Do The Rich Pay Their Fair Share In Taxes?
June 16th, 2008 · 2 Comments · Subscribe to this feed
Ah, the age-old question: do the rich pay their fair share in taxes? Many liberals argue that they don’t, saying the rich owe their success to the efforts of the poor and middle class and should bear a higher percentage of the tax burden in gratitude. On the opposite side of the spectrum, most conservatives would claim taxing the rich at a higher rate penalizes success and discourages the best and brightest from working even harder. Like most issues, both sides probably have some valid points. Also like most ideological debates, unfortunately, both sides area also full of crap. My belief is that the rich do, in fact, pay their fair share. More, even. But the nature of many of the taxes the rich pay are hidden whereas income and payroll taxes, which constitute the vast majority of what the poor and middle class pay, are in plain sight for everybody to see.
Just How Much Do The Rich Pay?
Earlier this year, Warren Buffett famously informed a room full of Hillary Clinton supporters that he pays a smaller percentage of his income in tax than his secretary, at only 17.7%. Is that true? Highly unlikely. Buffett is conveniently leaving out some large payments made to the IRS on his behalf, as well as a myriad of phantom “taxes” he and other super-wealthy people pay. For starters, Buffett claims his 2006 income was $46 million. Nonsense. His taxable income was far, far higher than that. In fact, he paid more than $46 million that year in taxes alone. Where does this discrepancy come from? Well, it all depends on what you consider “income”.
Buffett’s 2006 Income And Tax Bill
Obviously, I don’t know the details of Buffett’s personal household income so this will be broad by necessity. What we do know is that Buffett owns approximately 32% of Berkshire Hathaway (all these filings can be found on EDGAR) and that Berkshire Hathaway earned approximately $16.8 billion in 2006 before paying approximately $5.5 billion in taxes. “So what,” you ask? “That’s just his company paying the tax, not Buffett himself.” I beg to differ. For decades, Buffett has stressed in his shareholder letters that a stock is not just a piece of paper but rather a real claim on a company’s tangible property and earnings. If, as Buffett claims (and I share his view fully), stock ownership grants you a share of a company’s earnings, doesn’t it by definition also give you a share of a company’s liabilities, including its tax liability? Of course it does and Buffett knows it. It is disingenous to claim that stock ownership grants a share of positive outcomes (earnings) but not of negative outcomes (taxes, lawsuits, etc). Just ask any Enron shareholder if they shared in Enron’s losses or not.
The Rich Are Taxed Twice
Since Buffett owns 32% of Berkshire Hathaway, he also owns 32% of its earnings and 32% of its tax liability, which works out to be $1.72 billion, which works out to a tax rate of about 33% or almost double what Buffett claimed in his speech. But that’s not all! Owning stock doesn’t pay the bills. In order to pay the bills you must realize income either in the form of stock dividends, which Berkshire Hathaway doesn’t pay, or generating capital gains by selling shares. Both of these income-realization techniques are taxed by the government, ON TOP of the tax already paid by the corporation (and by extension the shareholder). This is called double taxation and is a well-known and hated phenomena within the investment community. Many liberals see that dividends are taxed at 15% and declare the tax rate on that income to be 15% to the investor. Wrong. They real tax rate to the investor is about 45% after factoring in the 35% corporate tax rate with the 15% dividend tax. To those who would argue that corporate income tax shouldn’t count, I say bollocks. Had the corporation not been required to pay taxes, the shareholder would have been better off by the amount of the taxes paid because either the share price would be higher or the dividend rate would be higher, if not both. In fact, the very existence of corporate structures such as REITs or MLPs, which allows the company to avoid corporate income tax so long as substantially all of their earnings flow through to shareholders’ personal income tax returns argues very strongly in favor of the fact that the market, congress, and the IRS all agree with my position. Whatever the true tax rate of dividends and capital gains, it is most certainly not the 15% paid by the end investor to the IRS. Taxes are paid on behalf of these rich investors all along the way. Taking all this into account, it’s not at all unusual for a wealthy individual to pay upwards of 50% of their income in taxes every year. What’s more, their corporate holdings must pay taxes regardless of whether or not any of the income is distributed to shareholders. To say the rich pay a lower percentage of their income in taxes than the poor is naive at best and downright dishonest at worst. Buffett, sadly, falls squarely into the dishonest category on this one.
There is also the issue of how the federal tax-exempt status of state and local municipal bonds are a hidden tax on the rich, but I will cover that from a slightly different angle in tomorrow’s post.
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