This morning, as part of his broader deficit reduction plan, President Obama called for a new rule that would raise taxes on the the wealthiest Americans. The proposal was quick to spark reaction from Republicans, who labeled it “class warfare.”
But politics aside, we thought it would be helpful to run through what’s actually known about the proposal, the impact it might have on the deficit, and the history behind it all.
So what, exactly, is the plan?
President Obama’s plan would require households making more than $1 million annually—and the president is one of them—to pay a certain minimum percentage in taxes that matches the rate at which middle-class households are taxed. (Think of it as a simpler version of the overly complicated alternative minimum tax, which was enacted to ensure that even with their many deductions, rich taxpayers still paid a minimum percentage in income taxes.)
Are there any more details?
Nope. The White House has left it quite vague. In fact, it’s unclear how serious the proposal is at this stage.
The president hasn’t yet specified at what rate the millionaires should be taxed. And as the New York Times puts it, administration officials have said that the plan is more of a guiding principle for negotiations. Indeed, they haven’t included its potential revenue in the president’s larger plan to trim $3 trillion from the deficit.
Here’s the White House’s own description of what it’s calling the “the Buffet Rule” [PDF]:
The plan calls for the Congress to undertake comprehensive tax reform that lowers tax rates, closes loopholes, boosts job creation here at home, cuts the deficit by $1.5 trillion, and observes the Buffett Rule—that people making more than $1 million a year should not pay a smaller share of their income in taxes than middle-class families pay.
Of course, however vague the plan, it plays to the preferences of voters—the majority of whom support raising taxes on wealthy Americans in order to reduce the deficit, according to recent polls.
Why is it called the Buffett rule?
Warren Buffet, an investor and America's second wealthiest person, has repeatedly argued that it’s wrong that he and his other “mega-rich” friends are taxed at a lower rate than middle-class taxpayers—including the secretaries and receptionists who work for them.
Buffett has been making this argument for years, and in 2007, Greg Mankiw, the former chairman of George W. Bush’s Council of Economic Advisers, argued that his numbers were misleading. Buffett’s tax burden was proportionally low not because of tax rates, but because he was clever enough to keep his taxable income low, Mankiw suggested. He also said Buffett’s calculations don’t apply to millionaires who make most of their income through their actual salaries, which would be taxed at rates approaching 35 percent.
Other critics have said Buffett’s proposal amounts to class warfare—essentially, ganging up on the rich and successful. To that argument, Buffett responded in a 2006 interview: “There’s class warfare, all right. But it’s my class, the rich class, that’s making war, and we’re winning.”
What’s the rationale behind the proposal to tax millionaires?
Obama’s proposal is designed to focus attention on America’s rising income gap and increase the “progressivity of the tax code” to balance it out.
Tax rates for the richest Americans today are at or near the lowest they have been for most of the last 50 years.
On the whole, the wealthiest Americans now pay a smaller percentage of their income as taxes than the average taxpayer. According to the Wall Street Journal:
The average tax rate for the top 400 earners in the U.S. fell to as low as 16.62% in 2007 from a recent peak of 29.9% in 1995. It ticked up again in 2008 to 18.11%, according to the latest annual Internal Revenue Service analysis of returns.
Why do the rich pay a lower percentage than other people?
A huge component of this is the capital gains tax, which investors have to pay on the profits they make from selling stocks, bonds or real estate. For long-term investments, that tax rate is capped at 15 percent—much lower than the rate at which wages and salaries are taxed for most people.
The Washington Post recently wrote a great piece that explains how the tax on capital gains primarily benefits the wealthy, who earn a far larger slice of their income via stocks and bonds than do middle-class Americans:
Over the past 20 years, more than 80 percent of the capital gains income realized in the United States has gone to 5 percent of the people; about half of all the capital gains have gone to the wealthiest 0.1 percent.
Have the capital gains taxes always been so low?
No. In 1986, the the Tax Reform Act backed by President Reagan and key congressional Democrats eliminated the special treatment for capital gains and dividends by bringing the peak tax rates for salaries and investments to the same level—28 percent.
But as the Post details, under the Clinton and George W. Bush administrations, the capital gains tax rate was bumped down to a historic low—thanks in large part to Fed Chairman Alan Greenspan, who advocated getting rid of the tax.
Are there any proposals to change the capital gains tax?
Yes. At least five GOP presidential candidates have said they support eliminating it although doing so would almost certainly increase the deficit. They argue that eliminating it would spur investment and economic growth.
Meanwhile, President Obama’s bipartisan fiscal commission proposed raising the capital gains tax to match the tax rate for ordinary income. According to economist Leonard Burman at Syracuse University’s Center for Policy Research, it’s not clear that the current historically low capital gains tax has had any effect on economic growth.
How much money would these millionaire taxes raise, and what impact, if any, would it have on reducing the deficit?
It’s hard to know until the actual tax rate is decided, but the Wall Street Journal has described the proposal: "unlikely to have much practical impact on federal deficits anytime soon.”
Ezra Klein’s WonkBlog reviewed a few past proposals that involve higher taxes on millionaires, and they were all over the map, both in terms of total dollars and years measured. One would raise a modest $10 billion over three years, while two others would raise $500 billion or nearly $1 trillion over 10 years respectively.