President Obama has lately been urging the enactment of tax legislation to implement the "Buffett Rule," which, according to his reelection campaign website, "would require the wealthiest Americans to pay a tax rate at least as high as the middle class."
The basic idea appears to be mathematical, or at least arithmetical. For each individual, you can make an equation where taxes paid are the numerator and some measure of income is the denominator. The Buffett Rule posits that the amount thus computed should be at least as high for the wealthiest Americans as it is for those individuals who are defined as representing the middle class.
Thus, if a middle-class individual earns $50,000 and pays $12,500 in relevant taxes (i.e., one-quarter), then a wealthy individual who earns $100 million should also pay at least 25 percent (i.e., $25 million).
The underlying computation, often called the average tax rate (as compared to the marginal tax rate that applies to your last dollar) is familiar. A number of conceptual problems emerge in trying to use it this way, however.
What's in the numerator? - Presumably not just income taxes, which is the usual Republican ploy to ignore the less progressive levies in our fiscal system. Thus, payroll taxes to finance Social Security and Medicare would presumably be included. But what about the benefits from those programs? Note, for example, that while Social Security taxes, considered in isolation, are extremely regressive, going from 12.4% to zero at around $100,000 of annual earnings, the program as a whole is progressive on a lifetime basis unless high-earners live significantly longer.
Likewise, what about non-federal taxes, which generally are less progressive but may vary significantly? Or the corporate tax, which is indirectly paid by the shareholders? While it has uncertain economic incidence, this issue would exist even if the shareholders paid it directly. What about the expected present value of future taxes on current earnings? This, by the way, is a huge issue in thinking about income tax versus consumption tax progressivity.
What's in the denominator? - Here we presumably don't mean taxable income, or else a system with graduated rates would automatically satisfy the Buffett Rule. But how far are we going towards a measure of economic income? Does all unrealized economic gain count? That would be a huge change, and perhaps a good one, but it would go way beyond anything the Buffet Rule could seriously be thought of as aiming at.
And once you start thinking about items that might be added to the denominator, you may realize that you need to think more about the numerator. Thus, suppose tax-exempt municipal bonds pay 3%, while taxable bonds pay 4%. A high-bracket municipal bondholder is effectively paying an "implicit tax" of 25%. Thus, suppose Warren Buffett holds $100 million in municipal bonds, on which he earns $3 million of tax-exempt income. In performing the computation, rather than adding zero to the numerator and $3 million to the denominator, shouldn't we add $1 million to the numerator and $4 million to the denominator? For a wide range of tax-favored assets, however, these computations will be very difficult to make, and once again far beyond the Buffett Rule's apparently intended scope.
Okay, enough. I understand that this somewhat crude and simplistic idea is in fact a potentially clever marketing device that may serve both (a) to support changes in the direction that I favor, which is increasing the relative tax burdens of the wealthiest Americans in an era when we have massive long-term budgetary shortfalls and they have shot away from the rest of us economically as if propelled by a nuclear rocket launcher, and (b) to dramatize the fact that our current system's progressivity is nothing close to what it may seem if you naively consult the income tax rate tables.
In that sense, the Buffett Rule could have some good effects, relative to the status quo, both on political debate and on the state of the tax law if it leads to some enactment. But it encourages a host of distracting debates about side issues so far as the true points of interest are concerned. And it may discourage focusing more directly on the real issues of tax preferences and after-tax income distribution. And it could lead to the enactment of Rube Goldbergish, alternative minimum tax-style rules, as compared to more straightforwardly broadening the base and increasing high-end marginal rates. Just like the AMT since 1986, moreover, it might be subject to slow-motion unwind, such as legislation removing a particular tax preference from the Buffett tax computation so that the ostensibly wonderful reasons for enacting the item could be fully realized.
So while the Buffett tax may be a clever rhetorical initiative in some respects, I wish they could have come up with something that was substantively more coherent and better. But I suppose that's just one more reason why I'm here (in academics) and they're there (in politics).