When it comes to taxes, the left is risking reform for rhetoric.
by David Kaufman
The echoes of Occupy Wall Street’s chants for egalitarianism have long faded from the streets of downtown Manhattan, but U.S. politicians have yet to decide how to spread the burden of taxation equitably among the citizenry. From the campaign trail to the Rose Garden, President Barack Obama has called upon the “wealthiest Americans” to pay their “fair share.” But essential to effective policymaking is establishing who exactly the “wealthy” are and what share is objectively fair.
Despite apocalyptic December 21 prognostications, 2012 should have been a year of hope for the United States. An election cycle and an automated round of sequestrations should have spurred rational discussion about raising revenue in the country. But the absurd reality of the fiscal cliff deal, or the American Taxpayer Relief Act of 2012, is that it actually punishes the upper-middle class while remaining silent on the continued, albeit legal, tax avoidance of the ultra-rich.
Citizens who earn an annual salary of over $400,000 will now pay roughly 40 percent of their income to Uncle Sam. But their wealthier counterparts who make millions yearly through Wall Street speculation still pay just the capital gains rate, which remains at 20 percent. Even more egregious is the fact that people working in private equity who make tens of millions in management fees—which are neither investments nor speculation—will continue to masquerade their income as capital gains through the yet-unclosed carried-interest loophole.
The issue at stake is the public’s tendency to divide society into the “1-percenters” and the “rest of us,” resulting in poor public policy. Why can we not discern between millionaires in home equity and those who actually earn millions? Given that the majority of the 0.1 percent of income earners work in finance, why do they continue to pay fewer taxes than even the middle class? Instead of punishing the few rich people who do pay their fair share, it is time to draw attention to those who do not.
American society is often divided into the working class, the middle class, the upper-middle class and the rich. The category of the rich, however, has become in some ways as socioeconomically diverse as the rest of the spectrum. The lifestyle of a public school district superintendent on Long Island (where salaries can often exceed $350,000, in part due to high costs of living) and a hedge fund billionaire in New York City have little in common, though the two individuals would fall into the same class, according to the model. Yet it seems every time Congress agrees on higher taxes for the wealthy, it is often the former who have to patriotically pay up. “The 99 percent versus the 1 percent” may sound like a noble and democratic idea, but it is woefully misleading.
The fundamental problem of the American left’s noble pursuit of progressivism and fairness is that it often translates into well-intentioned but ultimately unproductive or even counterproductive policies, such as rent control, farm subsidies and tax increases on the upper middle class during hard economic times. To avoid repeating these mistakes, policymakers must be specific when referring to the “wealthiest Americans.”
In contemporary American society, three distinct classes of the economic elite exist. Lowest on the scale are the rich, who constitute 5 percent of U.S. households and who, despite including millionaires in name, have most of their net worth tied up in home equity. These people live well compared to the average American, making between $400,000 and $1 million per year. They can pay full private university tuitions, take nice family vacations and still maintain their nest eggs. They should therefore pay a higher tax rate than the average. But they should not bear the brunt of the highest tax rate alone. The national tax agenda should instead focus on members in the other two groups: the very rich and the ultra-rich.
The very rich, comprising 0.9 percent of U.S. households, make between $1 million and $10 million a year and live quite nicely. They tend to own second homes and can travel in luxury. Most, but certainly not all, work in finance; others are executives of small and medium-sized companies. Those who do work in finance generally pay an effective tax rate of only 20 to 25 percent, while others who work in nonfinancial sectors have traditionally paid the top rate of 35 percent and this year will pay close to 40 percent.
Lastly, we have witnessed the emergence of a new class of rich—the top 0.01 percent of the wealthiest 1 percent, the richest of the rich. This extraordinarily affluent group is composed of billionaire entrepreneurs, private equity managers, Swiss bank account holders and World Economic Forum attendees. These are truly “the wealthiest Americans”; working almost exclusively in finance, they have yet to contribute their “fair share” because legally, they do not have to.
A subset of this group, those listed on the Forbes “400 Richest Americans,” netted an average income of $202 million and paid an effective tax rate of merely 19.9 percent in 2009, the most recent year for which these data are available. These figures are disturbing in a democratic society. Pinning down a tax rate that is fair to everyone may be impossible, but this level of economic injustice is inexcusable. The tax rate should not depend on how earners’ incomes are derived—despite Goldman Sachs CEO Lloyd Blankfein’s claim that his profession is “God’s work.”
But how do we resolve this outrageous inequity in income tax payment without further destabilizing the quavering economic recovery? The Green Party would have us tax capital gains as ordinary income. While there is certainly merit in this argument—it would raise the tax rates paid by the rich and close the carried interest loophole—it might also decrease investment that is necessary for growth, especially by the middle and upper-middle classes. Capital gains taxes are set lower than income taxes precisely to encourage risk taking, and while it seems implausible that top investors would resort to playing golf and smoking Stogies if their stock were taxed as income, this measure would adversely affect everyone else in the market by discouraging the purchase of shares in new companies.
There is a better way to right the wrong: the institution of new adjusted-for-inflation alternative minimum taxes (AMTs) for both the super-rich and the richest of the rich. Warren Buffett has proposed the idea twice, and while it would only serve as a stopgap measure until broader income tax overhaul, it would help bring a necessary sense of fairness to the United States’ Internal Revenue Service code.
The plan would work like this: individuals making over a million dollars a year and couples making $1.25 million would compute their current effective tax rates. If their income mostly came from capital gains and their calculated rate was, for example, around 20 percent, they’d pay an AMT of 36 percent. Since that rate would still be lower than the top marginal tax rate of 39.6 percent, it would not discourage investment, while representing a fairer share of the tax burden. The ultra-rich—those who make over 10 million dollars annually—would pay an AMT of 41 percent, which, though apparently high by today’s standards, does not approach the tax rates exceeding 70 percent until the early 1980s.
The prospects of such sweeping reform, however, are not bright, even if it is championed by the ultra-rich likes of Warren Buffett. Sadly, it is still those that own the gold who make the rules. Wall Street continues to spend hundreds of millions per year lobbying for low tax rates. As the current carried interest loophole nears its closure, the private equity lobby is busy negotiating favorable terms.
Despite the rhetoric of “igniting class warfare” and “European-style socialism,” equal application of tax law to all types of income should be a unifying, rather than divisive, call for the American populace. There are countless suggestions for remedies, but citizens need to unite behind fundamental ideals such as equality of legal status of incomes to preserve our American identity.
The unofficial American motto, e pluribus unum, is engraved on the currency of U.S. taxpayers. When it comes time for the federal government to collect taxes, it ought to apply the principle of national unity and responsibility championed by that motto.
David Kaufman ’16 is a Classics concentrator.
Art by Rachel Haberstroh
An earlier version of this article misstated the general capital gains rate as 25 percent. The correct figure is 20 percent.