Millionaire's tax will be a tough sell

Obama's proposed 'Buffett Rule' aims to cut an advantage the wealthy enjoy because of lower taxes on investment income from dividends and capital gains. Critics say it will hurt the market.

By MSN Money Partner Sep 19, 2011 11:03AM

By The Wall Street Journal

 

President Barack Obama's proposal to raise taxes on some millionaires will likely please members of his party, but it is unlikely to have much practical impact on federal deficits anytime soon.

 

The Wall Street JournalThe concept, part of a package of ideas the administration is taking to Congress, seeks to establish a minimum tax rate -- as yet undetermined -- for households with annual incomes above $1 million. The broad aim would be to counter the decline in effective tax rates for high-income households, which is largely because of the 15% top tax rates on dividends and capital gains put in place during the Bush administration.

 

The proposal is unlikely to see its way into legislation, as congressional Republicans have said they oppose any tax increase. But it is likely to add to the debate over how to tax investment income, including dividends and capital gains, at a time when wages have stagnated for millions of middle-class workers.

 

How many households would be hit?

In White House materials circulated to lawmakers, the administration cited statistics showing that the group of taxpayers likely to be hit the hardest by the idea numbered just 22,000 in 2009. Those are households making more than $1 million annually that pay less than 15% of their income in federal income taxes.

 

It isn't clear how much that group currently pays in federal taxes. The proposal also could apply to a broader selection of taxpayers -- all households with incomes of more than $1 million. Those earners are expected to pay an average of $845,000 this year, according to the nonpartisan Tax Policy Center. Assuming the households in the group of 22,000 pay that amount, even doubling their tax burden would raise just $19 billion a year at a time when deficit reduction is being measured in trillions of dollars. That doesn't take into effect any change in taxpayer behavior prompted by a new tax regime.

 

A senior administration official said that depending on where the minimum rate is set, the plan could be a "very significant" revenue raiser. The official wouldn't provide details.

 

The White House has dubbed the proposal the "Buffett Rule" after billionaire investor Warren Buffett, who has urged the federal government to raise the tax rates paid by the wealthiest Americans.

 

GOP already taking aim

On Sunday, Republicans critiqued the proposal sharply after details emerged during the weekend. "When you pick one area of the economy and you say, we're going to tax those people because most people are not those people, that's class warfare," Sen. Lindsey Graham, R-S.C. told CNN.

 

Some conservative economists say such a proposal could put a drag on capital markets and ignores the fact that many companies have already paid tax on the income before it is distributed to owners as dividends or capital gains. Reducing that double taxation was the basic point of the Bush-era changes.

 

"The corporate tax was already collected before most investment income is taxed at the personal level," said R. Glenn Hubbard, who was the top economist for President George W. Bush while the 2003 changes were being formulated. "It would be great to move beyond the silly season in the president's proposal to a discussion of tax reform."

 

Tax rates down, share of taxes up

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. Capital gains represented a very high proportion of the top earners' incomes -- about 56.7% on average.

 

Despite this decline, the share of taxes paid by wealthier Americans has been rising, in part because of soaring incomes and also tax breaks for the working poor and the middle class. The top 1% of the taxpayers -- those with income above $353,000 -- got 19.4% of all income in 2007 and paid 28.1% of all federal taxes. In 1987, by contrast, the top 1% got 11.2% of all income and paid 16.2% of all federal taxes.

 

Previous efforts to impose a minimum tax on the wealthy have had mixed success. The administration's principle resembles the Alternative Minimum Tax, which was first adopted in 1969 and was intended to hit the superwealthy. The AMT has been hitting an increasing number of the middle class because it wasn't indexed for inflation, and Congress has continually wrestled with how to get rid of it.

 

A surtax on millionaires has been a staple of left-leaning Democrats off and on for years and was raised and dismissed during the 2010 debate that extended the Bush tax cuts.

 

The tax break for capital gains and dividends, now strongly supported by Republicans in Congress, actually was eliminated by the Tax Reform Act of 1986 that Ronald Reagan backed: It lowered tax rates, but it taxed all income -- whether from wages, interest, dividends or capital gains -- at the same rate.

 

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