Boofhead rule

The Buffett rule, so named because of Warren’s abiding anxiety to pay more tax, will shortly be considered by the US Senate where the Democrats have the majority.

It will likely fail to progress.It is yet another Obama gimmick (like his budgets) that even his Democrat colleagues will be unable to stomach.

Apparently Buffett finds it anomalous that some people who work for him for wages have a higher average tax rate than he does. The fact that this completely misrepresents the situation is, to say the least, mystifying coming from such an astute investor in public companies. His tax rate and those of many rich people who own pieces of companies only look low. They aren’t really low at all. In fact they are quite high. To that later

What exactly is the Buffett rule you might ask. I did and went to www.whitehouse.gov for the answer. There you can find a video clip and the deputy director of the National Economic Council, Brian Deese, with a white board setting it all out. He explains that the average federal income tax rate on some of those earning over $1 million per year can be less than the tax rate on middle income earners (who pay, say, an average of 16 to 19 per cent). Under the Buffett rule, people earning over $1 million would pay a minimum tax rate of 30 per cent. Exactly how this would be done is not explained. Only a moment’s thought is required to see how difficult it would be to come in on top of a complex tax system and set a minimum average tax rate for those earning above $1 million. But that is not the name of the game.

Even if this tax could be implemented it would bring in only around $4 billion a year; according to one estimate provided last month to Associated Press by Congress’ Joint Committee on Taxation. The current budget deficit is around $1.3 trillion. Do the math, as the Americans would say; that would leave only another $1.296 trillion to find to balance the budget.

The objective is not to pass legislation to increase taxation on the rich. The game is to vilify and blame the rich (excluding good old Buffett and other notables like Bill Gates who have gone public with their personal agony about paying too little tax) as part of Obama’s re-election campaign. No engineered pitting of one group of Americans against another based on wealth (or on race or on gender) is too great a price to pay, apparently, to re-elect a president who can’t run on his miserable record and has no more hope and change to offer for the future.

But politics aside, rich people like Warren Buffett are not under-taxed. Their personal tax rate seems low because a significant portion of their income often comes in the form of dividends paid by companies that they partly own or in the form of capital gains from share sales. The companies involved pay tax. Companies are surrogates. They simply stand in for their owners. It is their owners that effectively pay the company tax.

The company tax rate in the US is 35 per cent and tax on dividends is 15 per cent – giving a total tax take (assuming say 75 per cent of after-tax company profits are distributed) of over 42 per cent. Exactly how much more tax does Buffett want to pay? Masochism knows no bounds evidently among the conscience-wracked super rich.

 Longer-term capital gains on share sales are also taxed at 15 per cent. While there is more complexity around capital gains, a similar rationale applies. Gains are linked to retained profits and to future expected profit, all subject to the company tax rate of 35 per cent. The treatment of dividends and capital gains in the US is not unusual. In Australia dividends (through imputation) are taxed at a concessionary rate as are longer-term capital gains. So far, I can’t recall an Australian one percenter objecting to this “generous” tax treatment; though I suspect we can’t rule out Wayne Swan picking up on Obama’s divisive political narrative.

Finally to economics; which is something Democrats and those on the left generally have difficulty in grasping. In fact they go to extraordinary lengths to avoid its logic in order to avoid having to weigh up and take account of those nasty consequences that conservatives talk so much about. In this case, consequences reveal the Buffett rule to be a boofhead rule.

Increasing the personal tax rate to 30 per cent on all those earning more than $1 million effectively increases taxes on company profits. Total taxes on owners of companies are already higher in the United States than in most other countries. Increasing these taxes (in the order, effectively, of another 7 plus percentage points) will make it harder for US companies to raise the capital they need. It will further depress economic growth in a struggling economy. It will tend to drive savings and investment out of the United States into overseas tax shelters. And for what? A measly amount of revenue to satisfy the politics of envy and divisiveness.

Peter Smith’s book, Bad Economics, will be published soon by Connor Court. You can pre-order (post free) here…