The chairman of Berkshire Hathaway, Warren Buffet, toted that he paid 17.4 percent of his taxable income in payroll and income taxes. This percentage was lower that that paid by any of the twenty people working in his office. He asserted that, although the mega rich pay income taxes at a rate of fifteen percent of their earnings, practically, they pay nothing in payroll taxes. The Obama’s administration, within a month, unveiled a strategic plan for deficit reduction and economic growth (Fletcher, 2006).
One of the principles for tax reforms that the administration stated was to observe “Buffet Rule”. Buffet rule states that, no household making an annual income of over one million dollars should pay a smaller proportion of its taxable income than that paid by middle income families. In October 2011, the American Jobs Act of 2011 (S. 1660) was introduced by Senator Harry Reid. The Act contains a 5.6 percent surtax on millionaires, which requires them to pay for the provision of employment bill. A bill was also introduced on March 2012 in the Senate, which seeks to reduce the deficit through the imposition of a minimum tax on high income. This report is analyzes the Buffet rule by incorporating the effect of corporate income tax, in addition to payroll and income tax, using a measure of income, which captures the ability of pay taxes (Warren, 2011).
The outcome of this analysis show that the current tax system of the United States violates the Buffet rule, since a large proportion of millionaires pays less in taxes with respect to the taxable income compared to the amount paid by moderate income taxpayers. Approximately, twenty five percent of all millionaires face lower tax rate than that faced by moderate taxpayers. Reforms that are consistent with Buffet rule are likely to stir capital gain and subsequently raise the rate of tax on. For instance, the proposal by Obama’s administration allows the Bush Tax cuts to expire for taxing carried interests of hedge fund managers and high income taxpayers as ordinary income as reforms observe the Buffet rule. Studies suggest that many small businesses are unlikely to be affected by the Buffet rule. In addition, research suggests that the Buffet rule will not impact on investment and saving (Craig, 2010).
Taxable income is not reflective of all the available resources to the taxpayer, nor does it properly gauge the capability of the taxpayer in paying of their taxes. Similarly, it not a fair measure of income since it is extremely narrow, (Warren, 2011). This is because itemized deductions and personal exemption have already been subtracted. Artificially, this can increase the effective mean tax rate that the taxpayers face.
A broader measure of income is the adjusted gross income, which does not exclude itemized deductions and personal exemptions for charitable contributions, mortgage interests, and state taxes. Adjusted gross income is vital useful in determining income categories and calculating tax rates. Corporate income tax is also excluded during calculation of income tax, since it is often used to justify for the reduced tax rates on various categories of income. One of the arguments, specifically used for justifying for reduced tax rates on qualified dividends and long-term capital gains is the reduction of double taxes, since an income may be subject to the corporate income tax. Analysis of the effective tax burden should take taxes from all sources into consideration. The taxes that should be incorporated in the analysis of income taxes include corporate income tax, individual income tax, and the payroll tax (Warren, 2011).
Various studies have estimated that most of the burden of the corporate income falls on labor through wage reductions. However, these studies have suffered from various methodological deficiencies. Evidences from such studies have supported that most of corporate income tax burden fall on the owner of capital. It is assumed that most of corporate income tax falls on dividend and capital gains, which majorly affects high income taxpayers. According to the Internal Revenue Service (IRS), not all income is taxed at the corporate level, since substantial amounts are reported by taxpayers as pass through losses or gains. These gains or losses following the sale of assets or government bonds are usually not taxed at the corporate level (Lendman, 2010. For instance, under the current tax law, hedge funds are usually organized as partnerships.
Payment of income taxes by a partnership is not provided for by the law. Instead, losses and gains flow through the partners, who are expected to incorporate it on their income tax returns. Partnership’s income is often taxed as qualified dividend or capital gains at a reduced tax rates. Essentially, when the partnership earn long-term qualified dividends or capital gains, the income will flow through the partners as long-term qualified dividends or capital gains and is taxed accordingly, the income will not be recharacterized as it passes to individual partners from the partnership. In exchange for contributions, limited partners receive partnership interests for their capital contributions. General partners are awarded partnership interest in exchange of carried interest since they actively participate in managing the partnership (Lendman, 2010).
According to the Internal Revenue Code, the proposed amendment stipulates that an individual taxpayer is required to pay a minimum tax rate of thirty percent of excess of the taxpayer’s adjusted taxable income over the modified charitable contribution deduction for the taxable year, when adjusted gross income exceeds one million dollar. This amendment will ensure at least one percent of the millionaires in America pay at least thirty percent of their taxable income towards their taxes (Kocieniewski, 2012). Otherwise, they will be required to show that a large proportion of their gross income is directed to a charity of their own choice. This will prevent the majority of the millionaires from using the loopholes within the system to evade paying taxes.
The administration had promised that the existing tax rates will not be tampered by the proposal. Instead, taxpayers making more than a million a year, under the proposal, will be required to calculate their tax rate while taking into account their income and the total sum of their tax payment (Lendman, 2010. They will be required to make up for the deficit when the calculated amount is less than thirty percent. The degree at which the best-off can take any advantage of existing loophole in the system is limited by the buffet rule. This implies tax rates will allow the millionaires to make less payment as income tax than the middle-class households (Miller, 2010).
Warren Buffet insists that anyone who does well for themselves should, in return, do a fair share so that more people have an opportunity to get ahead. The implementation of this rule will result to increases in revenue, which can be directed to research, education, and technology, Medicare and Social Security, and a strong military. While the middle class and poor struggle to survive, the rich continue to be awarded extraordinary tax breaks. The incomes of many investment managers, who earn billions, are classified as “carried interest”, which grants them a bargain fifteen percent tax rate. Such are the blessings showered by the current tax system.
According to government sources, eighty percent of the revenue collected in 2011 cam from payroll taxes and income taxes. The millionaires pay fifteen percent of their earnings, yet the pay nothing in payroll taxes. On the contrary, the middle class, who fall in the 15 percent and 25 percent income tax brackets, are the worst hit with the payroll taxes. According to studies, tax rates in the 1980s and 1990s were far higher for the rich. According to the theory, many middle class taxpayers have been discouraged to invest because of the elevated tax rate and on dividend and capital gains. Therefore, lower tax rates discourage job creation, which hurts the middle class and poor taxpayers. Studies have shown that roughly forty million jobs were created between 1980 and 2000. Since then, lower tax rates have discouraged investment, a factor that has impacted on job creation (Tom, 2011).
The I.R.S, since 1992, had compiled data from the returns of the four hundred American reporting the highest income. The top million of the four hundred sampled, in 1992, had aggregate income of approximately $16.9 billion. The millionaire had paid 29.2 percent of the total sum as federal taxes. In 2008, despite the aggregate income for the same millionaire souring to approximately $90.0 billion, the rate paid as federal taxes had fallen to 21.5 percent. The amounts paid in taxes by the 400 millionaire include federal income taxes. Certainly, any payroll tax paid by the four hundred millionaires was inconsequential considering their incomes. In fact, 88 of the four hundred sampled millionaires, in 2008, reported capital gains though every one of the reported no wage at all. This implies that, majority of millionaire in America shun work, but they prefer to invest, with a sole purpose of evading taxes. The Obama’s administration is devising a plan to reduce the ten-year deficit by roughly $1.5 trillion. However, it is crucial that more than the targeted deficit reduction is achieved (Kocieniewski, 2012).