Buffett's Fastball on the Buffett Tax

Warren Buffett pays himself just $100,000 a year in salary. His 17.4% tax bill is due to the low capital gains tax rate on his stake in Berkshire Hathaway, a stake valued at an estimated $38 billion. Buffett only pays taxes on that stake if he sells his shares. Since he sits on them, his tax bill is low.

So, instead of the billionaire calling for taxpayers to pay higher taxes for President Barack Obamas reckless, wasteful $4 trillion in spending that didnt move the needle on unemployment, why doesnt Buffett instead only back the hike in the tax rate that hedge fund and private equity fund managers pay?

Why force job creators, small businesses, and those who work hard for a living pony up more to cover the White Houses foolish stimulus bets with your tax dollars? When IRS data clearly show small businesses are overtaxed and overwhelmed by insensitive federal policies, and who are not in the Buffett mega-billionaire investor class?

Why doesnt the mega-billionaire simply say: I back the section in the presidents new plan which would raise the tax rate on carried interest, or a share of the profits, to the regular income tax rate instead of the lower 20% capital gains rate that I and other investment managers now pay?" That carried interest is not subject to payroll taxes, either, keeping Buffett's tax bill low.

But if he cares so much that he is not paying enough, why doesn't Buffett just outright pay, say, 70% of his income to the government directly (the top rate in 1980), instead of roping everyone else into paying higher taxes to satisfy his conscience about fairness, which oddly doesn't address the government's blatant waste of tax dollars?

Wouldnt this idea be better in keeping with the spirit of Buffetts compensation style anyway -- that you get rewarded based on profits earned from making smart, risky bets, and you dont get paid if you lose money by taking too much risk -- which is how the government has been treating your tax dollars?

Back in 1956, when Buffett launched his investing partnership, the structure he chose for his new business venture meant he would have to shoulder investor losses first before he himself got paid. Partnerships distribute a share of their profits to partners every year, whats called carried interest, as compensation.

Back then, Buffett also opted to only take those losses, and not his share of any profits, until his investors earned more than the government bond rate, which is a so-called risk free rate. That was in keeping with his standard of fiduciary duty and stewardship of his investors money. Buffett gets rewarded for risk, as did his investor owners, as he regarded them, and he lost money if he made foolish bets. Unlike politicians, who get re-elected despite wasting your money.

And now President Barack Obama wants to pay for his new $447 billion jobs act with more tax hikes. The president just introduced a new plan to reduce the federal deficit by about $3.6 trillion over a decade, about half of which would come from tax increases. And that includes the president's new "Buffett rule," which has three elements: Repeal the Bush tax cuts for the $250,000-plus crowd, cap tax deductions at 28% for this group, and tax carried interest. The president cites Buffett's argument that his effective federal rate is just 17.4% in wanting to tax the so-called rich--among whom are the jobs engine of the economy, small businesses.

The President's new tax on the rich is a sort of new alternative minimum tax for the upper brackets. Just as the first AMT, enacted in 1969, is not indexed to inflation, it's likely that this new tax would not be either. For that reason, the old AMT is increasingly hitting the middle class. Inflation is key here--all of the Federal Reserve's money printing creates inflation. Because the AMT bracket is not indexed, the money printing hurts taxpayers--a flip side that shows how recklessly hurtful loose monetary policy really is.

Buffett is being misleading when he uses his low 17.4% tax rate as proof that the rich dont pay their fair share. Because Buffett essentially favors raising everyone elses taxes that he doesnt pay. Separate from his $100,000, salary, he plans to donate his wealth to the Bill and Melinda Gates Foundation, which would lower his federal and estate tax bill.

Ask yourself, if Buffett truly cares so much that he thinks the government doesn't get enough money out of rich people, why doesn't he forego donating to charity and instead donate all those funds to the government?

Meanwhile, he often uses taxable income in discussing why its all right to hit the higher brackets with higher taxes. But he never uses the term adjusted gross income, which is misleading too, because that lower figure comes after he chops that figure down with his donations to charity.

And the Buffett tax would hurt small businesses, which generated 65% of net new jobs over the past 17 years, and which create annually more than half of nonfarm private GDP. Small businesses also employ nearly 80 million workers or approximately half of all private sector employees.

Small businesses typically file taxes on the income tax level, as a sole proprietorship or S corporation, which is essentially filing as an individual. At least 75% of small businesses file taxes on business income at individual rates, says the National Federation of Independent Business. Two thirds, or 65%, of joint filers with income above $250,000 and 50% of single filers above $200,000 earn business income.

In other words, about half of those subject to the Obama tax increases are small businesses with employees. This tax increase would directly cut job creation. Already, annual federal regulations cost the countrys small business $1.1 trillion annually, says the SBA.

Instead, Buffett should be saying: I want more millionaires, I want more billionaires, I want a lower flatter tax rate so everyone pays their fair share, and the president should too. Because the upper brackets are paying most of the federal taxes in this country, and when you hit them with higher rates, you hit small business job creators. Plus the mega rich routinely lower their tax bill by hiring a posse of tax lawyers and accountants to shelter their income in offshore accounts. So do corporations. A flat tax would make companies pay more because it would shut the loopholes.

