Tax System Favors Wealth Over Work

Tea Partiers rage against taxes and say they’re too high. Wrong, says billionaire Warren Buffett, on the rich they’re too low.

The Tax Code holds the answer to this standoff, and the Code backs Buffett. Taxes may be the bane of the Tea Party, but they’re a relative boon for the wealthy. Let’s look at some of the ways America’s tax system keeps Warren Buffett’s fortune in Warren Buffet’s hands.

The major vehicle is George W. Bush’s 15 percent levy on long-term capital gains—the lowest since FDR’s first term—and on corporate dividends. The top 1 percent of U.S. households owns nearly 40 percent of all privately-held stock, from which the dividends flow. Similarly, the super rich get more than half their income from capital gains. In the meantime, for the working middle-class, the tax rate on wages is 25 percent.

Taxing income from wealth at little more than half the rate of income from work: it’s the perfect recipe to make sure that Warren Buffett (and all the Buffett wannabes) pay effective tax rates far below what their incomes suggest.

How far below? In 2006, Buffett told an interviewer that his tax bill was “far, far less as a fraction of his income than the secretaries or the clerks or anyone else in his office” (and he repeated the statement only recently). His shame in 2006 hits home still: “How can this by fair? How can this be right?”

The Tax Code sets marginal rates too, and these were gutted by President Reagan in 1981 and again in 1986. He slashed the top rate from 70 to 28 percent, and made the Code even less progressive by cutting the number of brackets from 15 to four. The yearning for tax simplification (fewer brackets) trumped the case for progressivity (more brackets).

There are six today, with the top four at 25, 28, 33 and 35 percent—a narrow spread, easily offset by provisions like the capital gains rate. The top rate kicks in at about $400,000 of taxable income, which author and tax expert David Cay Johnston calls “bizarre.” It’s a long way, he argues, from $400,000 to $1 million, $5 million, $100 million and hedge-fund billions: “Why don’t we have higher rates for those incomes?”

Even the bottom marginal rates help top earners. A millionaire, filing singly, pays the same 10 percent on the first $8,375 of taxable income as the working poor—and so on, up the income scale. As the Center on Budget and Policy Priorities notes, the real winners from extending Bush’s middle-class tax cuts wouldn’t be middle class: “In fact, a family making more than $1 million will receive more than five times the tax cut benefit, in dollar terms, as a middle-class family making $50,000 to $75,000…” (Italics in original.)

The Tax Code is also loaded with deductions that effectively rain dollars down on the rich. The Code doesn’t overtly discriminate, but it’s hardwired to make every tax break worth more at the top. All deductions get written off at 35 percent, starting with personal exemptions and standard deductions. This alone trims $7,315 off the tax bill of a post-65 couple. The serious money goes to itemizers, with Uncle Sam handing out five-figure amounts to help pay mortgages on pricy real estate.

President Obama once proposed capping the mortgage interest deduction at 25 percent, the middle class rate. His idea quickly died, attacked as class warfare. This summer, in a piece titled “The Class War We Need,” conservative columnist Ross Douthat was aghast to learn that the owners of McMansions were defaulting at twice the usual rate. “The rich are different from you and me,” he wrote. “They know how to game the system.”

They also know that Congress always stands ready to tilt the tax laws their way. When the market crashed in 2008, lawmakers rushed to pass a one-year suspension of required distributions from retirement accounts. Only the haves stood to gain. Those who actually needed the distributions had to take them and pay taxes. The haves took a pass and saved thousands. Back to Douthat: “In case after case, Washington’s web of subsidies and tax breaks effectively takes money from the middle class and hands it out to speculators and have-mores.”

It’s taken a fortune in lobbying, but America’s tax system is bearing golden fruit. As even a conservative can see, it’s shifting income to the wealthy.