Class Warfare and the Buffett Rule

Implementing a surtax on 'millionaires' would hurt just about everyone but the super rich like Warren Buffett.

By ARTHUR B. LAFFER

The political season has barely begun, and yet we already know that class warfare will be President Obama's key issue in the 2012 general election. It's even reared its ugly head in the Republican primaries, with the candidates trying to paint front-runner Mitt Romney as a cold-hearted capitalist and Rick Santorum proposing targeted tax breaks for the "working class" manufacturing sector.


But none in the GOP can compare with the progressive intelligentsia's obsession with tax increases on the rich to raise revenues and achieve social justice. In a New York Times op-ed last August, Berkshire Hathaway CEO Warren Buffett famously asked Congress to "stop coddling the super-rich," complaining that his effective tax rate was half that of the other people in his office. He then instructed Washington to raise tax rates on millionaires and billionaires like him and retain the employee payroll tax cut on those "who need every break they can get."
Waving Mr. Buffett's op-ed for all to see, Mr. Obama wasted no time in proposing a surtax on millionaires called the "Buffett Rule." Putting aside all the oohing and ahhing over Mr. Buffett's selflessness, his effective tax rate on his true income would hardly budge if this "Buffett Rule" were applied. What's worse, raising the highest tax rates would most likely worsen the budget deficit and lead to a further weakening of the economy. Everyone would suffer.
Mr. Buffett stated in his op-ed that he paid $6,938,744 in total income and payroll taxes in 2010, representing 17.4% of his taxable income, which puts his taxable income just under $40 million. Although certainly a fantastic sum, $40 million actually understates Mr. Buffett's income in 2010 by more than 250-fold.
Mr. Buffett's net worth rose by $10 billion in 2010 to $47 billion, according to Forbes Magazine. That increase, an unrealized capital gain, is part of his total income by any standard definition, including the one used by the Congressional Budget Office. After also including a $1.6 billion gift to the Bill and Melinda Gates Foundation, Mr. Buffett's true income in 2010 was much closer to $11.6 billion than the $40 million figure cited in his op-ed. Hence his true effective tax rate was only 6/100ths of 1% as opposed to 17.4%. And these are just the additions to his income that we know about.

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Barack Obama awards the presidential Medal of Freedom to Warren Buffett, February 2011.

The "Buffett Rule" would not tax the vast majority of his shielded income, including either his unrealized capital gains, which are currently taxed at zero percent, or charitable contributions, which are tax deductible. If the "Buffett Rule" were applied as President Obama proposes, then Mr. Buffett's federal tax bill would have been $14.4 million, rather than the $6.9 million he actually paid. As a fraction of his true income, his effective tax rate would only have risen from 6/100ths of 1% to 12/100ths of 1%.
Mr. Buffett's donation to the Gates Foundation goes to the heart of my critique of his public call for higher tax rates on the rich. Just look at the second contractual condition for his ongoing pledge to the Gates Foundation: "The foundation must continue to satisfy the legal requirements qualifying Warren's gift as charitable, exempt from gift or other taxes."
In other words, if his gift weren't tax sheltered he wouldn't give it. So much for "shared sacrifice."
Incidentally, I'm not the first to question Mr. Buffett's commitment to "shared sacrifice" in balancing the federal budget. In a 2007 CNBC interview, when asked why he shelters his money through tax-free strategies rather than writing big checks to Uncle Sam, Mr. Buffett responded: "I think that on balance the Gates Foundation, my daughter's foundation, my two sons' foundations will do a better job with lower administrative costs and better selection of beneficiaries than the government."
So Mr. Buffett thinks he and his family can put their money to better use than the government can. I guess he's really not so different from the rest of us after all.
Mr. Buffett also stated in his op-ed that in his 60 years working with investors he has yet to see anyone "shy away from a sensible investment . . . even when capital gains rates were 39.9% in 1976-77." Mr. Buffett's choice of 1976-77 is prescient because the economy in 1977 was a basket case. The official Bureau of Labor Statistics unemployment rate was 7.1%, consumer price inflation was 6.7%, and the S&P 500 dropped a whopping 17% after adjusting for inflation. Indeed, 1977 is a good illustration of the type of economy Mr. Buffett's policies would deliver.
He also said in his op-ed that "people invest to make money, and potential taxes have never scared them off." To make his point he compares the 1980-2000 period when 40 million jobs were created to what's happened since 2000 with lower tax rates and fewer jobs created.
Surprisingly, Mr. Buffett is actually trying to cite the phenomenal growth during the Reagan-Clinton period of 1980-2000 as a result of high taxes. But the facts reveal that the 1980s and '90s should be used as Exhibit A for why Mr. Buffett's proposals are dead wrong. Between 1980 and 2000, the top marginal income tax rate was slashed to 39.6% from 70%, and between 1977 and 1997 the capital gains tax rate was cut to 20% from 39.9%.
When it comes to raising tax revenues by raising tax rates on the rich, Mr. Buffett would again appear to be on the wrong side of the argument. Between 1921 and 1928, the top marginal income tax rate fell to 25% from 73%. During this period, tax receipts from the top 1% of income earners rose to 1.1% of GDP from 0.6% of GDP. The top income tax rate dropped to 70% from 91% after the Kennedy tax cuts began in 1964, while tax receipts from the top 1% of earners rose to 1.9% of GDP from 1.3% of GDP in the period 1960 to 1968. By the way, these periods were two of the biggest booms in U.S. history.
Guess what was the third period of boom? Since 1978, the top earned income tax rate fell to 35% from 50%, the top capital gains tax rate fell to 15% from 39.9%, and the highest dividend tax rate fell to 15% from 70%. After taking office in 1993, President Clinton virtually eliminated the capital gains tax from the sale of owner-occupied homes and cut government spending as a share of GDP by the largest amount ever.
Meanwhile, the top 1% of earners saw their tax payments climb to 3.3% of GDP in 2007 from 1.5% of GDP in 1978, while the bottom 95% saw their tax payments drop to 3.2% of GDP in 2007 from 5.4% of GDP in 1978. Why would Mr. Buffett want to reverse these numbers?
Of course, cynics and die-hard progressives might object to the above evidence on the grounds that it was driven by an explosion of income gains. But that's largely the point.
Mr. Laffer, chairman of Laffer Associates and the Laffer Center for Supply-Side Economics, is co-author, with Stephen Moore, of "Return to Prosperity: How America Can Regain Its Economic Superpower Status" (Threshold, 2010).