The Buffett Rule Revisited

The “Buffett Rule” basically says that people at the top of the income scale shouldn’t face lower tax rates than middle-income people.  The Urban-Brookings Tax Policy Center has found that people making over $1 million a year who receive more than two-thirds of their income from capital gains and dividends — as some at that income level do — pay a combined individual income and payroll tax rate of just 12 percent, on average.  That’s lower than the combined income and payroll tax rate that many middle-income Americans face.

At the invitation of David Leonhardt of the New York Times, I participated this week in a back and forth with Greg Mankiw, the Harvard economist and former economic advisor to President George W. Bush, over the Buffett Rule and related issues.

Professor Mankiw makes two points.  First, Congressional Budget Office (CBO) data show that, on average, people with higher incomes face a higher federal tax rate than other people.  In other words, the federal tax code is progressive.  Second, in assessing an individual’s overall federal tax rate (i.e., the percentage of income that he or she pays in taxes), one must take into account the burden of corporate income taxes, which are effectively paid by individuals.  Let’s take each of these points in turn:

On tax progressivity. Most policymakers and opinion leaders who call for those at the top to pay somewhat more in taxes do not make the mistake of claiming that rich Americans pay a lower tax rate, on average, than ordinary Americans.  What they say, as President Obama reiterated in his State of the Union address, is that some high-income people pay a lower rate — and should not.

The federal tax code is progressive.  But Americans also pay state and local taxes, and nearly every state’s tax system is regressive.  The U.S. tax system as a whole is only mildly progressive.  A good part of the progressivity of the federal tax code is needed simply to offset the regressivity of state and local taxes.

Furthermore, the same CBO data that show the federal tax code to be progressive also show that inequality has grown very substantially in recent decades, with incomes at the very top growing by far the most.  This trend came even as federal policymakers were dramatically cutting the taxes that high-income people face.  And the federal tax system as a whole is doing less to push against increases in income inequality than it used to.

Finally, we now face a serious long-term deficit problem, to which these tax cuts have contributed, and some leading lawmakers and presidential candidates are calling for steep cuts in programs that serve families of low or modest incomes even as taxes for individuals at the top are at their lowest level in decades.

On the corporate income tax. Professor Mankiw correctly points out that CBO assumes that investors essentially pay the corporate income tax, and that corporate taxes should be taken into account in figuring high-income households’ overall tax rates.

But while the corporate tax may add significantly to the tax burdens of some high-income people, it adds much less to the tax bills of others.  That’s because many high-income taxpayers generate their business income through so-called “pass-through” entities that don’t pay the corporate tax.  And many corporations pay a very low effective tax rate, which means they pass a very low tax burden onto their shareholders.

Taking the trends both in tax rates and inequality into consideration, we believe that those at the top of the income scale — some of whom do pay tax at a very low rate — should make a contribution to the deficit reduction that the nation will need.  They should pay somewhat more in the interest of both fiscal responsibility and fairness.