WASHINGTON — Democrats and Republicans are playing fast and loose with the facts and misleading the public as they trade barbs on legislation to create a minimum tax on the wealthiest Americans, tax experts insist.
The Senate's scheduled a procedural vote next week on a Democratic measure to effectively impose a floor equal to at least 30 percent of income for the wealthiest Americans. The measure isn't expected to pass, but the act of voting is important as a centerpiece of President Barack Obama's re-election effort to paint his presumptive opponent, Mitt Romney, and the Republicans as friends of the fat cats.
The measure is dubbed the "Buffett Rule." because billionaire Warren Buffett has lamented that some of his peers in high finance pay less taxes, in relative terms, than does his secretary. It's a comment similar to one made decades ago by Republican icon Ronald Reagan when he was president.
Democrats point to the fact that Romney, a former founding partner in the investment firm Bain Capital, had an effective tax rate of around 15 percent over the past two tax years. Democrats contend middle-income Americans, by comparison, pay as much as 30 percent of their income in taxes.
"It's stretching things to suggest that 30 percent is what's paid by middle-income taxpayers," said Roberton Williams, a senior researcher at the Tax Policy Center, a joint effort between the centrist Urban Institute and the center-left Brookings Institution.
In fact, 52 percent of all tax returns filed in 2009 were from Americans earning between $15,000 and $75,000. Today, those citizens would fall into the tax bracket of 25 percent, or 15 percent if they earned less than $34,500. Once deductions and credits are factored in, their taxable income is much lower. And for the past two years, they've also had reduced payroll taxes taken out of their paychecks.
According to the non-partisan Tax Foundation, those Americans reporting income between $15,000 and $75,000 in 2009 paid anywhere from 1 percent to 7 percent of their income in federal taxes. It would suggest that Romney paid more than twice the rate of what low- and middle-income Americans paid as their effective tax rate.
But if Democrats are exaggerating what Americans actually pay in taxes as a percentage of their income, Republicans are overstating what Romney and other rich Americans are paying as a percentage. That's because there's a lot left out of their equation in determining income.
Romney and other wealthy Americans generally live off of investment income — capital gains and dividends from investments in stocks, bonds and other financial instruments. During the Bush-era tax cuts, these fell to 15 percent for wealthy Americans — down from the 28 percent rate for capital gains ushered in decades earlier by President Ronald Reagan.
Aside from being taxed at a more generous rate than wage income, investment income can also be sheltered through tax-deferred individual retirement accounts, tax-exempt bonds and a host of other means by which the rich can delay or avoid taxation.
"A lot of capital gains are not taxed at all, postponed for quite a while, even indefinitely. If you hold them until you die, you don't pay at all," said Leonard Burman, a Syracuse University professor and one of the nation's leading tax thinkers.
In other words, what Romney and others claim as their effective tax rate is an understated and inaccurate — albeit legal — statement about their overall income.
Most disturbing to tax experts, however, is that the Buffett Rule — which would raise $47 billion over 10 years — seems just poor tax policy.
"This is not the way to deal with the tax problem, this isn't the way to raise revenue," said Williams.
The tax code already has a provision put in place in 1969, a parallel tax to income taxes that was supposed to ensure that the rich don't use loopholes to get out of paying their fair share. It's called the alternative minimum tax, and it was originally targeted on individuals making more than $200,000.
The AMT was never indexed to inflation, so it threatens to ensnare more than 75 million Americans, and every year Congress must provide a "patch" to prevent it from hitting millions of unsuspecting Americans. Lawmakers often project lofty revenue hauls in the future, assuming the AMT won't be patched, knowing of course it will because it would amount to a huge tax increase on the middle class.
Now, the Buffett Rule could effectively amount to a second AMT in the tax code.
"Tack on another tax bracket if you are worried that people with investment income don't pay enough. Don't do it through the back door by imposing a second alternative minimum tax," said Williams. "The right thing to do if you are really concerned about how the tax system is working is to reform the tax system — put a seventh tax bracket in place for very high incomes."
The proposed Buffett Rule changes also wouldn't simplify the tax code as advertised.
"What I think is most misleading is that this would be simpler. It will be more complicated," said Burman. "It's going to make it hard for some high-income people to plan. They don't know if they're in the 30 percent bracket or something else.
"This is just another patch on the income tax (system)," he said. "The better thing would be to actually reform the system and tax capital gains as if they were other income. The president has kind of hinted that's what he ultimately has in mind."
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