NCPA - National Center for Policy Analysis

What's Wrong With the Buffett Rule

February 6, 2012

Senator Sheldon Whitehouse (D-R.I.) plans to introduce a "Buffett Rule" bill in the Senate, requiring anybody making over $1 million to pay at least a 30 percent tax rate.  This is more than a simple amendment to the existing income tax brackets, as it would also drastically raise taxes on capital gains -- a source of substantial income for millionaires, says Josh Barro, the Walter B. Wriston fellow at the Manhattan Institute.

However, the true problems with this policy option are not grounded in a certain point of view, but rather are seen in three objectively observable inefficiencies.  First, by failing to treat equally corporate equity and corporate debt, a Buffet rule will further encourage companies to overleverage their positions.

  • A corporation's interest payments are taxed as ordinary income for the individual owner of corporate debt.
  • Meanwhile, corporate profits are taxed directly, and then taxed again as dividends or capital gains for the business's investors.
  • The taxation of debt interest once and profits twice artificially pressures business to take on more debt than is healthy.
  • The Buffet Rule would not only continue this structure, but would exacerbate its damaging effects by lowering (in some cases) the effective tax rate on interest payments.

Second, the Buffet Rule's effects on the capital gains tax rate would make the United States a significant outlier among developed nations in its treatment of investment returns.

  • Preferential treatment for investment income has been a feature of the United States tax code for more than eight decades.
  • In every G7 country, even the taxpayers with the highest incomes pay capital gains tax at a significantly lower rate than on ordinary income.
  • For most of the last nine decades, the top rate on capital gains has been around 25 percent -- a drastic reduction over time from the 73 percent rate in 1922 when it was found that the high rate discouraged investment.

Third, because the Buffet Rule proposal fails to index taxation on capital gains with increases in inflation, investment will be further discouraged.  Additionally, investors will create a strong interest population against high-inflation monetary policies that may be beneficial but would hurt their specific interests.  While this is already a problem with the current tax code, the Buffet Rule would intensify the damage.

Source: Josh Barro, "What's Wrong With the Buffett Rule," Forbes, January 27, 2012.

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