What Sort of Tax System Do We Want?

During the second presidential debate, when answering a question about a recent story that he has not paid federal income tax in 18 years, Mr. Trump said that Democrats like Warren Buffett avoided paying income taxes, just as he does.

Mr. Buffett released some of his tax information, showing that Mr. Trump’s claim is false.

But let’s consider for a moment Mr. Buffett’s situation:

Adjusted Gross Income $11,563,931
Deductions $5,477,694 (mostly charitable donations and state/local taxes)
Taxable Income $6,086,237
Federal Tax $1,845,577
Effective Rate 30.32%
Rate on Gross Income 15.96%

There is nothing on the tax return that indicates the enormous wealth that Mr. Buffett enjoys. We know from other sources that Mr. Buffett owns around $66 billion worth of stock in Berkshire Hathaway. While he can probably live well on his multi-million dollar annual income, he could easily be making orders of magnitude more if he wanted. Mr. Buffett is one of the wealthiest people in the world, but his annual income is far less than many corporate chieftains, hedge fund managers, and professional athletes.

His taxes are between the earned income rate and the preferential rate for long term capital gains. That could indicate that he has around $2.7 million in long term capital gains, and the rest of his income is ordinary income or short term gains (There are also other possible explanations).

A New York Times article said that his tax rate was around 16%. That is true, as the percentage of his gross income he paid in taxes, but that doesn’t take it all into account.

In general when people talk about tax rates, they look at the rate as a percentage of taxable income (income after deductions). The number which you can compare with the published tax rates is 30.32%. That’s between the top rate on earned income (39.6%) and the top rate on long term capital gains (20%).

But all this brings to mind two very important questions:

  • Do we (as a society) want to give tax deductions for charitable donations? If so, then high income people can donate money to charity, and essentially each dollar they give to charity only costs them sixty cents or so and costs the government forty cents or so.
  • Do we want to tax income, or wealth? Some people have one and not the other. Many very wealthy people are like Buffett in that their income is a miniscule fraction of their wealth. This is especially true for real estate investors because of many provisions like depreciation and 1031 exchanges that subsidize real estate owners.

Neither Buffet nor Trump is “good” or “bad” based on taxes. Rather, we as a society need to decide how people should pay taxes, and then have some rules which reflect those decisions. Buffett himself has advocated for the “Millionaires Tax,” and Trump has promised to close at least one loophole (carried interest tax loophole). But as a nation, we must decide more than one or two rules. We must decide what an entire system that works for all Americans will look like.

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