All men’s wealth will be equal

By Cate Long
August 22, 2011

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.

16 comments

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You’re talking about an infinitesimally small number of people that are able to build a business from nothing to generating very large amounts of income in one lifetime. In some ways it could be fair to consider this labor income, but how you make this decision would be fraught with difficulty. That’s why their is an estate tax, which Buffet will not so cleverly avoid paying (all in the name of tax minimization of course).

For the vast majority of people, the lower capital gains tax rate exists because they are buying stock with after-tax money. In your IRA, you pay no tax on the money when it goes in and it gets to grow tax-deferred. The vast majority of people will take relatively small distributions from their IRA in retirement and will likely pay Federal rates far below 25%.

I’m not going to do the math for you, but the benefit of tax deferral far outweighs many percentage points of additional tax — for younger people the benefit border on the obscene.

Posted by jeremycjohnson | Report as abusive

“Resistance to tyranny is obedience to God”-Thomas Jefferson
Cracking the Code-by Peter Eric Hendrickson put me on the path; not without some great effort, to get ALL of my Social Security plus past Federal & State ‘income’ tax returned.

The average Joe in America has no idea that they are not liable for so-called ‘income tax’
The Federal & State governments operate on fear-once you know the law, you are then FREE & in the drivers seat.

At age 70 I am free of the IRS as well as freeing all of my adult children.
WE were not pu ton this earth to pay tribute to Caesar or any government-tax my consumption, but the fruit of my labor is 100% MINE!!!!!

Posted by Rebel1 | Report as abusive

Rebel1, feel free to elaborate… I’m skeptical but interested.

Posted by Nullcorp | Report as abusive

The real problem is that many corporations are now investing freely in the capital and commodity markets and paying half the effective tax rates on the paper profits earned so they are investing less in their own domestic business assets. Small business owners must pay at least twice the effective tax rates as these larger corporations which then dominate the marketplace. The tax code is absolutely upside down if we want to see real growth in our economy. This is we have only seen jobless growth for a decade now. Allowing publicly owned corporations to earn much of their profits gambling on the price of stocks and commodities is absolutely unsustainable. Many savvy investors are beginning to realize that profits earned on Wall Street are not as beneficial to our economy as profits earned producing tangible products/services in our domestic economy. Taxing paper profits at lower rates than real profits has led us into the economic disaster we have been experiencing for several years now.

Posted by RMForbes | Report as abusive

rebel is a nutjob…..you dont pay taxes you go to jail

Posted by JayWilcos | Report as abusive

the long term capital gains rate for everyone is 15%

my gosh if it goes much higher i will do something

more safe with my money as will most others

and watch the system fall apart as rates will rise

and people do nothing but pull cash from the markets

you can only write of a 2500 dollar loss and if you invest you have winners and losers if the rate goes very high bye bye investing bye bye innovation bye bye america

http://en.wikipedia.org/wiki/Capital_gai ns_tax_in_the_United_States

Posted by newbolivia | Report as abusive

once you know the law, you are then FREE ?

Posted by rudraksha | Report as abusive

The article mentions “fairness” as a concern of the democrats? How is it fair that one group of people are forced to pay all the income taxes while 40 – 50 % of americans pay no income tax? If you are going to have an income tax at all then FAIR is for everyone to pay the same rate, no loopholes, deductions or exceptions. Our constitution says that we are all to be treated equally under the law. This social justice nonsense is just a way for the politicians to divide us and waste money so they can get re-elected. If everyone had to pay the same rate then everyone would be against excess spending. Politicians would not get away with bridges to nowhere because no voters would want this kind of stuff done.

Posted by zotdoc | Report as abusive

In 2008 the bottom 50% of earners paid approximately 3% of all taxes collected.

The Top 1% paid approximately 28% of all taxes collected.

If we follow the same rules of “fairness” then I, being 59, should bowl on a shorter lane than someone who is 20. If I play basketball against someone who is 7 feet tall, my basket should be lowered about 15% lower than his, and my half of the court should be about 25% as long as his. And, the younger guy should have to carry an additional 150 pounds on his back to make up for the difference in weight, physical fitness, and age.

And, since everyone likes to point out how much quicker and clearer thinking the young are, I should get 3 votes to his one, because I stand a greater chance of “getting it wrong…”

After all, isn’t it time we made all areas of our soceity “Fair” since we’ve already thrown out that nasty bit about “equal before the law” in relation to our tax code.

Or is it really that like the Pigs in “Animal Farm”, the left believes that “All animals are equal, some are just more equal than others?”

And for the record, I’m not rich. Hell, I’m just barely middle class. However, I would just like be rich some day…

Posted by bobw111 | Report as abusive

Your article, and some of the comments, leave out half of Mr. Buffett’s argument. Employees and entrepreneurs also pay Employment Taxes – investors do not. Those taxes now provide more revenue for our government than personal income taxes, and are a bigger load on the budgets of half of our families than income taxes.

It’s also misleading to look at the tax rates without looking at the $$$ actually paid – many high rates are offset by loopholes and special tax treatments for designated individuals.

