In his State of the Union address last week, President Obama used billionaire investor Warren Buffett's secretary, Debbie Bosanek, as a prop to illustrate the unfairness of our tax system. "Right now," he said as Bosanek sat near first lady Michelle Obama, "Warren Buffett pays a lower tax rate than his secretary."
Commentators spent the next week speculating about what Obama meant. Was he referring to marginal rates or effective rates? On taxable income or adjusted gross income? Was he talking about federal income taxes or payroll taxes, as well? If the latter, was he counting the so-called employer's share or just the employee's share? What about state income taxes?
As is often the case with taxes, things got complicated pretty quickly. Much of that complexity is unnecessary, and it helps explains why taxpayers dread this time of year, when they start pulling together the evidence they need to make their case to the IRS: Take my money, please, but don't peruse, penalize or prosecute me. The headache-inducing complexity of the tax code is also a major reason for the unfairness Obama decries. Yet the policies he recommends would only make the problem worse.
There seem to be two main factors that explain why Bosanek pays a larger share of her income in taxes than Buffett does. First, she earns a salary, while her boss's income consists mostly of dividends and capital gains, which are taxed at a lower rate. Second, payroll taxes are assessed on just the first $100,000 or so of income.
One possible response is to raise the tax rate for dividends and capital gains so it is the same as the rate for wages. But there's a strong argument for reducing the rate, currently 15 percent, even further -- all the way to zero, since these earnings either already have been or will be taxed as corporate income. Indeed, Harvard economist N. Gregory Mankiw argues that Buffett underestimates his tax rate because he does not take into account the corporate taxes he pays indirectly as a shareholder.
As for payroll taxes, Buffett is right when he says they are highly regressive. But instead of raising the "wage base," why not abolish the taxes? Congress spent Social Security's surplus on other things for many years, and now it has to put money back into the program because annual payroll tax revenue no longer covers benefits. Pretending these are separate piles of cash serves only to obscure our tax burden and the federal government's fiscal condition.
Obama's idea of "tax reform," by contrast, is the "Buffett Rule," which says "if you make more than $1 million a year, you should not pay less than 30 percent in taxes." This is just a new wrinkle on the alternative minimum tax (AMT), which the national taxpayer advocate calls "the poster child for tax-law complexity," the "most serious problem facing taxpayers." The AMT, itself grotesquely complicated, was a response to the complexity that allows rich people to avoid taxes. It has morphed into a covert mechanism to spring tax hikes on people who are decidedly not rich.
The AMT encapsulates the problems with a system so byzantine that even Mitt Romney, a wealthy, financially sophisticated guy with plenty of expert help, can't figure out how much he owes. New York Times financial columnist Floyd Norris reports that the Republican presidential candidate overpaid by about $44,000 last year because of a capital gains miscalculation.
Yet in the same speech where Obama condemned the "loopholes and shelters" that rich people use to avoid paying their "fair share," he promoted policies that compound the complexity, including special breaks for college students, "companies that hire vets," "small businesses," "high-tech" manufacturers, "clean energy," energy-conserving building improvements and "companies that choose to stay here and hire here in America." This insistence on using taxes for economic meddling and social engineering has made the system the hideous mess it is today.