The Buffet Rule and Double Taxation

by Craig J. Walenta
1/24/2012

President Obama has called for tax fairness invoking the oft repeated statement that Warren Buffet’s secretary pays a higher rate than Warren Buffet himself.

Government spending as a percentage of GDP (gross domestic product) now exceeds 40%. Obviously the government is running a budget deficit and is borrowing, heavily I might add, but total government spending still remains the best overall measure of the actual impact of taxation on a society. Literally 40% of all the goods and services produced in the United States move from the private sector to the public sector.

The Democrats and Republicans in Congress, because ultimately it’s the Congress that spends the money and both parties are jointly and severally liable for the spending, have enacted social programs and military programs that are not sustainable. The realization has suddenly come to fruition that the United States is going to have difficulty borrowing in excess of a trillion dollars per annum.

Naturally, in this nation’s march to emulate the European social market economy, President Obama needs to make the case to the American people that taxes need to be raised. And if the social market economy is the goal, he is correct. Nevertheless, Americans have proven to be leery of new taxes, so the government needs an argument, and preferably an equitable argument to justify increases in taxes.

Of course, a general tax increase is completely out of the question, President Obama might lose the 2012 election as a result and the Republican House certainly won’t agree to a general tax hike, so, in order to make tax increases politically palatable, naturally those tax increases need to be on the rich, the 1%, those making over $250,000 per year, who, by the way aren’t in the 1%.

This argument is based on Warren Buffet’s statement that he pays a lower rate on his income (17%) than his secretary, who ostensibly pays higher rates based on her ordinary income as an employee of Berkshire Hathaway. Of course, looking at this myopically, it would seem quite equitable that somebody as wealthy as Buffet should pay a rate higher than his much poorer secretary. Most reasonable people would actually agree with that basic premise.

Nevertheless, the Buffet Rule is based on a fallacy, a false premise. Buffet’s individual rate of taxation on the 1040 that he files might very well be 17%, honestly I haven’t seen it; but to get a rate of this nature necessarily requires that a significant portion of the income be in the form of long term capital gains. Long term capital gains are taxed at 15%. This is not the totality of the taxation however. Buffet gets taxed on the long term capital gain at 15%, plus he pays the reduced value he receives for his shares since the corporation paid taxed over the course of Buffet’s ownership of the shares.

Corporations in the United States are subject to double taxation. The Buffet Rule and the premise underlying the equity of that rule focuses on only one half of that double taxation and completely omits the other half from the analysis.