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Solving The Buffett Conundrum On Taxes

03/26/2009 05:12 am ET | Updated May 25, 2011

Is President Barack Obama going to actually follow through on a vague promise he made on the campaign trail -- to fix the inherent unfairness of Warren Buffett paying a smaller percentage of his income in taxes than his secretary does? Call it the Buffett Conundrum: multimillionaires (and even some multibillionaires) pay less than half the tax rate as the employees who work for them (who make far less in income). But now, Obama has leaked his first budget outline, and it appears he is serious about attempting to fix this tax policy travesty.

This is a welcome surprise, since raising taxes on the rich is one of those things people like to talk about while campaigning... but seldom actually get around to doing. Both Barack Obama and Hillary Clinton (and others) drew attention to the Buffett Conundrum during their run for the presidency. But when asked directly what they would do to fix it, they both demurred at suggesting anything which would solve the Buffett Conundrum once and for all. It was, after all, campaign season, and while it's lots of fun to say something like "...those who are able to work the stock market and amass huge fortunes on capital gains are paying a lower tax rate than their secretaries. That's not fair." (Obama, during ABC debate 4/16/08), it's less fun to tell people that you're about to raise taxes.

The issue, in inside-the-Beltway-speak is "capital gains" versus "income taxes." Or, as it should be called "taxing the way the ultra-wealthy make money" versus "taxing the way that everybody else makes money." Because anything you do that makes you money (working in a job and getting a paycheck, working on commission, making money as a self-employed business, winning the lottery, dealing drugs, whatever...) is taxed as "income" -- except money you make trading things like stocks. That is "capital gains" and is taxed at a rate that is less than half of what you'd pay if you got such money as "income." In other words, people who make all their money on Wall Street have their own very special tax rate, and it is less than half of what everyone else has to pay. Special, indeed!

That's it in a nutshell. Now let's put some numbers on it. Income tax rates fall into "brackets" and the percent you pay on the money you make in each bracket is taxed at a fixed rate, from 10% in the lowest bracket to 35% in the highest. The highest bracket is currently historically low, which is Reagan's legacy. Coming out of World War II, the highest tax rate was 90%, and when Reagan took office it was 70%. Reagan lowered it considerably, and Republicans have been trimming it down further over the years until it is at the current 35%. When Obama talks about "repealing the Bush tax cuts," part of what he's talking about is raising the top rate from 35% to 39.6% (what it was when George W. Bush took office).

Then there are capital gains taxes. Currently, the highest rate anyone pays on capital gains (the top bracket) is 15%. You read that correctly. If you make a paycheck and make a million dollars, you are taxed at 35% and if you make the same amount of money trading stocks, then you are taxed at 15%. This is why Warren Buffett "pays a lower tax rate than his secretary," which even Warren Buffett points out is unfair.

Obama was directly asked how high he would raise the capital gains tax rate several times on the campaign trail. He started off rather vague, giving a range of "20% to 28%." That didn't satisfy reporters, and so he tried "capital gains rates that we had under Clinton," but again, this was too vague (this tax rate was lowered under Clinton, which was passed by the Republicans in Congress). Then it became "the tax rate when Clinton left office," or 20%. Hillary Clinton was even more disingenuous, as she used the Buffett Conundrum herself in talking points, but wouldn't even commit to raising the capital gains tax rate at all.

Anyone who can do math can easily see that raising the capital gains tax rate from 15% to 20% (or even 28%) does not solve the basic Buffett Conundrum problem, since Buffett would pay a bit more in taxes, but still less than the rate his secretary paid. Slightly raising capital gains taxes would make the gap between their rates smaller, but would not solve the inequity itself.

But from what I've heard about Obama's first budget proposal, Obama is going to really solve the problem. Or at least, he's going to try, for a limited group of people. From the New York Times last week:

The president will propose to tax the investment income of hedge fund and private equity partners at ordinary income tax rates, which are now as high as 35 percent and could return to 39.6 percent under his plans, instead of at the capital gains rate, which is 15 percent at most.

Senior Democrats in Congress joined with Republicans in 2007 to oppose that increase. But with Wall Street discredited and lucrative executive compensation a political target, the provision could prove more popular among lawmakers.

Mr. Obama will also call for letting the Bush tax cuts on income, dividends and capital gains lapse after 2010 for individuals who make more than $250,000 a year. But while the top rate for income would rise to 39.6 percent, the top rate for capital gains and dividends would be 20 percent.

So, for a very narrowly-defined group of people, tax equity will finally come. Maybe. Because after the congressional lawmaking meatgrinder gets done with Obama's proposal, this may be one of the things left on the committee room floor. Or the definition of who it applies to may be even-more narrowly defined. Look for this specific proposal to be quietly dropped at some point, in other words. Perhaps the inevitable criticism ("many lower-income Americans hold stocks") could be avoided by making capital gains totally tax free for anyone making less than $100,000 a year. It's worth a shot.

But whether it makes it into the final tax code or not, I have to at least salute President Obama for trying. He used the Buffett Conundrum repeatedly while campaigning, and the mere fact that he's trying to fix the problem in his first budget is impressive. I can't remember any other president even suggesting that it was a problem in the first place, so Obama is already in uncharted territory on the issue. And he's trying to do the right thing.

Because there is simply no reason why a hedge fund manager making millions of dollars a year should pay less than half the taxes everyone else pays. It makes no sense whatsoever. It is unfair by definition.

CNBC's Rick Santelli has been bizarrely framed as some sort of populist voice for his ranting about the unfairness of bailing out the mortgages of "losers." The traders on the floor behind him all joined in the weeping and wailing about how Obama was forcing them to "subsidize" these "losers," and taking money from their pockets to do so. But caution is always advised when inciting a populist mob. Because if the people agreeing with Santelli knew that Wall Street bigwigs paid less than half the taxes on the money they make as everyone else in America, then the populist mob might quickly find another target for their fury. Because all of us have been "subsidizing" these very fatcats themselves for far too long. And it's a lot easier to get outraged at millionaires than it is at some poor soul being foreclosed upon.

So it will be interesting to see if Obama talks about this tomorrow night when he addresses the nation. It will also be interesting to see if Obama really fights for this issue in the inevitable congressional wrangling over the final bill, or whether he allows it to be quietly removed (by Democrats or Republicans). But at least he has made the attempt, which is more than can be said about anyone else. For now, I give him credit for at least trying.

 

Chris Weigant blogs at: ChrisWeigant.com

 

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