequity arises when taxpayers have control over their tax rates, since few people willingly pay more tax than they are required to. (How many people in Massachusetts take up the option on their state income tax returns to voluntary pay an extra 0.95%?) It may be rational to have this sort of inequity in the tax system, if it causes people to behave in some way that’s socially beneficial, but choosing to receive your income as capital gains or qualified dividends rather than salary is (at a minimum) not obviously beneficial to society.

    • Tom says:

      Your argument says that raising the capital gains tax is not a solution, not that there isn’t a problem. If raising the CG tax is not a problem, then what we need is a wealth tax.

      • Garrett Wollman says:

        No, my argument says that all forms of income should receive the same tax treatment, unless there is a compelling social benefit that results from encouraging rich people (generally the only ones who can) to prefer one form of income over another.

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  5. slackful says:

    Investable money comes from post-tax funds. Capital gains are always in part a second taxation levied on gains obtained by investing an amount of money which has already been taxed. Somewhat similarly, dividends are a pass through of already-taxed corporate income, which are then taxed again when received by the owner. That’s why the rates are lower, from that perspective, it makes sense.

    • EMichael says:

      Umm, no.

      New income, as are “gains obtained by investing an amount of money”, is not being taxed twice, it is taxed once.

      And there is no business forced to accept a structure which causes dividends to be “double taxed”. It is a choice a business makes that have negatives and benefits.

      Like to have had responsibility for the debts of Lehman Brothers beyond the value of your stock?

      • John says:

        Wrong, the corporation pays taxes at 35% does NOT get a deduction for the dividends that are paid out to investors who then in turn pay 15% – thus = double taxation!!

        Wrong on your 2nd point as well, large publicly traded companies among others must be C-Corporations and thus pay at 35%

        I’m a CPA so if anyone knows the rules…

  6. Tyler says:

    1) Capital saved is capital already taxed. It is capital saved and taxed that is put to risk by someone like myself. It is capital that if risked and lost, is only allowed to be deducted against current year capital gains (what if there were no capital gains, only losses? Or, deducted at a measly $3,000 a year if the latter. So, If I risk a hypothetical $100,000 and lose it, I have paid taxes on that $100,000 with virtually no way to recoup those losses against future income (minus the pittance of $3,000 per year…yippee!!).

    In today’s enviromnent, I am forced to put my capital into risky investments, or lose it via the inflation mechanism of the Federal Reserve’s cartel control of the money supply, which destroys my capital and creates new money which flows down from the banking elite before inflation can destroy their capital.

    Does Warren Buffett utilize 10,000 times more goverment services than the hypothetical gardner that required W.B to pay millions in taxes, even if at only 15%. How is that fair at all?

    What is the incentive for anyone to risk capital vs consume that same capital on Chinese plastics and trinkets, if not a reduced tax rate on one’s capital gains on taxed capital (that has already been taxed to the hilt)?

    The fairness issue on taxation is nothing more than class warfare. I grew up poor, but instead of buying a Mcmansion, new cars, boats, ATV’s, motorcycles, designer clothes and all the other consumeristic trappings my neighbors bought into, I saved my money, foregoing immediate rewards for greater future security. Now, suddenly my frugality is unfair to for others?

    • EMichael says:

      It is certainly unfair if the results of your frugality(Income) are taxed at a level less than my taking a second job.

      Let’s take an example of the gene pool winning trust fund baby next door to me. Seven colleges with no degree, a lifetime working experience of two weeks as a lifeguard when he was eighteen(by his own admission.

      His income is almost exactly what my income is. Yet I pay more than twice as much in federal taxes than he does.

      • tyler says:

        The difference between my capital and your earnings is the risk quotient. If I invest 100K and you earn 100K what risk do you have of losing your money? Zero, unless you load up on useless chinese trinkets. What risk(s) do I have? I potentially risk it all, and I risk my money that is/was taxed just as yours was (the 100K I earned at my job).

        Emichael, if you want to pay the same as the lifeguard in your example, set aside ten percent (or more) of your income at use that money to invest and do it over the years and decades, just as someone fastidiously did so that the lifeguard could inherit that money.

