Taxes, Warren Buffett, and Paying My Fair Share

This week many of you will receive tax rebate checks from the I.R.S. Yes, that $600 you are receiving is meant to help kick start the economy.

The government tried the same thing in 2001, sending out $300 checks. But this time, there’s a difference — not all of us are getting a check. In fact, those earning six figures or more won’t be seeing any check this week.

So that got me to thinking about how fair the tax system really is. Do the well-off pay their fair share, or do they also deserve a tax break?

Well, let’s start with the ultra-rich. Bajillionaire Warren Buffett has argued that he isn’t being asked to pay his share. He went around his office, asking people what share of their income they pay in income taxes. Buffett’s 17.7 percent tax rate compared a bit too favorably with the 30 percent tax rate paid by his secretary.

So it appears that the tax system favors the super-rich over working stiffs.

And Buffett went a step further, putting his money where his mouth is. Last November he issued a challenge to his fellow billionaires:

I’ll bet a million dollars against any member of the Forbes 400 who challenges me that the average (federal tax rate including income and payroll taxes) for the Forbes 400 will be less than the average of their receptionists.

So far, no-one has taken him up on this bet.

What about those of us who are merely among the well-off, and not in the Buffett-stratosphere?

Now, I’m no Warren Buffett (believe me!), but I’ve just finished figuring out my federal taxes for the year. I live comfortably (one of the virtues of teaching in a business school), but was dismayed to learn that my federal taxes for 2007 amount to only 16 percent of my income.

This strikes me as astonishingly low. And it’s not like I have a fancy approach to tax minimization; I just write off a bunch of business-related expenses, and benefit enormously from deductions for mortgage interest and charitable giving. Obviously city and state taxes drive my total tax bill up a bit further, as do payroll taxes, although I plan on getting some of that back as social security in my old age.

But the point remains: I had never quite realized that the Warren Buffett problem extends far enough down the income distribution that even folks like myself aren’t paying their fair share.

So I repeated Warren Buffett’s experiment here at Wharton. And it appears that I’m paying lower taxes than the administrative staff in my department. And if it is true here, I suspect the same goes equally for most folks in the top 10 percent of income earners. (Incidentally, according to Piketty and Saez, around half of all income in the U.S. goes to those of us in the top decile — roughly anyone with a family income of six figures or more.)

Warren Buffett’s approach to casual empiricism is quite instructive. He just took a survey around the office of people’s average tax rates, finding that he paid the lowest share. Here’s a thought:

Why not run a similar survey in your own office, or among your circle of friends? It will be interesting to learn the extent to which Warren Buffett’s findings generalize.

Please post your findings in the comments.


Law_Student

Selling doesn't provide any benefit?

Seriously? Have you ever heard of boycotts? The best way to show market disapproval with a poor management decision or strategy and thereby to help that firm or the market as a whole reach peak efficiency is to sell!!!!
The reason why government never trashes a bad idea is that noone can sell out of it, and the only stakeholders with any say are those who need the program to continue.

Bert

Capitalism, Socialism
Rights, Responsibilities
All things in balance.
It strikes me that the fairest tax would be a cash flow tax.
Everyone pays some share of every cent that comes into their posession,
including corporations.
Then require congress to adjust the rate to balance the budget. A 5 year rolling average maybe. I'm guessing 5% until the budget is balanced.
And what happened to the "peace dividend".

ahbgone

Since you have business expenses (and assuming they are legitimate business expenses - wink, wink), isn't your income inflated to include these expenses?

This effectively lowers your tax rate.

Nicholas Weaver

Consider social security and medicare payroll taxes in YOUR calculation.

This is part of the huge unfairness. The payroll taxes are on earned income, and the social security payroll tax is only on the first ~110K or so.

Thus Warren Buffett's income is so far above that he doesn't have to pay that, but his secretary (and you) do.

The other huge thing is the shift on capital gains. When capital gains was ordinary income, there was no reason to shift income into capital gains. But now with it taxed at just 15%, there are huge incentives to structure compensation as capital gains.

