“Any reform should follow another simple principle: Middle-class families shouldn’t pay higher taxes than millionaires and billionaires. That’s pretty straightforward. It’s hard to argue against that. Warren Buffett’s secretary shouldn’t pay a higher tax rate than Warren Buffett. There is no justification for it. It is wrong that in the United States of America, a teacher or a nurse or a construction worker who earns $50,000 should pay higher tax rates than somebody pulling in $50 million.”
--President Obama, September 19, 2011
We have to admit we had overlooked this part of President Obama’s Rose Garden speech until we read David Brooks’s column in The New York Times Tuesday accusing the president of being misleading on the issue of taxes. “He repeated the old half-truth about millionaires not paying as much in taxes as their secretaries,” Brooks wrote.
We’re not going to get into an argument between Brooks and Obama. We understood Obama’s comments to be specific to the situation that investor Warren Buffett outlined in his famous opinion article in The New York Times, in which he noted that he paid a lower tax rate than other people in his office. But, looking at Obama’s words again, we can see why Brooks thought Obama was saying that in general middle-class families were paying more in taxes than millionaires. (For the record, the White House says that was not Obama’s intent.)
Indeed, the plan Obama released on Monday simply states the “Buffett Rule” as this: “No household making over $1 million annually should pay a smaller share of its income in taxes than middle-class families pay.”
But the report never really explains what that means, and administration officials have refused to lay out any detailed proposal. Already, on average, most teachers, nurses, construction workers and the like already pay a lower rate than people making more than $1 million.
Still, there are so many numbers tossed around about taxes that it seems a good time to take a step back and look at the data. After all, Republicans frequently note that 50 percent of Americans pay no income taxes. So how is it that Democrats can complain that billionaires are paying a lower tax rate than their secretaries? And does the so-called “Buffett Rule” make sense as tax policy?
The numbers are so confusing because the data points are so different. Democrats speak of tax rate averages, and include payroll taxes (Social Security and Medicare). Republicans tend to focus on just federal income taxes and marginal rates, which is the tax on each next dollar of earnings.
There is vast income disparity in the United States, which is why under the progressive tax system, the wealthy already pay most of the income taxes.
In 2001, in a previous life, The Fact Checker wrote the first article that disclosed how much the 400 richest Americans pay in federal income taxes. The number at the time was calculated as $8.7 billion — about as much in federal income taxes as paid by 40 million individuals and families at the bottom of the income scale.
That article caused quite a stir at the time, and now the Internal Revenue Service regularly releases data on the top 400 taxpayers. The most recent information, for 2008, shows that the 400 wealthiest Americans paid $19.5 billion in income taxes. That seems like a lot, but their average (effective) tax rate was 18.11 percent, down from as much as 29.93 percent in 1995.
Averages don’t tell the whole story. Of the 400 taxpayers, 238 taxpayers paid a marginal rate of 35 percent, the top income tax bracket. That figure — which Republicans focus on — means that more than one-third of each additional dollar earned went to the federal government. However, various deductions and the like helped bring down the average rate. In fact, only 59 taxpayers in this rarified group had an effective tax rate of between 30 and 35 percent.
The Congressional Budget Office also has released reports looking at taxation across income classes.
In 2006, the most recent data available, the top 1 percent of taxpayers (about 1 million households), with a minimum income of $332,000, paid nearly 40 percent of all federal income taxes collected. The average income tax rate was 19 percent for this group, compared to an average rate of 14 percent for the top one-fifth of households (minimum income of $71,000).
However, these numbers do not include payroll taxes. Social Security tax is no longer collected once a person makes more than $106,800, so the share of such taxes declines quickly for wealthier groups.
Thus, the top one percent pay an effective rate of 1.6 percent on social insurance taxes, compared to an effective rate of about 9 percent for most other income groups. (The data are further distorted by the fact that some wealthy individuals, such as lawyers, are paid through corporate structures, so their taxes are listed as corporate income taxes.)
When you add up all of the various taxes, and look at the effective tax rates, it is clear the tax system is already pretty progressive. Everyone pays some tax, even those who pay no federal income taxes, and the wealthiest pay a larger percentage share of taxes. Here’s the effective tax rate for all of the groups, according to the CBO:
Lowest quintile (23.4 million taxpayers), zero to $18,900: 4.3 percent
Second lowest quintile (22.4 million), $18,900-$32,100: 10.2 percent
Middle quintile (22.9 million), $32,100-$47,400: 14.2 percent
Fourth quintile (23 million), $47,400-$71,200: 17.6 percent
Highest quintile (23.6 million), above $71,200: 25.8 percent
Top 10 percent (12 million), minimum income of $98,100: 27.5 percent
Top 5 percent (5.9 million), minimum income of $134,400: 29 percent
Top 1 percent (1.1 million), minimum income of $332,300: 31.2 percent
The Bottom Line
Maybe it’s not a good thing to make policy by anecdote.
It may well be the case that Buffett pays a lower average rate than his secretary. (Buffett, in his article, never says that; that’s the president’s characterization.) Buffett wrote that although he paid an average of 17.4 percent on his income, other people in his office had tax burdens that “ranged from 33 percent to 41 percent and averaged 36 percent.”
Those numbers actually seem rather high when you look at the tax data. As shown, on average, people at lower income brackets have much lower effective rates. (At least one tax expert, in fact, thinks Buffett confused marginal rates with average rates.) Buffett’s effective rate, in fact, is actually virtually identical to the rate paid by the top 400 taxpayers.
Perhaps people in Buffett’s office make enough money that they are hit with the alternative minimum tax, which really bites taxpayers making between $150,000 and $400,000. But that’s certainly not a category that includes, as Obama put it, “a teacher or a nurse or a construction worker who earns $50,000.”
More broadly, there are certainly some people making millions of dollars in the securities markets who are only paying 15 percent on their capital gains taxes, compared to the lowest tax bracket of 10 percent (which is applied on the first $8,000 of income). Add in payroll taxes, and there could be some instances where the effective tax rate of a middle-income person is less than the stock trader — but it does not appear that would be a common situation.
We don’t have enough data to make a Pinocchio ruling, but we were struck by the fact that at a White House briefing, administration officials resolutely refused to explain how the Buffett Rule would be put into effect. “Now, there are lots of different ways to achieve that principle,” Treasury Secretary Timothy Geithner said. “How you do it depends on what you do to the broader tax system as a whole. … We’re going to fight to make sure that's part of what Congress considers and ultimately delivers.”
In other words, it may be an effective political argument, even if it’s not really much of a problem.