All men’s wealth will be equal
It’s hot in Washington DC and Congress will return soon to figure out how to balance the federal budget. Part of the equation is likely to include raising more tax revenue. It’s easy to picture the thousands of lobbyists on K Street polishing their Gucci loafers and sharpening up their arguments to protect the interests they are hired to lobby for. There is no more epic battle in Washington than when tax benefits are being redrawn. The federal pie is getting smaller, and the battles will be fought in close combat.
As the struggle around taxation heats up you hear two recurring arguments. First is the idea that if you raise taxes on the upper-income earners you would kill the incentive to invest in job creation. And because job creation is the most essential need of our economy, raising taxes on the wealthy would kill the golden goose. Saying that raising taxes hurts the “job creators” is generally a Republican talking point. The other common argument is one of fairness. This is a liberal talking point, although it should be one embraced by all elected officials representing “the people.”
In his well-circulated New York Times op-ed, Warren Buffett talked about the unfairness of the low tax rate for those who earn income from their wealth as opposed to those who earn their income from their wages:
If you make money with money, as some of my super-rich friends do, your [tax] percentage may be a bit lower than mine. But if you earn money from a job, your percentage will surely exceed mine — most likely by a lot.
New York Times columnist James Stewart dove deeper into the issue and began to address the legal difference that allows differential taxation:
The root of the problem highlighted by Mr. Buffett is the disparity between tax rates on capital gains and ordinary income. Were these rates the same, the debate over how to treat carried interest would vanish, along with much of the disparity between tax rates for the rich and people like Mr. Buffett’s secretary.
Both Buffett and Stewart are right in their thinking, but I want to suggest that much of this is a semantic mirage that has grown up over time. It’s really an issue of taxation on the capital of the rich versus the capital of the middle class, and it’s a prime example of how the privileged classes have twisted our tax code to benefit themselves in unfair ways.
Wealthy individuals have access to investment vehicles like hedge funds and private equity funds. Both of these investment structures are manipulated by the managing partners to reap significant tax savings for their investors. In the case of private equity funds, their distributions are taxed as long-term capital gains at a 15% rate.
When a middle-class man works throughout his career and saves his capital either through a private pension plan or through a personal retirement account, his retirement savings, or “capital,” is taxed as personal income at the time of distribution. For example, the personal income rate is 25% for a single person earning between $34,501 – $83,600 and after various deductions would pay that for distributions from capital. The income tax on middle-class capital is much higher than the 15% tax rate on rich man’s long-term capital gains.
Here is a table of the various investment structures for middle class and rich people. You can see the difference in taxation.
|Asset class||Assets||Tax treatment|
|Private pension funds||$ 6.4 T||Taxed as federal and state personal income|
|Personal retirement accounts||$ 7.1 T||Taxed as federal and state personal income|
|US hedge funds||$ 1.9 T||Taxed as partnerships|
|US private equity funds||$ 2.4 T||Taxed as long-term capital gain (15%)|
The capital of both the rich and middle class are part of a vast savings pool which is the fuel that funds new companies and expands existing companies. Although the whole pool of capital drives growth, the semantics have deemed earnings from rich people’s capital investment to be “profits or capital gains” and middle class capital held in retirement accounts is considered “deferred wages.” Because of the designation of middle class capital as “deferred wages” it is taxed as income.
Why think of personal retirement accounts as capital? Roughly 75% of 401(k) plans have a loan provision so funds can be borrowed and many even allow borrowing for the purchase of a primary residence. Withdrawals, with a penalty, also happen in personal retirement accounts. It’s often the only “capital” a family has. Although it it may be a small sum, it shouldn’t be taxed at a higher rate than a rich person’s capital.
This is what is unfair and what leads to Warren Buffett paying a 17% rate of income tax versus those in his office who make much less but pay income taxes at rates between 33% to 41%.
I don’t imagine this will change. No Gucci-loafered lobbyists are waiting to take Capitol Hill and fight for equal taxation for the capital of the middle class and rich. This is one of the issues deep in the weeds of the tax code that favors the rich and leads to their low effective tax rates. Keep singing, Mr. Buffett. One day your lament may become a hymn to fairness, and all men’s wealth will be treated equally.