For Mr Buffett, almost all of his income is capital gains. But its REAL capital gains, as he did put in the money for that when it was a hundred bucks a share.

Whats worse is the hedge fund managers, who manage to structure their 2-and-20 into captial gains. So they delay their compensation by just a year, and rather than being taxed at 30+%, its taxed at 15%. Which when you are talking a few hundred million, is not peanuts.

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dix

Is FICA counted as 'federal'? My salary is an even 100K. My semimonthly paycheck deducts 14.1% for federal income tax and 6.1% for Social Security (FICA) tax. Also 1.4% for Medicare and 4.3% for state (Massachusetts) tax. So the total tax burden is 25.9%. My wife makes almost as much per month to bring our AGI to around 170K and we file jointly and we own our own home. A quick back of the envelope calculation estimates my mortgage deduction is worth 3-3.5% of my income so if we rented the total tax burden would be about 29%. On tax day we usually have to write a check for a few hundred dollars so we're not severely over or under withholding. I could use some advice on getting it down to 16%.

For a good comparison shouldn't we also factor in the 6.2% your employer pays for half of FICA? Also, don't some states lean more heavily on property taxes vs income taxes? New Hampshire, for one.

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Doogle

My scenario: Married, one child, mortgage on home, investments in retirement accounts only, modest charitable giving, contribute max to 401k, salary + bonus = btwn 100k-200k. Fed tax = 17% of AGI. State adds another 8%.

According to the US Census Bureau, I PAY AS MUCH IN TAX AS THE AVERAGE U.S. WORKER EARNS IN ANNUAL INCOME.

Steve

@BrokeinSC,

You did not pay $2,200 in federal income taxes on $17,000 of gross income unless you're claimed as a dependent by someone else and you don't get to take any sort of standard deduction.

Single people who aren't dependents would pay, at most, around $800 of taxes on $17,000 of gross income in 2007. Plus you'd get a rebate of $600. You may be eligible for certain credits and deductions, too.

And when you say Warren Buffet's secretary pays more than he does, I guess you're saying that a several thousand dollars is somehow a larger sum than millions upon millions of dollars. Oh, and if Warren Buffet owns a company that pays tax at around a 35% tax rate and then pays tax on his dividends or capital gains at 15%, you're not counting the corporate taxes that he's effectively paying.

The fact is, low income people pay virtually nothing in income taxes, and often have effective tax rates approaching -10%.

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stephanie

I agree with Gary (#23). The reason for lower taxes on capital gains is to encourage investing. This benefits the companies invested in, and it also benefits all of us for people to invest in stocks, etc., that ideally will go up in value so we pay less money from gov. funds to take care of those stockholders later in life.

Also Denise (#14) - that's the exact question I had when reading this, who gets to determine "fair?" Is it fair to tax those who work hard to get wealthy, just because they chose to work hard instead of being content to stay with a $50,000/yr job? Of the well-off people I know, most of them spent years working 70-80 hour weeks to get where they are today, being more productive for the economy and giving a lot of personal things up in the process. Should they really pay more taxes than someone who is perfectly content working 30-40 hours a week at a lower paying job? (Who is usually both contributing less in output to the economy AND consuming less, which also doesn't help the economy.) (Obviously there is more to any given situation than this, but you get my point.)

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Rachel

I don't know too much about taxes hubby handles that stuff, but I do know that we aren't getting anything back this year but that 600 dollar check. It isn't going to stiumlate anything for our family just pay a bill off we haven't been able to pay off before. It isn't the only bill we need to pay which is why we had hoped we were getting more back, but oh well such is life.

Rachel
http://bakedblog.com

James

As a response to Mercutio.Mont & others about cap gains rates...
L
ower capital gains rates may provide some incentive to invest, but they provide more incentive to SELL.

Gaining income without having to work is plenty incentive to invest money. In fact, it's done just fine for a very long time.

I know this next statement is anathema to day traders and people who make money by speculation and flipping investments, but such activity doesn't provide REAL value to the economy.

