Wealth, Taxes, and Warren Buffett

Guess what share of his income the third richest person in America paid in federal taxes last year? 45%? Maybe 38%? It has to be at least 25%, right? Actually, Warren Buffett paid 17.4%, a lower tax rate than any of the twenty other people working in his office, who paid an average of 36%. Interestingly, Buffett isn’t happy about his low tax bill. Two weeks ago he wrote an attention-grabbing op-ed in the New York Times asking Congress to please tax him and other super-rich folks more.

So, just how does it happen that Warren Buffett pays a lower tax rate than his coworkers? It has a lot to do with how different types of taxes are structured.

  1. The super-rich make most of their income from earnings on investments, rather than wages paid for work (which is where the average, non-retired person makes most of her money). People who “make money with money,” as Buffett puts it, see much of their income taxed at the capital gains rate of 15%, rather than the highest personal income tax rate of 35%.
  2. People who earn more pay a smaller portion of their income in payroll taxes (the taxes designated for Social Security, Medicare, and unemployment), since Social Security taxes are only paid on income up to $107,000.

According to the Urban-Brookings Tax Policy Center, Buffett’s point about the discrepancy between the tax rates on investment income and wage income is a valid and important one. However, most high-earners pay a higher tax rate than Buffett’s 17% and most low- and middle-earners pay a lower rate than the 36% Buffett’s colleagues pay. For Buffett to imply that all, or even most, wealthy people pay a lower tax rate than low- and middle-income people is inaccurate.

The thing is, Buffett’s argument doesn’t really apply to your run-of-the-mill millionaires making $1 or $2 million a year. A lot of those people still earn most of their income from wages so they end up paying higher tax rates than someone making, say, $50,000. It’s the super-rich investors like Buffett who get the low tax rates. The average federal tax rate for the top 400 taxpayers is around 18%, which is significantly lower than the rate for someone making, for example, $180,000 or $1 million. The graph at left, from the excellent blog Visualizing Economics, shows just how far the average tax rate for the top 400 taxpayers has dropped  in the past two decades.

Another thing Buffett has been criticized for is not mentioning the corporate income tax in his article. Corporations pay taxes too, at a rate of about 35%, but since corporations aren’t people the burden of these taxes gets passed on to actual humans – to investors in the form of lower returns on their investments or to workers in the form of lower wages. Buffett’s true net tax rate, some argue, is 17.4% plus whatever share of corporate taxes fall on investors. The problem is, economists can’t agree on who, investors or workers, bears what share of the corporate tax burden. Given this disagreement, perhaps Buffett was right to leave it out of his argument.

Beneath all this is the question of fairness and how much every group should ideally contribute. For more on this, see one of my older posts here.

Stop Coddling The Super-Rich
Warren E. Buffett // NY Times // August 14, 2011

Was Buffett Right? Do Workers Pay More Tax than Their Bosses?
Tax Policy Center // Roberton Williams // August 23, 2011

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