Having recently discussed Len Burman’s vision for a sustainable tax reform, I was interested to read his critique of the Buffett Rule:
The Fair Share tax is not the right tool for this job. It is bad policy. If it became law, it would needlessly complicate taxes and create new inequities. In so doing, it would repeat an egregious error made 43 years ago when Congress created the first minimum tax in a poorly executed effort to rein in tax breaks for millionaires.
Burman offers several examples of perverse outcomes that might flow from the the Fair Share tax:
For example, imagine two elite lawyers, each making $999,000, who are considering marrying. They would owe no Fair Share tax if they stayed single but could owe tens or even hundreds of thousands of dollars in additional tax if they married.
Or consider if you were on the cusp of paying the Fair Share tax: you wouldn’t know at the beginning of the year whether your capital gains would be taxed at a rate of 30 percent or 15 percent; it would depend on whether you were ultimately hit by the tax….
More fundamental is that the idea of three different sets of tax rules — regular tax and alternative minimum tax and fair share tax — makes no sense. One set of rules should apply to everyone, and if we close some loopholes, a reformed tax code could satisfy the goal of the Buffett Rule.
Rather than add a new set of tax rules, Burman favors eliminating the favorable treatment for capital gains and dividends, an idea we’ve discussed a number of times in this space:
Specifically, we should fix the regular income tax to eliminate or curtail the tax loopholes that let rich people avoid tax, especially the lower tax rates on capital gains and dividends. And while it’s true that taxing capital gains at rates up to 35 percent (the current top income tax rate) might be counterproductive (because many investors would choose to hold on to their shares rather than pay the tax), there are other options. For instance, the top rate on capital gains could be raised from the current 15 percent to 28 percent — the rate set by Ronald Reagan’s Tax Reform Act of 1986, but undone in stages by tax changes under the administrations of Bill Clinton and George W. Bush.
This is a proposal Burman has been advancing for some time, and his contributions shaped the Debt Reduction Task Force’s decision to subject ordinary income and capital gains and dividends to the same rates of tax. Burman is less concerned about double taxation and lock-in effects, having observed that double taxation only applies in some cases and that lock-in effects seem relatively modest. Suffice it to say, not everyone agrees with Burman’s take.
The Committee for a Responsible Federal Budget’s Stabilize the Debt calculator gives you the option of eliminating the capital gains tax. One wonders how a reform that raised tax rates on ordinary income — say to Clinton-era levels — while eliminating or dramatically reducing capital income taxes would be received. This approach would certainly not address the concern that animates the Buffett Rule, i.e., that some small minority of high-earners derives most of its income from capital income. In a recent article in City Journal, Josh Barro explained the broad outlines of such an approach:
New York University professor David Bradford suggested a system called the “X tax,” in which both businesses and individuals would pay an income tax—but individuals, crucially, would pay no tax on interest, dividends, or capital gains. Since people can do only two things with their income—invest it or spend it—a government that taxes income without taxing capital is imposing the equivalent of a consumption tax. The businesses, meanwhile, would pay taxes on the revenue that they took in from customers—again, this would be a consumption tax—but subtract from their taxable income whatever they bought from other businesses, as well as what they paid their employees. Though its operation is significantly different, the base of the X tax is the same as that of a value-added tax (VAT). But unlike with a VAT, the government could levy tax at lower rates for lower-wage individual earners, introducing progressivity and potentially drawing some Democratic support to the plan.
Any of these reforms, of course, would bear a price, since the government would lose revenue by no longer double-taxing capital. To help make up for the gap, the top tax rate on individual wage income, for starters, would need to remain in the neighborhood of today’s 35 percent rate, instead of the much lower rates envisioned in the Bowles-Simpson plan. But by eliminating various tax credits and deductions, such as the deductions for state and local taxes paid and for mortgage interest, the government could pay for reform and even afford to set lower rates for lower- and middle-income earners. Better still, it could increase the earned income tax credit, a benefit that the very lowest wage earners receive.
Because these reforms would reduce or even eliminate the taxes that investors pay on capital income, Warren Buffett’s tax bill would be smaller than it is today. Some other investors with extremely high incomes would likewise be better off. But the tax burden wouldn’t be shifted to the middle class and the poor. Rather, the brunt would be borne by wage earners in the top quintile—partners in law firms and corporate executives, for instance—who have labor income taxed in the top bracket and who tend to benefit heavily from tax deductions. [Emphasis added]
My crude impression is that wage earners in the top quintile are collectively more influential than investors with extremely high incomes, though presumably less influential as individuals. These HENRYs (“high earners, not rich yet”) are relatively large in number, politically active, and overrepresented among small dollar donors to both political parties. Rather than frame fights over the tax code as fights between the homogeneous rich and the homogeneous non-rich, or even as fights between narrow special interest groups, one wonders if there’s an element of HENRYs vs. the capital rich. And is it obvious that the non-rich should be allied with HENRYs and not the capital rich? If it really is true, contra Burman, that a lower tax burden on capital income is growth-enhancing and (not contra Burman, as I think he’d agree) that higher marginal tax rates on individual wage income wouldn’t be that bad, something like a Bradford X tax would advance the interests of the non-rich and the capital rich while squeezing HENRYs.
(There is a decent case to be made that HENRYs are the real villains of our politics — my sense is that they tend to be the most avid and effective proponents of opportunity-restricting measures like onerous land-use regulations and licensing restrictions, of tax expenditures like the mortgage interest deduction and the state and local tax deduction, etc. But this is all very subjective.)