Buffett Rule Can Be Traversed by Tax Planning, Just Like Any Part of Our Swiss Cheese Tax Code
I don’t have a huge problem with the Buffett rule, which will get a vote in the Senate and fail on Monday. But I do have a problem with the concept of a minimum tax based on adjusted gross income as a killer app in tax policy, rather than just raising rates and closing loopholes. To wit, high-income earners already have their tax avoidance strategies lined up:
The highest-earning U.S. households have ways to escape President Barack Obama’s Buffett rule with tax-planning techniques that would limit their liability and undermine the proposal’s purpose.
Those affected taxpayers — the fewer than 0.5 percent of Americans with annual incomes exceeding $1 million and tax rates of less than 30 percent — could take advantage of tax-free investments such as municipal bonds to escape the Buffett rule’s bite. They also could time asset sales for maximum tax benefits, engage in transactions that don’t result in taxable income and make charitable contributions that yield deductions […]
“Largely, the Buffett rule is going to be manageable,” said David Miller, a partner at Cadwalader, Wickersham & Taft LLP in New York. “That is, with tax planning, people will be able to avoid it.”
For some reason, charitable deductions are exempt from the Buffett rule, which means that wealthy individuals can get below the 30% tax rate simply by giving a chunk of money to the opera or a new art center or really anything that falls within the range of charity.
The rest of this is simply a feature of the tax code. Capital gains aren’t taxed until the assets are sold. If you want to make them liquid, you then get taxed on them. The Buffett rule makes this worse than just raising the tax rate for capital gains. To avoid the Buffett rule penalty, you just time your sale of the assets until a year when you have losses to wipe out the gains. If you just raised the capital gains tax rate, you could still time the sale. But you’d pay 35% on a positive sale, rather than 15% under the Buffett rule, with that extra percentage to get to the minimum which may or may not get realized.
You can also “earn” income in ways that never show up as adjusted gross income, like interest on tax-free municipal bonds, for example, or health insurance provided by an employer. But again, that’s a feature of the current tax code, and has little to do with the Buffett rule. You always want to reduce your adjusted gross income. You can also become a shadow banker by taking out loans against your assets without selling them first. But again, the answer to that is regulating shadow banking.
The ways around the Buffett rule are the ways around the US tax system as a general rule. You can’t just layer on a minimum tax based on the same rules and expect it to work. You have to fix the system. And that’s possible as a theoretical matter. You raise the rates. You regulate and enforce against tax havens and shadow banking. You use the enforcement powers of the IRS to stop cheating. You close loopholes that allow untaxed income to flourish. You add a tax on personal wealth.
But all of these ideas assume that politicians actually want to fix the tax code in a way that would force everyone to contribute a fair share.
Taking this a step further, there are plenty of things that you can do pre-tax to reduce income inequality and promote prosperity. Many of them are discussed in Dean Baker’s book The End of Loser Liberalism. But that would once again presume a desire to ameliorate inequality.