Economic Fairness Lessons of Warren Buffet’s Secretary (Or How to Avoid Tax Avoidance and Sit Next to Michelle)

Economic Fairness Lessons of Warren Buffet’s Secretary (Or How to Avoid Tax Avoidance and Sit Next to Michelle)

Who doesn’t love Tax Avoidance?
Not only is it legal, it is also a vaunted, creative, and much admired American pastime, dating back to Hamilton’s Whiskey Rebellion days. It also pays handsomely - some of its more exalted consultants earn upward of $1000/hours. And who wants to hand over cash to little Timmy Geithner, if it can be legally avoided? As Tom Brokaw says, this is heady stuff. 

Successful Tax Avoiders
General Electric famously paid pay zero in income taxes on domestic income of over $5 Billion.  Warren Buffett, Mitt Romney, and many other 1 per centers, routinely pay a niggardly 15%, subsisting on capital gains and carried interest rather than wage slaving for the Yanqui dollar. Related to this is Barack Obama’s astute money move, signing a very sweet book deal days before assuming office, avoiding the possibility of running afoul of the government. He was just playing fair with the American people (while also playing all the angles).

Keeping $ Overseas
Tax avoidance is practiced by most large US corporations, who employ convoluted internecine black magic schemes. Money is shuffled between the Cayman Islands, Ireland, and various European nations, while at the same time payment of US taxes is deferred until another day. The tally is that over a trillion dollars is being held overseas in this way by much loved American companies. Apple, Google, Microsoft, MacDonald’s, Nike, GE, Facebook and so on. Perfectly legal, and why not, and btw the tax laws permitting this were lobbied into law by the very same companies.

Tax Patriotism
However the exception does prove the rule. Buffett’s secretary, poor little rich girl Debbie Bosanke, earns between $200K and $500K in salary, owns 2 homes, and has become the poster child for economic unfairness via poor tax planning and avoiding tax avoidance. She famously paid the ultimate price: the max tax rate of 35%. But she did get to sit in the Presidential box, next to Michelle, so don’t cry for her, Argenmerica. Her behavior is not well understood, since Warren would surely have loaned her his accountant had she but asked. Perhaps she paid the top rate as an act of patriotism and benevolence, unlike her boss, who refuses to voluntarily contribute more cash to the US coffers, while complaining that we are taxed too little. Buffett’s Berkshire Hathaway company works the tax avoidance tool to the limit, even skirting criminal tax evasion, and still owes taxes of an estimated $1B dating back to 2002 (see http://tax-evasion.org/buffets-berkshire-hathaway-admits-to-owing-back-taxes-since-2002.html).

2009 Collected Tax Rate Vs. Income (Figure 1)
Figure 1 “2009 Collected Tax Rate Vs. Income” illustrate these inconvenient truths. The black line shows the percentage of income tax filers versus income, indicating for example that  ~5% of all tax filers earned more than $200K. These folks constitute about 3.92 million taxpayers out of a total of 140 million filers. About 160 million American did not file taxes, and of those who did file, about 47% got a free ride - zero income taxes owing. 

Lowballing the Maximum Tax Rate
The average tax rate paid by Americans versus income is shown as a red line in Figure 1. Certainly there is plenty of progressiveness evident in the tax rate, at least up until about $500K income, where the tax rate flattens out to about the 25% level and stays there out to $10M incomes and beyond. This is part of what outrages some, like the Occupy Wall-Streeter’s,  since 25% is a whole 10% lower than the maximum 35% rate which the high earners were supposed to pay. How are they getting away with such unfair and non-egalitarian tricks? tax avoidance, of course. For example, did you know that one may eliminate up to 100% of the Alternative Minimum Tax by using credits for foreign taxes paid? 

Buffet Rule Brings Forth a Mouse
Tax reform obviously is a prime tool for attacking economic unfairness and income inequality. For example, Obama proposes the “Buffett Rule”, raising the tax rate for people with incomes above $1M to 30%. The Buffet Rule is shown as a green line drawn in Figure 1. But if you do the math, what you find is that the total additional tax revenue projected to be collected due to the Buffet Rule is approximately $20B. The US government spends that in about 20 days. So a jaundiced class warrior observer might conclude that the highly touted Buffett Rule reduces the deficit negligibly. So why propose it? Hmmm….

