The President rolled out his latest deficit reduction outline yesterday. As expected, it included several tax recommendations. In sum, the President is calling for an additional $1.5 trillion in tax collections over the next decade, including:
- Expire Bush Tax Cuts on High Income Earners ($800 billion)
- Cap Itemized Deductions & Exemptions at 28 percent ($400 billion)
- Various Loophole Closers ($300 billion)
There are a number of challenges with the list. First, allowing tax provisions already set to expire to, well, expire, doesn’t raise any revenue. It’s already in current law. That $800 billion in savings doesn’t exist.
Second, the President already proposed to use the cap on itemized deductions to offset his jobs proposal released earlier this month. That package would have increased the deficit and the cap on itemized deductions was to have offset most of that cost. No man can serve two masters, and no tax provision can be both deficit reduction and a pay-for at the same time. Like the higher taxes on high-income earners, this $400 billion in savings doesn’t exist.
So the tax savings from the President’s proposal are less than claimed.
What about the “loophole” closers? Here’s the list from the OMB summary of the plan:
- LIFO repeal ($52 billion)
- Repeal Lower Cost of Market ($8 billion)
- Coal Related Provisions ($2.4 billion)
- Insurance Provisions ($12 billion)
- International Tax Changes ($114 billion)
While the term “loophole” is certainly loaded and should not apply to many of these provisions — LIFO accounting rules, for example, are neither a loophole nor a tax expenditure — the larger challenge is that some of these are the very base-broadening measures that Ways and Means Chairman Camp says he needs to offset lower rates in tax reform.
If these provisions are used for deficit reduction instead, how is Congress supposed to lower rates? Where will the offsets come from? This is the reason Congressman Camp and others have been resisting the idea of doing tax reform within the context of a deficit reduction package.
Corporate Tax Reform
For the past half year, Washington has waited for the Obama Administration to release its so-called “White Paper” on corporate tax reform. The paper’s existence was publicly discussed and reported, as were the broad provisions it was said to contain — budget neutral, corporate only, territorial, eliminate certain tax expenditures, etc.
With the release of the President’s deficit reduction plan today, the waiting is over. We can all go home now, there’s nothing to see. Instead of a plan, the White House released a set of five “principles” the President would like Congress to follow as it grapples with the code. These are:
1) Lower tax rates;
2) Cut wasteful loopholes and tax breaks;
3) Reduce the deficit by $1.5 trillion;
4) Boost job creation and growth; and
5) Comport with the “Buffett Rule” that people making more than $1 million a year should not pay a smaller share of their income in taxes than middle-class families pay.
Number 5 is the easiest — the tax code already does that (see below). And we’re all for cutting rates and boosting job creation.
So in the spirit of articulating principles, we have three of our own that might be helpful.
- First, any reform of the tax code needs to address both the individual and the corporate side of the code. Most American jobs are created by employers who pay the individual rates, not the corporate rates, so Congress needs to focus on both.
- Next, Congress should seek to keep the top income tax rates paid by individuals and corporations at the same level. Splitting business income and taxing it at two significantly different rates would undermine tax administration and encourage business owners to plan around the higher rate. Keep it simple, keep it low, and keep it the same.
- And finally, Congress should seek to tax business income once, and only once. The study authored by Bob Carroll last spring made clear that the double tax on corporate earnings results in less investment and lower employment in the United States. To make American business more competitive, Congress should move business taxation towards the S corporation model, not away from it.
Those are our principles, and were working with other business groups in town to make certain tax writers in Congress understand them. By embracing these broad concepts, Congress can move the taxation of business income in a direction that helps ensure employers want to invest and create jobs in this country, not someplace else.
Warren Buffett is Wrong
The President continues to tie his efforts to raise taxes to Warren Buffett’s contention that he pays less tax than his secretary. As Buffett wrote in the New York Times earlier this year:
Last year my federal tax bill - the income tax I paid, as well as payroll taxes paid by me and on my behalf - was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income – and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.
Buffett has been making this argument for years, but he has finally found a receptive ear with the Obama Administration. As the President stated yesterday:
So I am ready, I am eager, to work with Democrats and Republicans to reform the tax code to make it simpler, make it fairer, and make America more competitive. But any reform plan will have to raise revenue to help close our deficit. That has to be part of the formula. And any reform should follow another simple principle: Middle-class families shouldn’t pay higher taxes than millionaires and billionaires. That’s pretty straightforward. 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.
Here’s the problem. Warren Buffett is wrong. While only he and his secretary know their exact tax burden, we do know the numbers he presents above are incorrect and shouldn’t be used as the basis for tax policy moving forward.
How did he get it wrong? Two errors. First, he overestimates his secretary’s tax burden by using the wrong denominator. Second, he underestimates his own tax burden by ignoring the corporate taxes his company pays.
Let’s take the first. Buffett claims that his employee’s effective tax burden, including the federal income and payroll taxes, ranges from 33 to 41 percent. That’s really high.
Measuring income and payroll taxes (including the employer share) against gross income, it’s simply impossible to get an effective rate that high — and that’s for a couple with no children and no deductions where both spouses earn right at the Social Security earnings limit.
So how does Buffett get to 41 percent? Apparently he uses taxable income rather than gross income. But no credible tax policy group would use taxable income to measure somebody’s tax burden. It excludes too much income to be useful. By contrast, when the CBO calculates effective rates, it uses an expanded definition of income that includes all wages and salary plus transfer payments and in-kind benefits.
Next, Buffett under counts his tax burden by ignoring the taxes paid by Berkshire Hathaway. He claims $7 million in payments, but last year Berkshire Hathaway paid $5.6 billion in corporate taxes on $19 billion in income, an effective tax rate of 30 percent. Here’s the CBO on the types of tax they include in their calculations:
CBO estimates effective tax rates for the four largest sources of federal revenues’ individual income taxes, social insurance (payroll) taxes, corporate income taxes, and excise taxes, as well as the total effective rate for the four taxes combined. Those taxes account for over 95 percent of total federal revenues. The analysis does not include federal estate and gift taxes, customs duties, and other miscellaneous receipts. Nor does it include state and local taxes.
Buffett still owns a large share of Berkshire Hathaway, so his real tax burden likely is in the billions, not millions, and his effective rate is 30 percent, not 17 percent.
The reality, as measured by the CBO, is that our tax code is remarkably progressive, with the top one percent paying an effective rate of 30 percent while the five quintiles of income earners pay, from highest to lowest, 25, 17, 14, 11, and 4 percent respectively. (As noted, these percentages do not include state and local taxes.)
So there you have it. The President is calling for tax code that ensures the rich pay more? We already have that tax code. So perhaps Congress can now focus on the cutting rates and encouraging job creation.