Buffett's Bunk

Now that Mitt Romney has released his tax returns, his effective federal tax rate of approximately 15% is being trumpeted by those on the left as "Exhibit A" in support of Warren Buffett's assertion, in his recent op-ed piece in the New York Times, that his federal tax rate of 17.4% is 18.6 percentage points less than the average rate paid by the workers in his office.  In actuality, Buffett's assertion is a gross and deliberate misrepresentation of the facts and simply cannot go unchallenged.

The primary flaw in Buffett's federal income tax rate "comparison" is that he includes in it Social Security taxes (including Social Security taxes paid by both employee and employer) and federal income taxes.  Social Security taxes and federal income taxes are two totally different taxing mechanisms, in place for totally different societal purposes.  To combine them into one "federal tax rate" is an analytical sleight of hand that cannot withstand the bright light of logical and knowledge-based scrutiny.

In 2010, combined Social Security taxes (employee- and employer-paid) were imposed at the rate of 12.4% on wages of up to a cap of $106,800 per year, yielding a maximum combined Social Security tax for any taxpayer of $13,243.  At this combined rate, Social Security taxes paid by a secretary (or on behalf of said person by his/her employer) earning $60,000 per year would be $7,440, or 12.4% of total earnings.  Buffett, with taxable income of roughly $40 million, paid the maximum Social Security tax of $13,243, or 0.03% of his earnings.

To the uninformed, this 12.37-percentage-point Social Security tax rate differential between Buffett and his secretary appears to buttress Buffett's argument of federal tax rate unfairness.  But what Buffett fails to mention (and what is never mentioned anywhere in any press accounts) is the fact that Social Security retirement benefits are capped as well.  While Buffett earns 667 times more than his secretary, his monthly Social Security benefit when he retires will be less than two times that paid to his secretary (and, because of the wage cap, it will be proportionate to what each of them will have paid into the system).  Put another way, if the combined Social Security tax rate of 12.4% were imposed against Buffett's total 2010 earnings of $40 million, the resultant Social Security tax of $4.96 million (paid by him or on his behalf) in one year would be roughly seven times the amount he could expect to receive in Social Security benefits over the entire duration of his retirement.  The capping of both the wage base upon which Social Security taxes are imposed and the ultimate amount of Social Security benefits derived leads to the mathematical optics that Buffett and his ilk draw upon in making their fallacious conclusions.  Social Security, flawed as it may be, is a system based on the premise that benefits derived from it are proportionate to what has been paid into it by all Americans -- rich, poor, or in between.  What a concept!  

Clearly, looked at in this way, Social Security tax rates should not be taken into account in any fair comparison of federal tax rates between Buffett and his office workers, thus eliminating 12.4 points of the 18.6-percentage-point federal tax rate differential claimed by Buffett.

Buffett's second flaw is that he includes Medicare taxes in his comparison.  The secretary noted above will pay (or have paid on his/her behalf) Medicare taxes at 2.9% of wages.  Buffett pays these taxes as well, but in the case of Medicare, taxes are assessed on all wages earned (there is no cap on Medicare-taxable wages).  But because the vast majority of Buffett's income is derived from non-wage sources (capital gains and dividend income), which are not subject to Medicare tax, his Medicare tax, as a percent of his taxable income, is likely near 1.0%.  Thus, another of 1.9 percentage points of the remaining 6.2-percentage-point differential is explained away, leaving a differential of 4.3 percentage points.

Another factor that is contributing to the alleged federal tax rate differential between Buffett and his office workers is the impact that dividend income (federally taxed on individual taxpayers at the rate of 15%) has on his effective federal tax rate.  The analytical deficiencies here are (1) that the money used to fund the investments that generated the dividend income has likely already been federally taxed, and (2) dividend income has already been federally taxed (at 35%) at the corporate level before the dividend is reflected as income on Buffett's personal federal tax return.  Buffett's true federal tax on his dividend income (including federal corporate taxes) is actually 69% of dividend income.  While Buffett does not disclose the amount of dividend income he reported in his federal tax return, if it constitutes 10% of his total taxable income (or $4 million), his true overall tax rate is 22.7%, not the 17.4% that he claims.  Under this reasonable assumption, the remaining 4.3-percentage-point differential between Buffett and his office workers disappears (and then some).

