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The Buffett Rule and Tax Fairness

The so-called Buffett Rule will come up for a vote in the Senate today and will almost certainly fail. And that’s a good thing because the Buffett Rule is not tax policy, it is demagogy.

President Obama is exploiting the fact that the corporate and personal income taxes have never been properly integrated into a single, coherent tax system, which is a failure of government. Instead, there has been an endless series of ad hoc, jerry-built fixes during the last century to either prevent the exploitation of the two tax systems by taxpayers (such as individuals incorporating themselves to pay lower corporate rates) or to obviate what would be double taxation and thus—pardon the expression—unfair. Often, the fixes caused new opportunities for exploitation or created new unfairness (not to mention new opportunities for demagogy). This generated new fixes, and so on and on ad infinitum. The result is a tax code that is a national disgrace.

So instead of the Buffett Rule, how about a couple of fixes that would eliminate much of the illusory unfairness that the president wants to exploit for his own selfish purposes (i.e. re-election).

1) Dividends are taxed at 15 percent because they are paid out of corporate profits that have already been taxed at the corporate level, at 35 percent. Interest on corporate bonds, however, is a business expense and thus deductible. That’s why interest income at the personal level is taxed at the normal rate. So why not treat interest and dividends alike? Allow corporations to deduct them both as business expenses and tax both of them fully at the personal level. This would not only eliminate the illusory unfairness at a stroke, but it would have the considerable additional virtue of eliminating the bias towards raising capital through borrowing rather than equity. It would also tax dividend income at the same progressive rates that are laid on wages and salaries, rather than at a flat rate. Liberals should love that idea.

2) Capital gains also come out of after-tax profits, although indirectly. (The profits not taxed away or paid as dividends increase the book value of the corporation —the value of its liquidated assets minus liabilities—and thus raise the floor price of the stock regardless of market conditions, as a stock seldom sells for below its book value.) This, along with the fact that the money is at risk while invested (which wages and salaries are not) and that capital gains are not adjusted for inflation, is why they, too, are taxed at 15 percent, not the full personal rate.

If capital gains were adjusted for inflation, at least some of the unfairness inherent at taxing them at higher rates would be eliminated. Consider an example. If you inherited $100,000 worth of stock in 1962 and sold it today for $760,000, your capital gains tax on that stock would be $99,000. But your real, inflation-adjusted gain would be zero. The $99,000 would, in fact, not be an income tax on a capital gain but an excise tax, measured in inflation, on the privilege of living in a country whose government has failed to maintain the value of the currency. Talk about unfair!

If President Obama cared about tax fairness, he would seek to actually make the tax code more fair. Instead, he is seeking to be re-elected–nothing more, nothing less.

 



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