For example, General Electric (NYSE:GE) paid nothing in taxes last year due to write-offs associated with losses from its financial services arm; GE is a master at lowering its taxbill. Google (NASDAQ:GOOG) paid an effective rate of 2.4%, far below the 35% statutory corporate rate for publicly traded. Goldman Sachs (NYSE:GS) paid $14 million last year on its billions of dollars in revenues.

Heres what IRS data show -- ask yourself how the White House and Buffett define fair share. You'll see the U.S. tax code is already pretty progressive, and why the OECD, the European economic development group, calls the U.S. tax code one of the most progressive in the world.

The really high earners, taxpayers with annual incomes at $10 million or more--call them the top 0.1% of all federal income tax returns--accounted for 4% of all taxable income in the country, had an average federal income tax rate of 26%, and paid 6% of all personal federal income taxes, according to IRS data as of 2009.

The top 2% of taxpayers who make $1 million or more were responsible for a big 20.5% share of federal income tax receipts in 2009, even though they accounted for just 13% of all taxable income in the U.S.. The average income-tax rate of those earning between $1 million and $10 million was 24.6% in 2009.

Taxpayers with adjusted gross income at $500,000 or more a year accounted for 0.5% of all federal income tax returns, earned 19% of  total U.S. taxable income, but paid 29.8% of all federal personal income taxes. They had an average federal income tax rate of 24.5%.

Taxpayers with adjusted gross income at $200,000 or more a year accounted for just 2.8% of all federal income tax returns, but paid 50.2% of all federal personal income taxes even though they earned a third of all taxable income in the U.S. They had an average federal income tax rate of 22.2%.

Meanwhile, according to the Congressional Budget Office [CBO], middle-class families in 2007, those earning between $34,000 and $50,000, paid an effective 14.3% of their income in all federal taxes. And nearly half of all taxpayers do not pay federal taxes, although they pay state, local and payroll taxes, depending on their bracket. This means the top 3% paid more than the bottom 97%.

And while Buffett says the rich need to do more to pay their fair share, they actually paid a third more in federal income taxes in 2008 than they did in 2001, IRS data show.

Even before the recession, the $200,000 income group paid 54.5% of the income tax. In 2007, 390,000 tax filers reported adjusted gross income of $1 million or more. They paid $309 billion in taxes. As the recession hit hard, in 2009, there were only 237,000 such filers. Thats a drop of 39%. That means about four of 10 millionaires disappeared in two years, and the total taxes they paid in 2009 declined to $178 billion, a drop of 42%, reports The Wall Street Journal. The number of those with $10 million or more in reported income dropped to 8,274 from 18,394 in 2007, a 55% decline, says the paper. As a result, their tax payments tanked by 51%. These disappearing millionaires go a long way toward explaining why federal tax revenues have sunk to 15% of GDP in recent years, says the WSJ.

And the taxes paid by the richest 400 in 1994 were almost identical to the amount they paid in 1992, despite the intervening Clinton tax hike, says the WSJ. But by 2000, just 123 of these 400 paid 25% or more in taxes, down from 30% before Clinton's tax hikes went into effect, IRS data show, which means they sheltered their income.

In contrast, capital gains taxes paid by these super rich rose dramatically each time the government cut the capital gains rate, as they were more willing to realize gains at the lower rates, says the WSJ. At higher cap gains rates, taxpayers sit on their assets, afraid of paying. It says realized capital gains climbed 28% after the rate cut in 1997, and 21% after the 2003 cut, based on IRS data.

Besides, doubling the tax rate on Mr. Buffetts fellow billionaires, the countrys 400 wealthiest households, would only raise enough money to run the federal government for only two days, says the WSJ.

Dont forget this either. Earlier this year, Treasury Secretary Timothy Geithner told the House Small Business Committee  that the Obama administration believes taxes on small business must rise in order that the administration does not have to shrink the overall size of government programs. Geithner initially responded by saying that the administrations planned tax increase would hit three percent of your small businesses.

A Congressmen though retorted: Sixty-four percent of jobs that are created in this country are for small business.

After Mr. Geithner agreed to that point, he testified that the administrations planned tax increase on small businesses would be good for growth.

Specifically, he said he felt the Administration had no alternative but to raise taxes on small businesses because otherwise you have to shrink the overall size of government programsincluding federal education spending.

Remember this too: President Obama has always got what he wanted. Under his direction, Congress passed $830 billion in stimulus, $3 billion for cash for clunkers, $30 billion in small business loans, $30 billion for mortgage modification, the GM-Chrysler bailouts, health reform, Dodd-Frank, credit card price controls, Build America Bonds, and jobless benefits for a record 99 weeks.

And now the president wants another $447 billion for a newfangled Jobs Act that contains rehashed, warmed over ideas.