As Americans complete their tax returns U.S. Senators are preparing to cast an important vote on tax fairness. Early next week the Paying a Fair Share Act of 2012 (S. 2230) will be put to a vote. The bill, sponsored by Sen. Sheldon Whitehouse (D-RI), codifies the “Buffett Rule,” the principle that no millionaire should pay a smaller percentage of income in taxes than middle-class families.
Though the Fair Share Act aims to implement a principle of tax fairness that should be uncontroversial, it has become a lightning rod for criticism, much of it misplaced. So it’s worth focusing on what the Fair Share Act will and won’t do.
What the Buffett Rule will do
Under the Fair Share Act, taxpayers with adjusted gross incomes of more than $1 million who pay less than 30 percent in federal income and payroll taxes under the existing tax code would be subject to an additional “Fair Share” tax to make up the difference. (Between $1 million and $2 million, taxpayers would pay an increasing portion of the difference because of the bill’s phase-in.) Taxpayers would be allowed to deduct charitable contributions before figuring whether their effective tax rate is lower than 30 percent.
The Buffett Rule would address a number of critical issues:
1. The Buffett Rule will restore a sense of fairness by ensuring that no millionaire is paying a lower tax rate than middle-class families
Some conservatives have claimed that the Buffett rule is “trying to solve a problem that doesn’t exist” and that there isn’t a problem with millionaires paying a lower tax rate than average American families. But let’s consider the facts.
- According to an analysis by the nonpartisan Congressional Research Service, 25 percent of millionaires pay a lower effective tax rate than 10 million Americans who earn less than $100,000. This includes 4,000 “ultramillionaires” (those making more than $5 million a year) who pay a lower tax rate than average Americans.
- The top 400 richest Americans – a group whose incomes averaged $270 million – paid an average rate of only 18 percent in 2008, according to data from the Internal Revenue Service. The vast majority (85 percent) paid a rate of less than 30 percent.
- According to the IRS, there were 1,470 households with more than $1 million in “adjusted gross income” who managed to pay no federal income taxes at all in 2009.
Conservatives are certainly entitled to believe that this isn’t a problem, but it is true that a great many millionaires pay a lower tax rate than average Americans. When a millionaire pays a lower tax rate than an average American family, it is not an anomaly. This is a commonplace occurrence every Tax Day. The Buffett rule offers a fix for unfairness in the tax system that is both real and pervasive.
Further, there is no evidence that the rich are currently overtaxed. In fact, the share of taxes paid by the rich is about proportional to their share of income, when all taxes, including federal payroll taxes and state and local taxes are included. The richest 1 percent of taxpayers take home 20.3 percent of the nation’s income and pay 21.5 percent of the taxes, according to an analysis by the Institute on Taxation and Economic Policy. In other words, the overall tax system is only slightly progressive. And in many specific instances, it is upside-down, with millionaires contributing less than those below them on the income scale.
2. The Buffett Rule will require those who have captured an outsized share of the gains to finally contribute to deficit reduction
Over the past three decades the top 1 percent has captured more of the nation’s riches, yet the burden of deficit reduction has so far fallen squarely on the middle class. Since 1980 the incomes of the top 1 percent have nearly quadrupled in real terms, while the share of income going to the richest 1 percent of Americans has more than doubled. And the wealthiest 1 percent now owns more than 40 percent of all the wealth in America. Inequality has reached levels not seen since the 1920s. Given the disproportionate share of the nation’s prosperity that has gone to the rich, it makes sense that we should ask them to contribute to reducing the deficit.
But we haven’t. Instead, measures adopted over the past year aimed at reducing the deficit have consisted entirely of spending cuts that mostly harm the middle class. The Budget Control Act, which was enacted into law with bipartisan support last summer, achieves deficit reduction through discretionary spending cuts. And House Republicans would take these spending cuts even further, while also offering tax cuts for the richest 1 percent. Slashing investments in education, infrastructure, research, and safety net programs—the key drivers of economic growth and mobility—puts the burden of deficit reduction on the middle class and cripples future economic growth. The Buffett Rule would help distribute the burden of deficit reduction to include those who can most afford it.
3. The Buffett Rule will make a sizeable contribution to reducing deficits
Among the many arguments lobbed against the Buffett Rule is that it would only raise a “meager” amount of revenue. In fact, the Buffett Rule would significantly contribute to meeting our fiscal challenges.
The congressional Joint Committee on Taxation estimated the Buffett Rule to raise $47 billion in additional revenue over 10 years. But that estimate was against a “current law” baseline that assumes that the Bush tax cuts expire—a scenario that would result in hundreds of billions in additional revenue from high-income taxpayers. In other words, the $47 billion would be on top of the revenue from ending the high-end Bush tax cuts. An estimate from the Institute on Taxation and Economic Policy using the same baseline but different assumptions about behavioral responses estimates Sen. Whitehouse’s bill would raise $171 billion in revenue over 10 years.