Buffett's analysis is further flawed because it ignores federal estate taxes on his accumulated wealth that will be assessed when he dies.  Given that this event will likely take place years into the future and that Buffett will certainly employ effective estate planning techniques to minimize these taxes, it is impossible to speculate on what his estate tax rate amount will be.  It is, however, safe to assume that his estate will be taxed at a significantly higher rate than that of his secretary.     

The remaining factor contributing to the tax rate differential between Buffett and his secretary is the impact of capital gains (federally taxed at 15%) on his overall federal tax rate.  Unlike the inaccurate analytical techniques exposed above, taxable income arising from capital gains does truly lower Buffett's effective federal tax rate.  Whether capital gains should receive favorable federal tax treatment is a subject of honest debate.  But in attempting to engage in this debate, Buffett loses all credibility when he states:

And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what's happened since then: lower tax rates and far lower job creation.

Astonishingly, Buffett is apparently ignorant of the fact that, without a doubt, the primary driver of the massive job creation between 1980 and 2000 was...lower federal tax rates!  In 1980, the highest federal income tax bracket was 70%.  This rate was lowered 1981 to 50% and further lowered to 38.5% in 1987 and to 28% in 1988.  It was these federal tax cuts that fueled the massive creation of jobs in the '80s and '90s.  The magnitude of the Reagan tax decreases that fueled this massive job creation was far higher than the tax decreases passed by George Bush in 2001.  So let's have the debate about federal tax rates.  But let's do so by basing our positions actual economic principles and not on egregiously flawed and erroneous historical perspectives.

As shown above, Warren Buffett's assertion that his federal tax rate is 18.6% higher than that of his office workers is clearly flawed and demonstrably false.  That this abject falsehood has been seized upon by President Obama and Democrats in the House and Senate as an argument to increase taxes on the "rich" is enormously troubling.  Obama, Buffett, and the Democrats are either ignorant of basic federal taxation concepts or they are deliberately propagating what they know are lies to fan the fires of resentment and class warfare in order to gain political support from the left.  Neither of these alternatives casts the president and his allies in a particularly favorable light.

Now that Mitt Romney has released his tax returns, his effective federal tax rate of approximately 15% is being trumpeted by those on the left as "Exhibit A" in support of Warren Buffett's assertion, in his recent op-ed piece in the New York Times, that his federal tax rate of 17.4% is 18.6 percentage points less than the average rate paid by the workers in his office.  In actuality, Buffett's assertion is a gross and deliberate misrepresentation of the facts and simply cannot go unchallenged.

The primary flaw in Buffett's federal income tax rate "comparison" is that he includes in it Social Security taxes (including Social Security taxes paid by both employee and employer) and federal income taxes.  Social Security taxes and federal income taxes are two totally different taxing mechanisms, in place for totally different societal purposes.  To combine them into one "federal tax rate" is an analytical sleight of hand that cannot withstand the bright light of logical and knowledge-based scrutiny.

In 2010, combined Social Security taxes (employee- and employer-paid) were imposed at the rate of 12.4% on wages of up to a cap of $106,800 per year, yielding a maximum combined Social Security tax for any taxpayer of $13,243.  At this combined rate, Social Security taxes paid by a secretary (or on behalf of said person by his/her employer) earning $60,000 per year would be $7,440, or 12.4% of total earnings.  Buffett, with taxable income of roughly $40 million, paid the maximum Social Security tax of $13,243, or 0.03% of his earnings.

To the uninformed, this 12.37-percentage-point Social Security tax rate differential between Buffett and his secretary appears to buttress Buffett's argument of federal tax rate unfairness.  But what Buffett fails to mention (and what is never mentioned anywhere in any press accounts) is the fact that Social Security retirement benefits are capped as well.  While Buffett earns 667 times more than his secretary, his monthly Social Security benefit when he retires will be less than two times that paid to his secretary (and, because of the wage cap, it will be proportionate to what each of them will have paid into the system).  Put another way, if the combined Social Security tax rate of 12.4% were imposed against Buffett's total 2010 earnings of $40 million, the resultant Social Security tax of $4.96 million (paid by him or on his behalf) in one year would be roughly seven times the amount he could expect to receive in Social Security benefits over the entire duration of his retirement.  The capping of both the wage base upon which Social Security taxes are imposed and the ultimate amount of Social Security benefits derived leads to the mathematical optics that Buffett and his ilk draw upon in making their fallacious conclusions.  Social Security, flawed as it may be, is a system based on the premise that benefits derived from it are proportionate to what has been paid into it by all Americans -- rich, poor, or in between.  What a concept!  

