What's Wrong With the Buffett Rule?

Kevin Drum defends the Buffett Rule:

The whole piece is pretty ridiculous. Obama's point isn't that millionaires pay lower tax rates than truck drivers. It's that some millionaires pay lower tax rates than truck drivers -- and as a simple matter of fairness and equity they shouldn't. Take a look at the table below, extracted from the Tax Policy Center. It doesn't just show the tax rates of mere millionaires, it shows the tax rates of the top 400 super-duper millionaires. Back in 1992, only 33 of them paid less than 20% of their income in federal taxes. Today, 289 of them do. That's just not right.

On Fox News, they brush this off with a yawn. "It's because most of their income comes from capital gains," they repeat tirelessly, as if that was sufficient explanation all by itself. But why? Surely even trust fund babies ought to pay some kind of minimum tax rate no matter where their income comes from. Is a 20% tax floor on the income of the rich really so outrageous?

To which I'd offer two responses:

1.  You cannot build a tax code on the principle that no millionaire, ever, should ever have an effective tax rate lower than their secretary.  The tax code covers 300 million people.  Rules written to cover that many people, in a complex economy where there are lots of different ways to make money, and some uncertainty as to what constitutes income, will not produce the same result that we would get if the economy were the size of a kindergarten class, and we had an omnipotent teacher charged with making the income distribution perfectly fair.  (Though as you'll recall, even in kindergarten class, there was frequently a lot of indignation about teacher decisions).

Just to take one example, what about a millionaire who had a $750,000 capital loss last year, and $1 million in capital income this year.  Since you're allowed to offset past losses against future gains, even a millionaire with a 50% nominal effective tax rate on their capital gains would only pay $125,000 in taxes--50% of the difference between last year's loss, and this year's gain.  If he pays his secretary decently, he'll have a lower effective tax rate that she does.  

Likewise, unless you get rid of the tax-free status of muni bonds, Theresa Heinz-Kerry will continue to have the effective tax rate of a probationary janitor.

Now, you could change the tax rules about capital losses and municipal bonds.  But this would hurt a lot of people who aren't millionaires, and dramatically increases the potential cost of investments with lumpy cash flows, as well as state and local infrastructure projects*.  

The only way to actually ensure that no millionaire, anywhere, pays less than 20% on their annual income would be to essentially suspend the rule of law for wealthy people, and give the IRS power to seize income from rich people at will within some very broad guideline about fair shares.  This strikes me (she said, with dramatic understatement) as a very bad idea.

2.  Even if you dismiss the above as so much airy fairy theorizing in the face of REAL WORLD PROBLEMS, the fact is that as far as I can tell, the Obama Administration itself has not outlined anything of the sort.  At least in the White House document that I read, I saw no proposal to set some sort of AMT on millionaires.  Instead, it claims to do this, while rehashing a bunch of things that the administration has long proposed: allowing the Bush tax cuts to expire for those making more than $250,000; changing the treatment of carried interest income accrued from capital gains; and altering the treatment of deductions for very high earners. If all of these things were passed, guess who would still pay a lower effective tax rate than his secretary?  Hint:  his initials are WB, and he lives in Omaha, Nebraska.

If a "Buffett Rule" is such a great idea, how come the administration doesn't actually propose enacting one?

Presumably for some of the following reasons: it would add complexity to the tax code; it might not be possible to do in a way that would stand up even in our very IRS-friendly tax courts; it would have upsetting effects on the market for various forms of capital, particularly municipal bonds; it might well involve taking away deductions that less well-heeled voters currently enjoy, and they'd freak out.  Note that I do not include "Republican obstructionism" on this list, because the existing proposals won't pass the house; there's no reason not to include a real hard "Buffett Rule" if they think such a thing is even vaguely workable.  From the fact that they didn't, I infer that they thought the idea maybe had some problems.

So no, I don't think that it's unreasonable for Fox News to be dismissive.  The administration seems to have dismissed the idea as well.

* Even if you merely limited the interest-free status of the bonds, borrowing costs would go up, because rich people have bid up the cost of muni bonds so that they are right around the post-tax yield of an equivalently risky taxable bond taxed at the top rate; if you limit the deductibility to the second-highest rate, bond yields will adjust accordingly, making municipal borrowing more expensive.