Buying/investing is good for the ecomony. It gibes firms capital to hire workers and buy computers, etc. On the other hand, SELLING doesn't provide much benefit to the economy as a whole (your stock broker very much appreciates the commision, however).

In my _opinion_, a lower rate on the income you get when you _sell_ stocks doesn't provide enough of a real, shared ecomomic benefit to offset its effects of lost tax revenue and unfairness to workers' income.

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James

just as an aside, if any of you are regular commenters here... I'm obviously new to this blog, and as a software developer it's been a long time since I've had the chance to participate in informed economic debate. This is a great forum for some really interesting discussion... keep it up guys :)

mike

Do not lose sight of the fact that fully 40 percent of the population owes NO federal individual income tax -- that segment of the population pays an effective rate of zero or less (they get net credits refunded). The individual income tax is overall progressive -- high income people pay higher effective tax rates on average than do low income people on average. There is a significant dispersion around that average, but this is what the data show -- check the Congressional Budget Office (not a partisan operation) data out if you do not believe it. www.cbo.gov is where to get the numbers.

The pattern gets worse (less progressive) if you add the Soc Sec and Medicare payroll taxes in -- that's where the real burden on low income households is.

Katie

ptm (#11) is right - students will throw this off somewhat.

Case in point - I graduated last spring, and worked part time in college and over the summer, then full time starting in September for a low but livable wage. My 2007 Federal Taxes? $0

Than God for education credits.

Dave

#16 is right, the 15% cap gains / dividend tax at the personal level is on top of the 35% corporate - so corporate income to taxable investors is effectively taxed at 45% if I'm doing the math right, which is higher than income in even the top bracket of earned income.

It's a little misleading to count mortgage interest deductons against your effective tax rate - you're not really saving on taxes since the benefit of the deduction is included in the price of your home. It's similar to municipal bonds - you're saving taxes, but it's mostly made up for by the low interest rate.

Payroll taxes skew things as well - yes you don't pay payroll taxes above a certain income level, but you don't accrue benefits above that level either.

The IRS website has data on effective tax rate by income level, and indeed, the super rich ($1M+) pay lower effective taxes than the next couple of brackets below them - this is down to the effect of more of the income for the super rich coming from capital gains, dividends, and tax-free interest. In the top bucket, nearly all of the income is from long-term capital gains - most likely these are people netting one-time windfalls from sales of their businesses, etc.

However, the same data show that 90% of taxes are paid by people in the top half of income, and 75% by people making over $75k, so I don't think taxation is necessarily unfairly distributed.

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SJ

I'm a DINK (dual-income, no kids) household with gross household income around $150k. My spouse is self-employed so we directly pay both halves of SS and Medicare taxes for her income (that is painful). We are paying over 25% tax to the federal government.

If you think of Social Security and Medicare as just another part of the income tax it is quite regressive. On the other hand, if you see them as independent programs, they're quite progressive. When they retire, someone who made 80k for 60 years will not be getting payments 8 times larger than somebody who made 8 times as much (20k for 30 years, for example)... maybe they'll get twice as much. Low-income earners might actually get better returns than if they had invested their SS payments in the market; SS is always a bad ROI for middle- and high-income individuals. For more info on how benefits are calculated:

http://www.aarp.org/research/socialsecurity/benefits/aresearch-import-354-FS59R.html

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Fred

"This would also be a good way to get taxes from those who avoid paying income taxes through illegal jobs (drug dealers) and tax evaders."

Exactly, because if there's anything we've learned over the years, it's that drug dealers and tax evaders do everything else completely on the up-and-up.

"You could easily make it those who make under a certain amount dont have to pay, so you are not taxing the poor."

So much for the idea of a flat tax. If you start excluding certain people from taxes in the case of a flat tax, it's a quick path right back to where we are right now.

Say you set the minimal taxable income at $15,000. What about the person who made $15,100? Are they really in THAT much better of a financial situation than the person who made $14,900?

If you want a flat tax, then it needs to be just that: a flat tax.

Alex

1) I think that Buffet is including SS taxes.

