Josh Barro on the Buffett Rule

by Reihan Salam

Last fall, I described the Buffett Rule as a step away from the ideal of a progressive consumption tax, which has been embraced on the right and the left, and as a revised version of the AMT.

Yet as Josh Barro explains, it is actually much worse than that, as the current AMT allows for more favorable treatment of capital gains. Moreover, it exacerbates preferential treatment for corporate debt finance:

A corporation deducts interest payments before calculating its taxable income, and then an individual owner of corporate debt pays tax on interest payments at ordinary income rates. On the other hand, a corporation pays tax on profits after interest expense. These after-tax profits are either distributed to shareholders, who pay tax on the dividends; or they are retained, in which case the stock price rises and shareholders pay tax on capital gains.

Because interest is taxed only once and profits are taxed twice, corporations take on more debt than they would in absence of the tax distortion. The distortion is mitigated by the fact that dividends and capital gains are taxed at lower rates than interest income. Because the Buffett Rule would raise capital gains and dividend tax rates and, in many cases, lower the effective tax rate on interest, corporations would face even more incentive to overleverage themselves.

There is an irony here: one of the criticisms of Mitt Romney’s record at Bain Capital is that private equity firms put unhealthy amounts of leverage on the firms they acquire in order to exploit the favorable tax treatment of debt. The Buffett Rule would make that strategy even more attractive.

Josh also suggests that a Buffett Rule might make the U.S. a less attractive destination for investment, as capital income would face an unusually onerous burden relative to the other major market democracies. He concludes his post with thoughts on the importance of indexation and recommendations for how we should think about tax reform. Like Josh, I’m inclined to think that taxing capital income twice is unwise.

My strong suspicion is that the Obama administration has no intention of actually implementing something like a Buffett Rule, but we can’t know that for sure. It is entirely possible that I’m engaging in wishful thinking. But given the obvious problems it creates, and the likely political configuration of Congress, it has the trappings of an idea that is meant only for the campaign trail. Just as economist Austan Goolsbee assured Canadian diplomatic officials that the president’s anti-NAFTA rhetoric “should be viewed as more about political positioning than a clear articulation of policy plans,” it is not difficult to imagine White House staffers explaining to various business interests that a Buffett Rule would be tough to implement and thus not a pressing concern. 

I’m reminded of the observation Peter Thiel shared with Declan McCullagh of CNET last fall:

You once told The Wall Street Journal, referring to President Obama: “I’m not sure I’d describe him as a socialist. I might even say he has a naive and touching faith in capitalism. He believes you can impose all sorts of burdens on the system and it will still work.” Is that still true?

Thiel: Yes. I think there is an incredible faith in capitalism–that you can put any burdens on business, and people will just work. It’s like people are hardwired to make money and there’s nothing you can do to change that, irrespective of politics. In that sense it is an incredible faith in capitalism that I don’t quite share.

I think it’s also that the left in the U.S., the Democratic Party, is not socialist in the other sense in that there is actually no plan for the future. What socialism and communism was characterized by were five-year plans, these development plans of what you’re actually going to do. What’s remarkable is how little of a plan there’s going to be.

I don’t think most of the economy should be planned. But I think to the extent you’re going to have large government, it would be good if the government should be planned rather than unplanned. If you’re going to invest in alternate energy, you should have a plan of what kind of alternate energy you should be investing in, and you shouldn’t be randomly buying lottery tickets. Planning is preferable to buying random lottery tickets or politically motivated lottery tickets, which is the concern with the clean-tech stuff. That’s levels worse than having a rigorously centrally planned economy a la Krushchev. [Emphasis added]

If Thiel is right, President Obama might actually support the Buffett Rule and consider it an essentially costless policy. If the president is somewhat more evidence-sensitive, he recognizes that it has fairly serious downside risks.

(Incidentally, I actually do believe that some people “will just work,” though the locus of work might shift, e.g., from market production to household production, or to non-market peer production, etc.)  

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.