Clearly, looked at in this way, Social Security tax rates should not be taken into account in any fair comparison of federal tax rates between Buffett and his office workers, thus eliminating 12.4 points of the 18.6-percentage-point federal tax rate differential claimed by Buffett.

Buffett's second flaw is that he includes Medicare taxes in his comparison.  The secretary noted above will pay (or have paid on his/her behalf) Medicare taxes at 2.9% of wages.  Buffett pays these taxes as well, but in the case of Medicare, taxes are assessed on all wages earned (there is no cap on Medicare-taxable wages).  But because the vast majority of Buffett's income is derived from non-wage sources (capital gains and dividend income), which are not subject to Medicare tax, his Medicare tax, as a percent of his taxable income, is likely near 1.0%.  Thus, another of 1.9 percentage points of the remaining 6.2-percentage-point differential is explained away, leaving a differential of 4.3 percentage points.

Another factor that is contributing to the alleged federal tax rate differential between Buffett and his office workers is the impact that dividend income (federally taxed on individual taxpayers at the rate of 15%) has on his effective federal tax rate.  The analytical deficiencies here are (1) that the money used to fund the investments that generated the dividend income has likely already been federally taxed, and (2) dividend income has already been federally taxed (at 35%) at the corporate level before the dividend is reflected as income on Buffett's personal federal tax return.  Buffett's true federal tax on his dividend income (including federal corporate taxes) is actually 69% of dividend income.  While Buffett does not disclose the amount of dividend income he reported in his federal tax return, if it constitutes 10% of his total taxable income (or $4 million), his true overall tax rate is 22.7%, not the 17.4% that he claims.  Under this reasonable assumption, the remaining 4.3-percentage-point differential between Buffett and his office workers disappears (and then some).

Buffett's analysis is further flawed because it ignores federal estate taxes on his accumulated wealth that will be assessed when he dies.  Given that this event will likely take place years into the future and that Buffett will certainly employ effective estate planning techniques to minimize these taxes, it is impossible to speculate on what his estate tax rate amount will be.  It is, however, safe to assume that his estate will be taxed at a significantly higher rate than that of his secretary.     

The remaining factor contributing to the tax rate differential between Buffett and his secretary is the impact of capital gains (federally taxed at 15%) on his overall federal tax rate.  Unlike the inaccurate analytical techniques exposed above, taxable income arising from capital gains does truly lower Buffett's effective federal tax rate.  Whether capital gains should receive favorable federal tax treatment is a subject of honest debate.  But in attempting to engage in this debate, Buffett loses all credibility when he states:

And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what's happened since then: lower tax rates and far lower job creation.

Astonishingly, Buffett is apparently ignorant of the fact that, without a doubt, the primary driver of the massive job creation between 1980 and 2000 was...lower federal tax rates!  In 1980, the highest federal income tax bracket was 70%.  This rate was lowered 1981 to 50% and further lowered to 38.5% in 1987 and to 28% in 1988.  It was these federal tax cuts that fueled the massive creation of jobs in the '80s and '90s.  The magnitude of the Reagan tax decreases that fueled this massive job creation was far higher than the tax decreases passed by George Bush in 2001.  So let's have the debate about federal tax rates.  But let's do so by basing our positions actual economic principles and not on egregiously flawed and erroneous historical perspectives.

As shown above, Warren Buffett's assertion that his federal tax rate is 18.6% higher than that of his office workers is clearly flawed and demonstrably false.  That this abject falsehood has been seized upon by President Obama and Democrats in the House and Senate as an argument to increase taxes on the "rich" is enormously troubling.  Obama, Buffett, and the Democrats are either ignorant of basic federal taxation concepts or they are deliberately propagating what they know are lies to fan the fires of resentment and class warfare in order to gain political support from the left.  Neither of these alternatives casts the president and his allies in a particularly favorable light.