        There is a reason that most people live off the sweat of their brows; because they don’t understand the power of capital and wealth which is a proxy for labor. Taxing capital gains at a lower rate incentivizes people to create wealth for themselves, their communities and their nation. The reason it is taxed lower is because the risk is much higher and that incentive creates the conditions more favorably for capital formation.

      • EMichael says:

        I do not understand the point. The topic is income.

        No one makes you invest the money. Your risk is your problem.

    • EMichael says:

      “What is the incentive for anyone to risk capital vs consume that same capital on Chinese plastics and trinkets, if not a reduced tax rate on one’s capital gains on taxed capital .”

      Umm, more money?

      As in 65% (assuming investment taxed the same as income) of something is a lot better than nothing?

      • Tyler says:

        Yes, the topic is income, and the taxes levied currently reflect the thinking and belief that capital gains taxes should be taxed lower than ordinary income. I agree, while you do not.

        Progressive taxation is unfair. You seem to think that it is, while I do not. Risk taking and the lowered taxation on those gains offsets the “unfairness” of the tax code.

        Slave away at your job and sock those saved dollars under the mattress if you like. They will be stolen from you eventually via inflation.

      • EMichael says:

        At least we agree on the first paragraph.

        You assume I have no investments, trying to “blame” my position on eny; at the same time talk about the effects of inflation on mattress money; rant about high taxes on wages that reduce possible investment income in arguing that investment gains are double taxed; then talk about risk(life is full of it); and all of this while trying to defend taxing different sources of incomes at different amounts.

        As you say, current law is what is. Doesn’t make it right. Doesn’t make it fair. And doesn’t make most of your valid arguments not apply to the wage earner.

      • Tyler says:

        No, the current tax system is unfair, it rewards the rich far more than the working class. I don’t want my money killing brown people the world over, but I don’t have a choice in that matter. I don’t want my money to go into a goverment black hole of accountability, waste and fraud, but I don’t have a choice in that either, no matter how I vote. What is fair about that?

        Life isn’t fair and it will never be. I would gladly pay higher capital gains taxes (when I ever earn them. Can’t remember ever earning a capital gain, I have only enjoyed the losses.), if the goverment would quit killing people in the name of freedom and democracy, and start acting responsible and frugal towards the tax money we all pay.

    • S. Z. says:

      The fairness issue on taxation is nothing more than class warfare.

      I love this formulation! Fairness = class warfare, goes along great with Corporations = people and money = speech

  7. Tom Shillock says:

    Why shouldn’t capital gains taxation also be progressive in a finely graduated manner? If one is elderly and rich like Buffett then you pay a high rate whereas if you are elderly and comparatively poor but have a little captial gains then you pay much less? To put it another way, why should Buffett’s secretary pay the same capital gains tax rate as Buffett?

    Taxation and justice in America are largely window dressing because that is how we want it. America since the Pilgrims has preeminently represented the potential for invidudual economic betterment by hook or by crook. Crook is okay and too often admired if you cleverly get away with it. America is like the Great Depression era board game Monopoly: based on luck (inheritance, marriage, business) with stay out of jail free passes available to players who can afford them. For whatever reasons we Americans accept the morality of luck while professing a commitment to the distribution of burdens and benefits based on hard work, character, etc.

    • tyler says:

      Does Warren Buffett use 10,000 times more goverment services than does his secretary? Remember he still paid millions and millions in taxes. Should Warrent Buffett be forced to pay $5,000 for a Big mac while his secretary pays $3.50 in the name of “fairness” and just because he can and because he is rich? Why would goverment services be different than the products we consume from the private sector?

      What is unfair, is that U.S tax system is progressive. Imagine if whenever you walked into a store to buy a good or service, you had to pay a retail price based on your earnings or wealth. Sound fair? It doesn’t to me, and taxes are no different.

      • S. Z. says:

        Put it differently: why should the secretary be forced to pay nearly all of her disposable income, while Buffet pays an unnoticeable amount?

  8. Garrett Wollman says:

    Re: “What is the incentive for anyone to risk capital vs consume that same capital on Chinese plastics and trinkets, if not a reduced tax rate on one’s capital gains on taxed capital (that has already been taxed to the hilt)?”

    You tell me. Investment didn’t cease during the years when the Federal tax laws did not favor capital gains over ordinary income. In any case, the capital gains are *not* “already taxed to the hilt”, unless you made that investment (and were a top-bracket earner) in the 1950s.