Posted by SpudM | Report as abusive

For wage earners, being defrauded of retirement income due to Federal default on retirement benefits already sold (“entitlement cuts”) makes the funds set aside in retirement accounts eligible for tax free withdrawals of both principal and interest rather than being overly taxed. The defaulted Social Security and Medicare benefits, by the way, were already double taxed at the highest “wage” rate. Then they are not going to be paid.

How about getting the FDA to rate pet food for human consumption as an alternative to the originally intended animal consumption? How about providing Air Force transports as free charter ambulances taking ill American elderly to Mexico for reasonably priced medical treatment since they don’t want to provide medicare for anything except colds? They need to find some sort of fig leaf.

The rich in America do not grow jobs. They export them with Federal tax incentives to do so and grow richer on the backs of America’s working and middle classes. We would be better off without them here, or permitted to hire lobbyists, at all. Kick them all out and be quick about it. They will NEVER pay their fair share or stop preying on the People.

Posted by txgadfly | Report as abusive

Would-be rich people: Get over yourselves. You’re obviously not millionaires and almost certainly never will be. If the US wants to encourage innovation, entrepreneurship, and economic equality then it must give back to people in the middle and lower classes – people like you and me.

Some things to keep in mind:
1. Everyone owes some of their wealth to government. Government provides public goods and social institutions which make wealth creation possible.
2. It’s easier to make money once you have money.
3. There is a social interest in some degree of economic equality and therefore redistribution. Or would you rather live in a society completely controlled by a stratified elite? If so, move to Russia.

Posted by RealityCheck1 | Report as abusive

correct me if I am wrong, but even when u get 15% tax on capital gain, then it will add up if ur ordinary income combined is more than $34K… so there is no escape.

Posted by robb1 | Report as abusive

I have yet to find a person that believes that rich people should get better police protection, should be allowed at the front of the line when going into a public building, should be allowed to ignore laws they don’t like, to basically be treated as if defacto royalty. Equally difficult to find people that believe that the poor should be taxed more and the rich taxed less.

Yet if we want a truly equitable society where ALL men are treated equal, where the weight of ones wallet never sways justice or service by the state… well we have to look at reality first. And when you do look at reality, the rich that are paying more taxes than the poor should be treated better, they should be coddled, they should receive preferred services – because in the end the government has an interest in keeping them happy and paying taxes much more than they do the poor guy that pays little or no taxes.

Imagine a small town with one rich family that paid more than 30% of the taxes in that town compared to the remaining families that paid far less… if that family decides to pack up and move away, whether because they felt the police didn’t respond quickly enough or didn’t like getting a speeding ticket, well the town would suffer enormously by having a huge dent in the little town’s budget. That same theory applies to everyone in the country simply on a larger scale…

The only answer is to tax everyone, rich or poor the exact same amount. Who know what that amount would be, maybe $5,000 a person maybe more, but whatever the amount if you move to that system then everyone is equal in the eyes of the government. There is no need to coddle one rich family at the expense of the poor man down the street because they all pay the same amount. There is no incentive for a congressman to push for more spending that will only be taken from the backs of a few because it will be taken from everyone equally, the next battle ship isn’t going to be a mystical 50 billion dollar ship, it is going to be one that every man/woman/child will be paying $142 dollars for. Now if the congress wants to hit everyone up for that amount let them, but they will remember that come election time every voter will remember how much the congressman cost them.

But please stop trying to push the caste system taxation where some people pay more than others. If we want a society were all men are equal, then all men need to be taxed the same amount… not same percent but the same exact dollar amount. Anyone that can’t cough of the cash can feel free to migrate to a socialist country like Canada.

Posted by Yirmin | Report as abusive

Good article. Unfortunately, it appears that a significant percentage of your readers — at least of the ones who comment — have insufficient education to participate in a reasoned discussion. They are merely repeating points they have heard or read.

Posted by Ralphooo | Report as abusive

“Taxes” means considerably more than “Income Tax” which just barely brings in more than the other “tax on income” — FICA low wage earner taxes. 45% of revenue comes from individual “Income Tax” while 36% comes from FICA or tax on low wage income. Wage earners who pay Income Tax (and most do) pay Income Tax and then pay FICA taxes out of the “after tax” (cute phrase, no?) remainder. So that the FICA tax also is responsible for the slice of Income Tax on FICA tax totals. Income Tax on 36% of Federal revenues. At a 15% Income Tax rate that would make the Federal take from FICA almost the same size as from Income Tax excluding FICA double taxation. No, the rich do not pay “most of the taxes”. They just make most of the money.

No, the rich do not pay most of the taxes. They just pay all the bribes directly to politicians. They don’t die in combat either. They don’t keep the highways repaired. They aren’t in the Police or Fire Departments, or the Water department either. They do own a large number of factories in other countries which used to be here. And they want a “strong dollar” so that their investments overseas will continue to be profitable. And so that even more jobs here will be lost.

No, they do not deserve special treatment. And yes, I would call someone who makes $950,000. “rich”. Sorry! How about getting rid of FICA altogether and getting rid of regressive taxation?

Posted by txgadfly | Report as abusive