2) "Fair share," in this context, I think means that the rich do not pay a dramatically lower rate than the poor. It's a long standing principle in this country, and others, that taxes are flat fees, but rather a percentage of income. Whether a "flat [percentage] tax" or a progressive tax, the idea is that higher income people should pay at least as high a rate as lower income people.

3) I am fascinated by the degree to which the comments fail to address the question in the post (i.e. how do federal tax rates compare across job/income in your office). Rather, most of the comments are about the political/ideological questions of who/what should be taxed at higher or lower rate. Has there ever been any proof that capital gains tax rates should be HALF of income tax rates? Of course not! This thread has devolved into a argument for why taxes (for some people) should be lower, without examination of context (i.e. the tax rates paid by others, the costs of maintaining the system in which that income/profits were made).

We all want lower taxes. We each can think of some reasoning by which our own taxes should be lower. Each of us can name some federal programs that we would be willing to sacrifice or cut back on in order to lower our own taxes -- though we'd have different ideas as to what those things are.

But we are a democracy, or at least are supposed to be, of hundreds of millions of people. We have accept that there will be programs that each of us don't approve of. And we have to pay for all the programs.

So, the question is not simply "how high should taxes be?" Rather, it is "How should be distribute the tax burden, given all the things that our democratically elected government choses to pay for?"

And to help address that question, Mr. Wolfers has asked readers to supply data about how the tax burden is distributed in the status quo.

Most anyone who is not willing to answer that question, or is unable to see that question, likely cares only about his/her own tax burden, regardless of impact on others or the needs of society.

(I cannot answer the question myself, as I do not work in a office these days.)

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Helen

A few years back, I compared my effective tax rate with that of my brother, who lost his job when the tech bubble burst and had only managed to find work in his field as an independent contractor on a less than full-time basis. It bears repeating that had he been able to work more, he would have. For my part, I was (and am still) married and our joint income was several times his. We owned a home as a principal residence and a second as a rental property, both of which had (tax-favored) mortgages. We, too, were comfortable enough to allow donations to charities, and, according to Turbotax, we donated considerably more, percentagewise, than others in our 'tax group'.

His tax rate was considerably higher than ours. Not orders of magnitude higher, no, but he was seriously scraping by, while we were absolutely unconcerned about our finances.

So yes, even at our comfortable-but-not-super-rich position in the economic pecking order, the disparity exists and it is shameful. But that said, it could have been even worse. According to Turbotax, my spouse and I were quite the anomalies in our 'tax group' because none of our income was derived from capital gains on investments - we actually earned the income (and were taxed more because of it).

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Common Sense

Are you guys serious? Anybody at the top of the income ladder is going to have money to save and therefore be able to invest.

Yes, qualified dividends and L/T capital gains are taxed at lower rates. Yes, CPAs can help higher income people reduce their tax liability by informing them about receipts they need to keep and expenses they need to keep track of. Yes, mortgage payments help too.

But, the working guy who doesn't make much and has two kids and a wife is still getting a good refund b/c of child tax credits and such.

It's a tax "system". And like any system it works for certain things (like that guy I just mentioned who probably doesn't know jack to benefit from the system) and otherwise you have to learn how to work it.

If you can work the system it will work for you. So it benefits the rich AND smart people and not the guy who posted and just guesses that no kids and renting (not to mention lack of investing) are why he might pay what he does for taxes.

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Joe D

Okay, I just did ours. I took our entire income (AGI + 401(k) etc. pre-tax deductions), about 115K, and our entire federal tax (income + medicare + soc sec), about 13.5K. As you can see, it comes to 11.8% (although it's 14.9% as a fraction of AGI).

Now, we do lots of charitable giving (including property taxes, our deductions are over 22K); we put lots away in 401(k) and we have medical savings & child care savings pre-tax accounts (so we have another 22K in pre-tax); and we have a child (extra exemption & credit).

Why is our tax rate so low (whether it's 15% or 12%)? Shouldn't it be more like 20% (or 25%, or 30%)? But as long as the tax code says I get these breaks, I'm just stupid not to.

But why