    • tyler says:

      I meant income; the income to save the necessary capital is “taxed to the hilt”. As a business owner, I have the privilige of paying 7.65 of Fica taxes on myself. I pay it twice. Then I pay federal and state taxes. When you earn 150K it is easily 50% of your income.

      Then, if I lose my money in land, stocks or whatever, the goverment lets me write off $3,000 a year. All that is left if you lose your money is the receipt of what you paid to the goverment in taxes and the phantom illusion that you ever earned the money in the first place.

      Unless you have sacrificed to save your money, risked it and lost it, will you ever understand the fairness of lower capital gains taxes.

      • EMichael says:

        Every time I hear one of my fellow small business owners(going on my third decade)| complain about paying self employment taxes I have to laugh.

        C’mon, that “extra share” of Fica is a drop in the bucket of the dollar value contained in being self employed. Geez, just take a look at what you can legally deduct as “business expenses”. And that is not even considering the tremendous amount of fraudulent deductions that easily escape the largely neutered IRS.

        In my business I have seen thousands upon thousands of returns frm small business owners. Over 90% are pure, unadulterated bs. And most of them are not doing anything illegal.

      • Tyler says:

        I haven’t “complained” about paying double FICA taxes, I am only stating the facts about it. As for your allegations of fraud concerning “business deductions”, write-offs and the like, that is irrelevant to this discussion or as to whether the current tax system is “fair” or not.

        I am sure that our tax code could be made fairer concerning capital gains taxes and interest income. Just as lumping “millionaires and billionaires” into the same category is laughable, so is believing that ALL capital gains should be taxed at higher rates, or as ordinary income equally laughable (because the gulf between millionaire and billionaire is so extraordinary large), and the circumstances of earned capital gains so varied and diverse also.

        If people believe the system is “unfair” then just do what rich people do. If capital gains are taxed at only 15% then go make a bunch of money investing (it is so easy and riskless right?). Why complain about taxes when the solution to making capital gains is so easy and the taxes so much less.

      • EMichael says:

        That last sentence is incredibly stupid.

        C’mon.

        Most investment portfolios in this country were made the old fashioned way. They were inherited.

  9. ezra abrams says:

    I’m sorry, why is any discussion about cap gains taxs rates, that doesn’t start off with cap gains should be taxed as normal income, interesting or worth talking about ? (in case you havn’t noticed, our problem is excess capital; the world is awash in money that has no home, and you know this is true from the interest rate on long term debt – people are willing to give the US gov’t money for 10 or 20 years at 4%, which basically says that the largest, most diverse free market in the world, the bond market, has 100% confidence that the US gov’t will repay every single dime it owes, and 100% confidence that inflation will be low for a long time…doesn’t sound like capital is limiting in any way shape or form, which is contrary to our common sense everyday perception from life, where money, for most of us, is limiting; thats the thing about the rich – they are rich !!)

    I know as an intellectual, I’m supposed to defend my positions on some sort of thought out, logical basis; but the idea that cap gains should not be taxed as ordinary income is so silly, why bother ?

    There are only so many hours in the day, and sicne thright wing has way more money and way more people pumping out white papers, liberals sort of have to pick and choose what battles to fight.

    On economics, the main battles appear to be (a) the rich are waging war on the poor, and (b) it appears that the “deal” of the industrial revolution, that has held more or less for 300 years, that innovation destroys jobs and creates more net new jobs (kinda hard on the destroyees) is coming apart, that we really won’t have enough jobs in the next 20 years, and that this is a profound, profound change in our society.

    The reason is that software is Quantitatively different from, say electricity or precision machine tools or antibiotics or cheap refridgeration: software replaces general tasks, whereas prev generations of industrialization and technology have replaced specific tasks.

    Take the combine, which harvests wheat in the field: one combine can do the work of ..I dunno, mayb3 200 men. But a combine can only harvest wheat, and very closely related crops; it can’t plant, or weed, or spray pesticide or herd cows.

    ON the other hand robotic equipment drivers can do all these things.

  10. diomavro says:

    I think neither is efficient there’s lots of people who just day trade from home, the stock market is a job creator and it makes no sense to limit what people can do. Instead tax people on their accumulated wealth, would take quite abit of organization but that’s the real definition of “fair. “

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