Mon, 10 Aug 2015 09:42:43 GMT
The table below demonstrates two types of unfairness: taxpayers at the same income level with different effective tax rates, and taxpayers at a very high income level with a lower effective tax rate than taxpayers who have much less income. This second problem, which is highlighted by the circled figures and arrows, is what the Buffett Rule seeks to resolve. Both problems are caused by the fact that certain types of investment income are taxed less than other types of income.
The Buffett Rule is named for the super-successful investor Warren Buffett, who makes tens of millions of dollars each year but has said he pays a lower effective tax rate than his secretary, who makes about $60,000. The left side of the table below divides people like Mr. Buffett’s secretary (people making between $60,000 and $65,000 annually) into three groups, depending on how much of their income they receive from investments. Over 90 percent of these taxpayers fall into the third group of taxpayers, who receive less than a tenth of their income from investments. The right side of the table divides people like Mr. Buffett (people making over $10 million annually) into the same three groups depending on how much of their income they receive from investments. These taxpayers are far more likely to receive most of their income from investments. Almost a third of these taxpayers are in the first group, who receive over half of their income from investments — and, as a result, pay a smaller percentage of their income in federal income and payroll taxes, on average, than the 90 percent of taxpayers in the $60,000-$65,000 income range who receive less than a tenth of their income from investments. Investment income is taxed less than other types of income in two ways. First, the personal income tax has special, low rates for two key types of investment income (long-term capital gains and qualified stock dividends), including a top rate of 15 percent. Second, the payroll taxes that apply to wages do not apply to investment income.
Average effective tax rates are estimated here as federal personal income taxes and federal payroll taxes divided by reported income. The payroll taxes include the 12.4 percent Social Security tax that applies to the first $106,800 of wages earned and the 2.9 percent Medicare tax that applies to all wages. This includes both the half of payroll taxes paid directly by employees and the half paid directly by employers. (Economists agree that even the employer half of the tax is ultimately borne by employees in the form of reduced wages and benefits.)The effective tax rates for the groups of taxpayers are shown as averages and there is, of course, variation within those groups. For example, Mr. Buffett has said that his secretary, who made $60,000 annually, paid about 30 percent of his or her income in federal personal income and payroll taxes. The secretary would likely fall into the third group of taxpayers with less than one tenth of income coming from investments. The average effective tax rate for this group is 21.3 percent, but the secretary’s rate is above the average, probably for several reasons. Married couples within this group will have lower effective rates, and the secretary may be single. Also, this group includes some recipients of Social Security benefits, most of which are not taxed. Assuming the secretary is single and receives $60,000 of income entirely from wages in 2011 and does not itemize deductions, he or she would pay $8,750 in federal income taxes and $9,180 in federal payroll taxes, which combined are 29.9 percent of his or her income.