04.16.2012 0

Understanding why some people pay lower tax rates

Warren BuffettBy Rick Manning — The so-called “Buffett Rule” would automatically subject anyone who has taxable income above one million dollars to a 30 percent tax rate regardless of how that money was earned. But, it is based upon the hope that Americans fundamentally misunderstand the way different types of income are taxed and the reasons behind these differences.

The first question to ask is: Do those who make over a million dollars a year pay a lower income tax than those who make under that amount?

The answer is some do, and some don’t.  It depends upon how they make their money.

If a single wage earner has taxable income equaling more than a million dollars in straight wages in 2011, then that person will pay $327,313 in federal taxes, or 32.7 percent of their income in taxes.

Yet, if the same person earns all of their money in capital gains from investments that (s)he owned for more than a year, the money is taxed at the lower rate of 15 percent, and the investor would owe $150,000.

And that is where the entire confusion over the ill-named “Buffett Rule” comes about.  Most workers get a vast majority, or all of their income from wages so they are taxed at a sliding scale rate depending upon the taxable income.

Whereas, it is not uncommon for people who make in excess of one million dollars annually in income to have much of that money as a result of selling property or assets that they have owned for more than a year and their income is derived from the profit they made from the asset.  These transactions are called long-term capital gains.

What is the difference between the two scenarios?

The person earning money through wages has not put any of his or her personal wealth at risk in order to gain a return, the straight wage earner is trading his/her time in exchange for money.

The person earning wealth through investing is risking his or her wealth in pursuit of a return.  Because there is risk involved and the investor could end up losing their initial investment, Congress has chosen to not tax gains resulting from this risk at as high of a rate as ordinary wage income.

And they have made this decision for good reason.

They have chosen to provide a lower tax rate for capital gains to encourage people to put their resources at risk in order to provide the financing to fund the launching and expansion of businesses.

It is this investment that allows those businesses to hire others who then make straight wages, which is why the term “job creators” is so often associated with people who make more than a million dollars.

And it is this investment that the “Buffett Rule” fundamentally attacks by significantly lowering the rate of return on those very economic activities that drive our national prosperity.

The ultimate irony in this debate is that the Obama Administration continually bemoans that there is not enough venture capital being risked on innovative alternative energy technologies and that is why the government is forced to put taxpayer dollars at risk.  And at the same time, they are attempting to dry up the availability of private capital for the riskiest of ventures by lowering the potential return from success by significantly increasing taxes on that success.

At the end of the day, it is in every American’s economic interest to encourage private sector capital investment, and Obama’s politically motivated attempt to significantly increase taxes on this exact investment is foolish.

Perhaps President John F. Kennedy explained it best when he said, “The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital… the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential for growth in the economy.”

And that is why the so-called “Buffett Rule” should be rejected by Congress, because ultimately it will be far more taxing for our overall economy than it will be even on those who make more than a million dollars in taxable income a year.

If Congress is truly concerned about “fairness,” they should lower the marginal tax rates to make them more in line with the capital gains tax. However, I doubt that thought ever occurred to Mr. Obama.

Rick Manning is the Director of Communications for Americans for Limited Government.

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