Use Of Outlier Examples For Tax Policy
Figure 1 also shows where Warren Buffett, Mitt Romney, and Buffet’s secretary’s tax rate  show up, as compared to the rest of America. They are all gross outliers. The secretary, perhaps by patriotic choice, paid about almost double the rate of her average cohort, and Buffett and Romney, tax avoiders par excellence, on the other hand paid only 2/3 of the rate paid by their fat feline friends. Yet they are at the point of the spear of Obama’s tax proposals. Note that the use of gross outlier examples like the above for purposes of making demagogic tax proposals has a pretty rancid history. For example the Alternative Minimum Tax, which has inched its way up to now involving 40% of American taxpayers, started out as a hammer blow against 155 very wealthy people (less than 1/10,000^th  Percent)  who figured out how to legally avoided taxes altogether.  

Economic Fairness Trumps Tax Revenue for Tax Policy
George W’s 15% capital gains rate gets blamed a lot for both economic unfairness and income inequality. In a presidential debate with Hillary on April 16, 2008 Obama said: 

"I would look at raising the cap gain tax, for purposes of fairness…those who are able to … amass huge fortunes on cap gains are paying a lower tax rate than their secretaries. That’s not fair”.

It was pointed out by debate moderator Charles Gibson that historically tax revenue went up as capital gain rates went down. Obama’s reply: “…that might happen, or it might not, it depends on what’s happening on wall street…”  Well? Which is it? Let’s look at the IRS record, shown in Figure 2: “Capital Gain Tax Collections, 1980-2009”.

Capital Gain Tax Collections, 1980-2009 (Figure 2)

Clearly Charles Gibson was right, and with a vengeance. In the period 1996 to 2002 capital gains tax fell from 26% to 20% (see blue line in Figure 2) while tax revenue from capital gains taxes more than doubled (see red line in Figure 2). Similarly, in the period 2003 to 2008 capital gains tax rate fell to the George W 15% low and tax revenue from capital gains doubled. Point made?

But you know what they say about statistics: sometimes it works and sometimes it doesn’t. The great sociologist Emile Durkheim, for example, pointed out that there was a correlation between an increase in the number of storks in northern Europe and an increase in birthrate… So go know. Figure 2 does not lie, and supports Mr. Gibson’s statement. So you can believe your lying eyes, or you can believe Obama’s equivocating and discounting statement: “... that might happen, or it might not…”

Scheduled Tax Rates (%) Vs. Collected Tax Rates  1948-2011 (Figure 3)
The potency of taxation, be it the income tax, excise tax, estate tax, sin tax, or the biggest tax of all, the Federal Reserve, is indisputable. Everyone from Ron Paul to Paul Krugman believes that if only his tax ideas were implemented, the nation would see God. So it is instructive to observe how Americans of all ilks have responded to taxation over the years.

Figure 3 is entitled:  “Scheduled Tax Rates (%) Vs. Collected Tax Rates  1948-2011”.  This is a large enough span of time to perhaps wash out the effects of any specific large tax event (for example the Reagan tax cuts of 1986), and allow some more general observations to be made about the behavior of Americans, at least in their response to federal taxation.

Is There A Universal Comfort Level Top Tax Rate?

Figure 3 shows that the scheduled tax rates versus income (stepped lines for multiple years, upper left hand of Figure), and in particular the top tax rates, have been all over the place, reflecting the changing whims of tax policy mavens. The top rate was 90% in 1948, 28% in 1988, and currently is 35%. Note, however, that at the same time as the scheduled top tax rates jumped around by as much as 62% points, top to bottom, that the top tax rate actually paid by the high earners on average never exceeded about 27%, and never fell below about 20%, as shown in the multiple horizontal lines at the bottom and right of the Figure. Regardless of the rate that the IRS tax table called for versus income, the rata actually paid (on average) was always significantly less, over a period of many years.

 The inference from this seems to be that no matter how much Americans are asked to pay as a tax rate, they somehow manage to never pay more than  ~ 27%. Perhaps the reason for this is a failure of enforcement, but a more likely explanation is that Americans are skilled tax avoiders, and know how to keep avoiding until they reach the apparent comfort level of 27%.

Conclusion

This bodes ill for the grand plans of reducing the deficit via increased taxation, as there seems to be a kind of natural universal upper limit to the tax rate that can be collected from Americans, judging from the data over more than half a century. This also supports the claim that what we have here is not a failure to communicate, nor a tax revenue problem, but a spending problem.  (See Figure 4, “Federal Budget Deficit as Share of GDP, 1946-2012”).