Against a “current policy” baseline, the Buffett Rule legislation would raise more than three times as much, or $160 billion over 10 years, hardly a meager amount. That amount exceeds the budget savings that the House Republican budget gets from cutting federal nutrition assistance. Even the lower $47 billion amount is about enough to prevent interest rates on new student loans from doubling, as is scheduled to happen on July 1, and to make the lower rates permanent.
In addition, Sen. Whitehouse’s bill is only a first step toward a fairer and more adequate tax code—essentially a failsafe mechanism to ensure basic fairness. It carefully shields everyone making less than a million, even those making $999,999, from any tax increase. To do so, it is necessary to phase in the “Fair Share” tax between $1 million and $2 million of income, which results in less revenue.
In addition, the Joint Committee made fairly clear that it assumed millionaires would seek to avoid the Fair Share tax through tax planning, such as delaying asset sales from one year to the next. If the Buffett Rule were implemented as part of broader tax reform that reduced the disparities in the treatment of wage and investment income, such strategies would be less prevalent. That would result in both a fairer tax code and significantly more revenue.
Buffett Rule critics often compare the budget savings from the Fair Share Act to the size of future deficits. That’s a false comparison because no single policy can come close to closing deficits on its own. But the Buffett Rule is a step in the right direction, and an essential part of any balanced approach.
What the Buffett Rule won’t do
A number of claims have been lobbed against the Buffett Rule, none of them compelling. It’s worth setting the record straight about what the Buffett Rule won’t do.
1. The Buffett Rule won’t harm small businesses or job growth
A frequently used claim is that since millionaires are small-business owners, we cannot raise taxes on millionaires without harming small businesses. For example, Rep. Paul Ryan (R-WI) has said, “When we think of millionaires in the tax code, we often think of Aaron Rogers or Prince Fielder or a movie star… It’s mostly small businesses.” He’s flat-out wrong.
Small business owners are not millionaires. A report by the Office of Tax Analysis at the U.S. Treasury found that millionaires only own 3.3 percent of small businesses. In reality, the vast majority of small businesses are owned by taxpayers who make under $200,000 a year. Furthermore, the report found that only 2.5 percent of millionaires’ income comes from small businesses. There simply isn’t much overlap between millionaires and small-business owners. For this reason, the Buffett Rule would have no effect on the vast majority of small businesses.
Nor will raising taxes on millionaires hurt overall economic growth. Despite the conservative dogma that we need to cut taxes on “job creators” in order to facilitate growth, most economists and small-business owners agree that lack of consumer demand is hampering growth—not high taxes. The National Federation of Independent Businesses, a small-business organization, reported again this month that sales are still the most important concern for their members, as has been the case since July 2008.
Indeed, economists ranging from Federal Reserve Chairman Ben Bernanke to those surveyed by the Wall Street Journal have all cited a dearth of demand as the biggest factor holding back job creation. Millionaire entrepreneur and venture capitalist Nick Hanauer puts it this way: “An ordinary middle-class consumer is far more of a job creator than I ever have been or ever will be.”
Requiring the ultra-wealthy to pay at least 30 percent is not a heavy burden. Millionaires were paying an average effective federal income tax rate higher than 30 percent as recently as the 1990s, a time of strong economic growth and small-business job creation.
2. The Buffett Rule won’t affect the middle-class … not even close
Some Buffett Rule critics have advanced the creative argument that the Buffett Rule could eventually become a tax on the middle-class. Republican economist Douglas Holtz-Eakin writes that the Buffett Rule could mean “another alternative minimum tax,” which, he says “stands as a perennial threat to the middle class because it was never indexed to inflation.”
But the Fair Share Act expressly indexes the $1 million threshold to inflation. In any event, at the rate that median household income has grown in recent decades, it would take nearly a half-century before a family earning $200,000 would hit $1 million in annual income. (In nominal terms, median household income as measured by the U.S. Census Bureau has grown by 3.6 percent since 1980.) There is no chance, therefore, that the Fair Share tax would apply to the middle class, now or ever.
3. The Buffett Rule won’t preclude tax reform, and in fact is a step toward tax reform
Other Buffett Rule critics argue that more fundamental tax reform is preferable to the Buffett Rule. But it is not an either-or proposition. Nothing about the Buffett Rule would make future, more comprehensive tax reform less likely.
The refrain “what we really need is fundamental tax reform” has ironically become the most common defense of the status quo. The prospect of some future, idealized tax reform is used as an excuse for officeholders not to exercise any leadership on taxes in the present. But tax reform is extremely difficult. It hasn’t happened in more than 25 years—and there are large disagreements on the fundamental question of whether revenues should even be a part of any long-term deficit solution.
There is simply no need to wait until all aspects of the tax code are overhauled before addressing one glaring area of unfairness. That’s like refusing to fix a leaky faucet because you are planning to remodel the kitchen some day. The Buffett Rule vote provides an opportunity to make a modest, but important, improvement to the tax code, both in terms of fairness and in terms of raising sufficient revenue.
A vote for the Buffett Rule is a vote to move forward in addressing national challenges with balance and fairness.
Seth Hanlon is Director of Fiscal Reform and Sarah Ayres is a Research Associate at the Center for American Progress.
. Estimate by the Senate Budget Committee.